Not Just Bulk Drugs, This Segment Too Is Doing Well For Divi’s Laboratories
A capsule is arranged for a photograph (Photographer: Kiyoshi Ota/Bloomberg)

Not Just Bulk Drugs, This Segment Too Is Doing Well For Divi’s Laboratories

Indian pharmaceutical companies saw their businesses grow in the pandemic-marred first quarter, mostly aided by bulk drugs amid global supply chain disruptions and trade pushback against China. But there’s another segment that has been working in favour of Divi’s Laboratories Ltd.: custom synthesis.

Founded 29 years ago by Murali Divi, the company’s product portfolio comprises generic active pharmaceutical ingredients business, or raw materials for drugs; nutraceuticals; and custom synthesis or contract manufacturing services for global innovators.

While API and nutraceuticals together contributed 59% to the company’s total revenue in the quarter ended June, custom synthesis accounted for 41%, the management said in a post-earnings conference call. The revenue of the mainstay API business rose 54% year-on-year during the period, closely followed by 49% growth in custom synthesis.

Like for many other Indian peers, API segment continues to lead the momentum for Divi’s. More so after domestic drugmakers ramped up local manufacturing amid import curbs on China after a deadly border tension and increased demand during the pandemic.

Yet, custom synthesis business is also expected to be margin-accretive.

Goldman Sachs expects Divi’s margin to expand to 40% by 2022-23, of which custom synthesis will contribute 55%. The contract manufacturing business, the research firm said, contributed more than 50% to the company’s 2019-20 earnings before interest, tax, depreciation and amortisation. This segment will also raise Divi’s return profile and reduce Food and Drug Administration risks, it said in a report.

Frost and Sullivan—growth strategy and consulting research firm—pegs the global contract manufacturing industry at $100 billion, growing at 7-8% annually.

The custom synthesis business has shown a good recovery on account of an improved business environment, according to ICICI Securities. Strong research and development capabilities and India’s cost arbitrage are some legacy strengths, which will drive incremental assignments from multinationals, the brokerage said.

Shares of Divi’s have recovered 79% from their lowest in March, when the coronavirus pandemic led to the worst plunge in equities in a decade. The stock has gained 74% so far this year compared with a more than 40% rise in the Nifty Pharma Index.

Of the 16 analysts tracking the stock, 10 have a ‘buy’ rating, while three each recommend a ‘sell’ and ‘hold’. The average of Bloomberg consensus 12-month price targets implies a downside of 3.9%, largely because the stock has run ahead of analysts' expectations.

Here’s what may aid Divi’s custom synthesis and other business, according to the company’s exchange filings, post-earnings interaction, and research reports of Motilal Oswal, Edelweiss and Goldman Sachs.

High Entry Barriers & Better Regulatory Track Record

Innovator pharma companies focus their partnerships only with select vendors with which their intellectual property on patented molecules and products under development is safe.

Divi’s is the largest contract manufacturing services provider in India after Piramal Enterprises Ltd. The company has a long-standing relationship with six of the top 10 pharma innovators, which ensures steady revenue.

Contract manufacturers are also subject to regular manufacturing compliance audits by quality teams of global innovators. That helps in maintaining a good regulatory track record than API and generic companies.

Rise In Outsourcing

Large biopharma companies currently outsource around 25% of their manufacturing, while emerging biotech firms outsource 100%.

Outsourcing of research and manufacturing is expected to increase as costs associated with developing new drugs rise and price falls after a generic is launched. Companies such as Divi’s with strong technical capabilities, scale of commercial manufacturing and level of regulatory compliance stand to benefit.

Besides, capacity expansion, debottlenecking of key facilities, and increasing backward integration, are expected to aid Divi’s API business.

Lower Dependence On China

Big pharma companies seeking to reduce their reliance on China present Indian drugmakers with an opportunity.

Divi’s may gain not only as a leader and preferred partner in the custom synthesis segment, but also because of the way it has strategically positioned itself over the past years.

“Looking at the negative signs of going towards China, maybe India will get more opportunities in terms of consumption of custom synthesis. We are geared to accept those opportunities,” Murali K Divi, managing director, at the drugmaker, said during a conference call post first-quarter results. “There are X number of big pharmas and we are connected with most of them, the business is already happening.”

Besides, the managing director said countries like the U.S. and Europe are more inclined towards collaboration with Indian companies than China. “We are very strong to take significant market share in all our generic products where we have long-term contract with our customers, and the customers are always increasing their businesses,” he said.

Brokerage View

Motilal Oswal

  • Earnings are expected to grow at an annualised growth rate of 33% over FY22, led by increased business prospects from custom synthesis and generics
  • A 600-basis-point margin expansion on better operating leverage

ICICI Securities

  • Expects a 14.5% compounded annual growth in custom synthesis business and 15% in generics business over FY22
  • Incremental assignments from multinationals for custom synthesis, and focus on brownfield expansion for generics business will be the drivers

Goldman Sachs

  • Generic sales are expected to grow at a 15% compounded growth over FY23 and custom synthesis at 13%.
  • Higher utilisation on monetisation of new capacities as well as increased dual sourcing and import substitution mandates, coupled with deepening wallet share among existing customers and widening service offering will aid growth

Emkay Global

  • Expects the earnings per share to double over FY23 with strong sector tailwinds and upcoming capex
  • Expects the company to trade at a premium to its historical valuations
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