Divi’s Labs Vying For No. 2 Spot Among India’s Generics-Dominated Pharma Stocks

When the U.S. drug regulator effectively barred exports from Divi’s Laboratories Ltd.’s biggest facility in Visakhapatnam in March 2017, the maker of pharma raw materials wiped off half of its value in five months.The U.S. Food and Drug Administration cited improper controls, falsified or poor documentation and R&D that was inconsistent with good manufacturing practices for the import alert for Visakhapatnam Unit 2 that contributes 70 percent of the company’s business.The company swung into action to fix things. In September that year, the U.S. FDA again inspected the unit and cleared it by November, and the shares have more than doubled since then.Barring that blip, the maker of active pharma ingredients has risen steadily in the past decade. It now vies with Dr. Reddy’s Laboratories Ltd. to be India’s second-largest pharma company with a market valuation of more than Rs 50,000 crore ($7 billion)..Founded 29 years ago by Murali Divi, his bet on the high-margin chemicals that go into making medicines has more than paid off. His family’s stake in the company is now valued at more than Rs 24,000 crore ($3.6 billion). And while Indian drugmakers struggle in the U.S., their largest market, as competition squeezed prices and margins, Divi’s Labs has seen its revenue, profit and margins improve in the last two years and clocked its best-ever sales in the quarter ended September..Lupin’s Troubles In U.S. Run Deep.BloombergQuint’s emailed queries and requests to Divi’s for an interview remained unanswered.Divi’s Labs has returned the best gains among pharma peers in the last 12 months. While estimates tracked by Bloomberg don’t suggest any upside, that’s partly because the stock is the costliest among index members, it trades at 30 times of its estimated earnings for 2020-21. That’s about 40 percent premium over generics-making peers, including Sun Pharmaceuticals Industries Ltd., Cipla Ltd., Lupin Ltd. and Dr. Reddy’s.Equirus Capital expects the valuations to sustain on consistent profit, industry-leading operating margin of 35-40 percent, debt-free balance sheet, a superior asset-turnover ratio and a strong business model..Here’s what sets Divi’s Labs apart:.Robust Demand, Track RecordDivi’s focuses on its API business and refrains from filing its own products in client markets. This gives its clients comfort in sharing important product-related data.Besides strict adherence to intellectual property rights, Equirus Capital said Divi’s has an established track record, a sticky customer base and robust execution skills.Outlook for raw material outsourcing by global formulation and generic drug makers remains strong with R&D funding rising, according to Equirus Capital.Regulatory environment is also conducive, with the U.S. FDA approving record 836 abbreviated new drug applications in 2019 as the count rose for at least the fourth straight year, according to the U.S. regulatory data.Higher R&D spends and more drug approvals will only increase demand for pharma ingredients.Low Costs, Product SelectionUnlike drugmakers, Divi’s refrained from making expensive acquisitions overseas and instead leveraged on its low-cost manufacturing base in India. Given that costs in India are less than half of what they are in regulated countries, the company clocked higher profit even during downcycles.Divi’s also follows a rigorous filtering process and selects only products where it can command a large market share, or control pricing, or which involve complex technologies that limit competition, according to an Equirus note. Its facilities can switch products and scale or reduce production levels as per client needs, giving it an edge over peers, the brokerage said.OutlookThe company sources raw materials from China, increasing costs. Additional capacity and backward-integration or self-production of raw materials will boost growth and margin, the management told investors after the second-quarter earnings.The company is investing Rs 1,700 crore to boost capex—including a brownfield unit at Unit-2 near Visakhapatnam special economic zone, project at Unit-1 near Hyderabad SEZ, easing bottlenecks at Units 1 and 2, and expansion and modernisation of utilities at the export-oriented unit expected to be completed by March.The expansion is aimed at tapping opportunities in Big Pharma amid supply disruptions as China shuts polluting units.According to Edelweiss, capacity addition and emerging opportunity at China’s expense underpin their long-term growth outlook for the company.BofA Securities expects benefits of backward integration and new capacities to flow in the next fiscal FY21.Axis Capital estimates the capex would lead to 10 percent growth in the ongoing financial year ending March, and even better in the next two years.Also Read: A Breed Of Pharma Companies Is Doing Well. Here’s WhyCurrency, however, continues to be a key variable as exports contribute 87 percent of the Divi’s sales. Depreciation of the dollar and the euro against the rupee could pose a risk to financials. Besides, brokerages also cite any U.S. FDA action and dependence on select clients and products as other key risks..Watch | How Divi’s Labs transformed in just over two years

Divi’s Labs Vying For No. 2 Spot Among India’s Generics-Dominated Pharma Stocks

Founded 29 years ago by Murali Divi, his bet on the high-margin chemicals that go into making medicines more than paid off.

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