Divi’s Lab, one of the leading players in pharma contract research and manufacturing services (Crams) segment with its low-cost advantage and strong association with global innovators, would benefit from improved pharma outsourcing environment.

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Business: Divi’s Laboratories Limited, engages in manufacturing of active pharma ingredients (APIs) and intermediates for the pharma industry in India and abroad. The company, established in 1990, undertakes custom chemical synthesis (CCS) of API’s and advanced intermediates for discovery compounds for global pharma giants. It also makes building blocks for peptides and nucleotides apart from manufacturing  carotenoids, and chiral ligands.

Generic API segment: The company derives close to 45% revenues from its generic segment wherein it develops alternate and non-fringing processes for APIs for leading generic pharma companies.   

CCS segment: The company generates close to 49% revenues from this segment wherein it has emerged as the largest player in India on back of its strong chemistry research skills, IPR- protecting corporate philosophy and substantial cost advantage. Nutraceuticals segment: This segment set up in recent years, develops and undertakes multi-step total synthesis of important carotenoids.

The Hyderabad-based company has three manufacturing facilities — one at Hyderabad and two in Visakhapatnam. Divi’s is further setting up new facility “DSN SEZ Unit” at Visakhapatnam, commissioning of which is over and trial manufacturing is underway. The unit is expected to start contributing to revenues by second quarter of next fiscal. The company also has two overseas subsidiaries (in the US and Switzerland) for marketing its nutraceuticals products.

The company derives almost 92% of its revenues from exports to North America, Europe, Far East and Asia.

Investment rationale: The company has attained leadership position in few products in generic API segment that offer stable revenue stream. The order inflows from outsourcing in custom synthesis by global innovators on back of inventory de-stocking bode well for the company. The growing demand for carotenoids over next few years would also benefit nutraceuticals segment.

The company’s additional capacities coming into stream by next year would aid the volumes. The company has a strong balance sheet with very low debt which would take care of capital expenditures and probable expansion in other segments in future.

Concerns: The company faces typical industry-specific risks related to dependence on orders from global pharma majors who may witness slowdown in drug discovery. Also, as it derives more than 90% revenues in form of exports, the company faces exchange rate fluctuation risks.

Valuations: Driven by new product launches in API segment, increasing contracts in CS segment and ramp up in nutraceuticals segment, the company’s revenues are expected to grow at a compound annual growth rate (CAGR) of 22% over FY11-FY13E. The company’s margins are likely to come down a bit due to higher tax slab and additional expenses from new capacities, hence net profits are expected to grow at CAGR of 18% over the same period. At current market price of Rs724.75, the stock trades at price to earnings multiple of 19.72 and 16.16 for fiscal years 2012 and 2013, respectively. Investors with medium to long term view can consider the stock on declines.

Disclaimer: The writer does not hold any shares in the company