Divis Lab Q2FY11 Result Update; Below expectations; Downgrade: Emkay

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Divi’s Lab

Below expectations; Downgrade to Accumulate

ACCUMULATE

CMP: Rs723                                        Target Price: Rs756

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n     Divi’s Q211 performance was below expectations with a) Revenue at Rs2.6bn (est. of Rs2.9bn); b) EBIDTA at Rs878mn (est. of Rs1.2bn)  & c) APAT at Rs719mn (est. of Rs976mn)

n     Unfavorable product mix impacted operating performance; expect gradual recovery going forward

n     Carotenoids is the next growth driver for the company; to drive earnings growth in FY12E

n     Tweak earning estimates by 14%/10% for FY11E/FY12E; Cut target price to Rs756 and downgrade the rating from Buy to Accumulate

Adverse product mix and slower take-off impacted Q2 performance

Divi’s Q2FY11 performance was mainly impacted because of slower pick-up and

adverse product mix (lower contribution of CSS business). Despite 14% YoY growth in

revenue, operating margins was down by 1331bps to 33.9% (lowest in last 14 quarters)

mainly on the back of higher contribution of low margin products in the generic segment,

currency appreciation and slower pick-up in custom synthesis business. Higher other

income (up 67% YoY), lower interest cost (down by 82%) and lower tax provision (9.7%

of PBT vs. 10.5% in Q2FY10) restricted PAT decline to 15% to Rs719mn (est. of

Rs976mn).

Expect gradual recovery in 2H and full recovery in FY12E; Carotenoids to

drive earnings growth in FY12E

We expect gradual recovery in 2HFY11E (15-16% growth) and full recovery in FY12E

(upward of 22% growth). We expect operating margins to improve going forward to 37-

38% for rest of FY11E and reach to upwards of 40% in FY12E driven by a) improved

product mix, b) higher contribution of high margin Carotenoids business and c)

commencement of Vizag SEZ facility. Overall we expect earning growth of 4% in

FY11E which is likely to move up by 32% in FY12E on the back of a) increased

outsourcing from global players post consolidation phase, b) restocking of the inventory

and c) lower base effect. We believe that Carotenoids will be next growth driver for the

company. Though the scale-up of Carotenoids took longer time then anticipated but now

management is confident to attain higher revenue from this segment. Carotenoids

segment did a revenue of Rs300mn in 1HFY11 (expect Rs700mn revenue in FY11E).

We expect this business to record revenue of Rs1200mn in FY12E. We are of the view

that since depreciation and interest cost on account of Carotenoids plant is already in

P&L account; incremental contribution of Carotenoids will boost the profitability of the

company.

Tweaking earning estimates by 14%/10%; cut target price and downgrade to

Accumulate

Owing to lower than expected Q2FY11 performance and gradual recovery in CRAMS

business, we cut our earning estimates by 14% and 10% to Rs27 and Rs36 for FY11E and

FY12E respectively. We also cut our target price from Rs852 to Rs756 and downgrade our

rating from Buy to Accumulate. We are of the view that Divi’s would be key beneficiaries of

improved global outsourcing environment. Best in class margins and return profile (RoIC in

excess of 31%), strong balance sheet, India centric assets coupled with positive cash flow

provides incremental comforts to the investors