Divi’s Laboratories, or Divi’s Labs, is one of the leading manufacturers of generic active pharmaceutical ingredients (APIs), nutraceutical ingredients, custom synthesis of APIs and intermediates for global innovator companies. Established in 1990, the company has manufacturing plants in Telangana (unit 1) and Andhra Pradesh (unit 2). It has a presence across 95 countries. As global pharmaceutical companies are diversifying their API supply chains away from China, Divi’s Labs seems to be a good play to take advantage of this shift with its strong product mix, robust financials and aggressive capex outlay.

Quick Takes:

• After implementing a Rs. 2,000 crore capital expenditure (capex) plan from 2013-18, Divi’s Labs announced a Rs 1,800 crore capex in 2019

• Capex has been utilized for reducing bottlenecks, backward integration of raw materials and new product expansion at DC SEZ units

• Additional capex of Rs 400 crores for custom synthesis segment has been announced

• Instead of pushing ahead through costly acquisitions, organic expansion is the company’s mantra for long term competitive growth.

• The company has received fast-track projects from big US and EU pharma companies for custom synthesis (CS) and has started work on a war footing

• CS capex is expected to be completed in the next 6-9 months

• The company has received final government clearance for its Kakinada plant and has announced another Rs 1,500 crores capex

Stellar September Quarter FY21

Pharma companies world over are reducing their dependence on China and looking for alternatives to boost their API supply chain resilience. The disruption caused by the COVID19 pandemic has placed Indian API manufacturers in a sweet spot. Laurus Labs, Neuland Labs, Granules India, all have reported strong numbers driven by rising volumes and higher API prices over the past two quarters. Divi’s Labs, second only to Sun Pharma in terms of market capitalisation among Indian pharma companies, is one of the leading API manufacturers in the world. The company’s consolidated sales in the September 2020 quarter were Rs 1,749 crores compared to Rs 1,446 crores in the same period a year ago. It posted strong double-digit growth in APIs, custom synthesis and robust operating leverage. 

Operating profit jumped 1.5 times YoY to Rs. 741 crores in Q2 FY21. Operating margins came in at 42.37%, expanding by 840 bps YoY, driven by backward integration benefits and improving operating leverage. Net profit (PAT) came in at Rs. 520 crores during the quarter against Rs 357 crores, rising 46% YoY. The stock soared 4% after Q2 results came out, touching its 52-week high of  Rs 3,400.

Robust Organic Growth

Divi’s Labs’ product portfolio is segmented under three broad categories, generic APIs, nutraceuticals and custom synthesis (CS). Nearly 87% of its revenues come from exports, with 48% from Europe  and 23% from the US, 11% from Asia and 4% from the rest of the world. The company earns 13% of its revenues from India. 

Divi’s Labs is one of the global leaders in large volume generic APIs with a product portfolio of 30 APIs. In the custom synthesis (CS) segment (contract manufacturing services of APIs), it caters to 12 out of the top 20 big pharma companies across US, EU and Japan. The company earned 60% of revenues from generic API and 40% from CS segment in the September 2020 quarter. Revenues of the generic API segment rose 26% YoY and for the CS segment growth was 18% YoY. 

The nutraceuticals vertical saw revenues grow 10% YoY in the September 2020 quarter. It constitutes a complete set of carotenoids (anti-oxidants). Dr Murali K Divi, Managing Director of Divi’s Labs said the nutraceuticals business may grow around 10-15% in the current financial year and expects revenues to grow at around 15%-18% in the coming years as it expands into more markets.

Divi’s Labs revenues have been growing at a CAGR of 19% over the past 10 years while its PAT grew at a 15% CAGR. All this growth is organic. Instead of pushing ahead through costly acquisitions, organic expansion is the company’s mantra for long term competitive growth. In fact, naproxen (anti-inflammatory drug), gabapentin (preventing seizures), levetiracetam (epilepsy treatment) and dextromethorphan (cough suppressant) are few significant generic APIs where Divi’s has more than 50% market share. Even its nutraceuticals business launched in 2005 expanded organically and is expected to post a turnover of Rs 600 crore this year. 

US FDA Hiccup

The US FDA had inspected Divi’s Labs’ unit 2 facility at Visakhapatnam in Andhra Pradesh in December 2016 and issued five observations. The unit was imposed with an import alert three months later. Consequently, the stock went into heavy correction, declining 40% in the next six months. But unlike Dr Reddy’s, Wockhardt and IPCA Labs, Divi’s Labs implemented a faster and efficient resolution of the US FDA observations within a year, starting with getting a significant set of its product list exempted from the import alert. And after re-inspection in September 2017, the import alert was lifted in November 2017. 

Thus, after a complete washout in FY18, the company reported revenue and net profit growth of 27% and 54% respectively in FY19. Along with resumption of growth, capex was further intensified to take advantage of API supply shortage caused by Chinese pollution control disruption, which is bearing fruit in FY21.

Robust Capex Outlay

After implementing around Rs 2,000 crore capex from 2013-18, Divi’s Labs announced Rs 1,800 crore capex in 2019. The outlay of Rs. 1000 crore has already been utilized for reducing bottlenecks at both Unit 1 and 2. In addition, the company has focussed on the backward integration of intermediates at both sites, and for new products at DC-SEZ at unit I and DCV SEZ at unit 2. 

The management says both these new units are strong growth engines with SEZ benefits. Though commercial operations have started for these units only partially from February and March respectively, construction work will be completed by the end of this fiscal. This includes validation, regulatory submission and waiting for clearances. Capacity expansion due to benefits from reduced bottlenecks have already started playing out as is visible from the increase in top-line in the past two quarters. Also, around 25-30% capacity expansion is expected and the backward integration efforts to minimize dependency on supplies of raw materials from China assumes significance. These efforts will add to both top-line and bottom-line in the next few quarters. 

Another growth trigger is with respect to recently announced additional capex of Rs 400 crores for the CS segment. The company has received fast-track projects from big US and EU pharma companies. The he management says work has started on a war footing and CS capex will have to be completed in the next 6-9 months. 

The company has proposed a capex of Rs 1,500 crores (from internal accruals) for its Kakinada plant. Although construction commenced on December 7, 2020 with all government clearances coming after 4 years, the plant has yet again run into opposition from the local population. Hopefully, there is a resolution soon and the facility will start yielding results.