Accumulate Divi’s Lab Strong quarter; Target Price: Rs 756: Emkay

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Divi’s Lab

Strong quarter; Maintain Accumulate

ACCUMULATE

CMP: Rs 633                                       Target Price: Rs 756

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n     Divi’s Q3FY11 performance was above expectations with a) Revenue at Rs3.1bn (est. of Rs2.8bn); b) EBIDTA at Rs1.2bn (est. of Rs1.0bn)  & c) APAT at Rs984mn (est. of Rs855mn)

n     Revenues were driven by strong performance of the CSS (Custom Synthesis) and its Generics portfolio

n     Favorable product mix (improved contribution of high margin products) and cost optimization led to improved operating profitability; expect gradual recovery going forward

n     Maintain Accumulate with a price target of Rs756.

Strong quarter driven by higher off-take in business segments

Divi’s Q3FY11 performance was driven by good off-take in the company’s Generic and

the CSS portfolio. Growth in the Generics segment was on account of robust

performance from its key products. Operating margins expanded by 454bps QoQ to

38.5% mainly on the back of higher contribution of high margin products in the generic

segment and good off-take in the custom synthesis business. Strong operating

performance coupled with lower interest and lower depreciation charge (up 2% YoY) led

to PAT growth of 45% to Rs984mn (est. of Rs855mn).

Expect gradual recovery going ahead; Carotenoids to drive earnings

growth in FY12E

We expect gradual recovery going ahead in FY12E (upward of 22% growth) driven by

good order off-take from new products in the Generics segment and sustained

momentum in the CSS business. Operating margins are likely to improve going forward

to around 40% for rest of FY12E driven by a) improved product mix, b) higher

contribution of high margin Carotenoids business and c) commencement of Vizag SEZ

facility, expect the plant to get commissioned in Q1FY12 and commercial production to

kick-in H2FY12. We expect the company to clock revenue CAGR of 20% over FY10-

12E. Overall we expect earnings growth of 6% in FY11E which is likely to move up to

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 than anticipated but now management is confident to

attain higher revenue from this segment. Carotenoids segment did a revenue of

Rs440mn in 9MFY11 (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.

Sharp correction in stock price leaves enough room for upside, Maintain

Accumulate

On account of strong performance in Q3FY11 and gradual recovery in CRAMS business,

we maintain our earning estimates of Rs27 and Rs36 for FY11E and FY12E respectively

with a target price of Rs756. The company expects its Vizag plant to get commissioned in

Q1FY12 and operational H2FY12. Management has guided for 50% capacity utilization

from this plant in its first year of operation. 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 (near zero debt), India centric assets

coupled with positive cash flow provides incremental comforts to the investors. At CMP, the

stock trades at 23.3xFY11E and 17.6xFY12E EPS.