Divi’s Lab: Unveiling New Avenues for Earnings Growth

In the dynamic landscape of pharmaceuticals, Divi’s Lab (CMP: Rs 3,655; Market cap: Rs 97,026 crore) stands as a player with the potential to redefine its earnings trajectory through emerging growth opportunities. 

Despite a sequential dip in sales in Q1FY24, the company showcased a positive trend in margins, laying the groundwork for a promising future. Let's delve into the areas that could reshape Divi's Lab's fortunes and drive its success.

Weathering the Storm

The Q1FY24 results, displaying a decline in sales, need context to be understood. This drop can be attributed to the pass-through of lower raw material costs. On a brighter note, there was a notable improvement in the EBITDA margin. 

This was partly due to the exhaustion of high-cost inventory and decreased operating expenses. While pricing challenges persist in the generic portfolio, the company’s growth prospects lie in diverse fields that could redefine its earnings trajectory.

Unlocking Growth: Contrast Media and Beyond

Intriguing growth opportunities lie ahead for Divi’s Lab in the realm of contrast media, peptide building blocks, and carotenoids. Among these, the contrast media sector holds substantial promise. 

The company has already established its foothold in iodine-based contrast media for CT/X-Ray scans and is actively working to enhance yields and iodine recovery efficiency. The expansion into MRI-based contrast media or Gadolinium compounds could be a significant move, with the formulation market size nearing $7 billion. Despite a handful of players in this space, Divi’s Lab is well-positioned to make a meaningful impact.

Margin Matters and Market Outlook

While Q1FY24 saw a consistent contribution from the custom synthesis segment (40% of sales), it marked a decrease from the previous year when sales of the COVID drug Molnupiravir provided a boost. 

Nutraceuticals, accounting for 10% of sales, maintained steady performance. The share of exports stood at 86%, with Europe and the US being the primary contributors (67% of sales).

An improvement in EBITDA margins on a sequential basis was largely driven by factors such as reduced raw material prices, lower logistic expenses, and yield improvements. 

However, a YoY analysis, accounting for forex fluctuations, showed a margin contraction of approximately 700 bps due to changes in the COVID-related business landscape.

Expanding Horizons: Carotenoids and Beyond

One of Divi’s Lab’s strategies to optimize its operations involves the construction of Unit-3 with an initial outlay of Rs 1,500 crore. 

This unit is anticipated to manufacture Key Starting Materials (KSMs), nutraceuticals, and intermediates. This move is expected to create additional capacity for carotenoids/nutraceuticals. With existing carotenoid capacity running at 95%, this expansion could provide a much-needed boost.

The Road Ahead

Despite a gradual expected growth in the near term, Divi’s Lab has a plethora of promising opportunities on the horizon. 

As it explores areas like contrast media, sartans, carotenoids, and patented molecules, the company is guided by its belief that the recent drug master filings (DMFs) will contribute to growth beyond FY25. 

Additionally, Divi’s Lab is poised to enhance its market share for established molecules through the application of innovative technologies that optimize production while minimizing costs and environmental impact.

The company's foray into peptide building blocks, driven by ongoing trials of patented amino acid molecules, underscores its commitment to innovation and custom synthesis. With such potential drivers of growth and improvement in margins, Divi’s Lab has positioned itself as a frontrunner in the API segment.

After a consolidation period of about 22 months, Divi’s Lab's stock is now trading at 29x FY25e EBITDA, signaling the market's confidence in its potential. 

While valuation remains ahead of peers, the company's strategic moves and growth prospects warrant optimism. 

With progress on the Kakinada construction front and promising ventures into novel molecular segments, Divi’s Lab is primed for success. 

As a testament to its potential to harness emerging opportunities, we recommend an ‘overweight’ stance on the stock. Investors looking to ride the upcycle in the API segment and seize the company's growth potential should consider accumulating the stock. 

The path ahead for Divi’s Lab is paved with innovation, diversification, and potential wealth creation.