By Suhani Adilabadkar
After a muted September 2021 quarter, Q3FY22 was a relief for Divi’s Labs investors. The company posted its highest YoY revenue growth in Q3FY22 over the past seven quarters. There was also a more than three percentage point operating margin expansion during the quarter.
Divi’s Labs’ stock jumped 4% post the quarter results being announced. While the custom synthesis segment is now the major growth driver for Divi’s Labs amid Covid-19 disruption, the management is also confident of long-term growth prospects for its generic active pharmaceutical ingredient (API), sartans, and contrast media API segments. Divi’s Labs’ long-term growth levers are strongly intact, but investors are keenly waiting for the Kakinada plant capital expenditure (capex) to unfold.
Quick Takes:
- Divi’s Labs reported revenues of Rs 2,493 crore, a rise of 47% YoY, driven by robust custom synthesis revenue growth of 120% YoY in Q3FY22
- Custom synthesis revenue is also up 70% YoY in 9MFY22 and is expected to report healthy growth in the medium term
- Backward integration, revamping and upgrading of utilities over the past two years is supporting strong operating margin performance
- Operating margins might be impacted by rise in prices of solvents (crude derivatives) in the coming quarters
- The company is still awaiting possession of land for Kakinada plant to start construction, capex is expected to be around Rs 1,000-2,000 crore in the next two years
Stellar Q3FY22 performance, operating margins improve
Divi’s Labs is the best play on the Indian contract research and manufacturing services (CRAMs) and API spaces. It reported strong numbers in the December 2021 quarter as revenues rose to Rs 2,493 crore, a growth of 47% YoY, the highest since the June 2020 quarter. Revenue growth was driven by robust custom synthesis revenue growth (up 2.2x YoY). Sequentially, revenues grew 25% in Q3FY22.
Exports constituted 92% of total revenues, with Europe and the US contributing 79% to the total revenue mix in the December 2021 quarter. Operating margins came in at 44%, the best in the industry expanding 340 basis points (bps) YoY in Q3FY22. Operating margins improved 280 bps sequentially in December 2021 Quarter.

Divi’s Labs maintained its operating margins despite a significant increase in raw material prices due to the energy crisis in China over the past three quarters. Power outages in China impacted the raw material supply leading to shortage and volatility in prices of basic chemicals, commodities, raw materials such as solvents. Operating margins in the coming quarters might be impacted due to an increase in the price of solvents (crude derivatives) with galloping crude prices (up 60% YoY).

Speaking on raw material cost pressures, Dr Murali K. Divi, Managing Director at Divi’s Laboratories said, “We were able to mitigate some of these cost pressures due to geographical diversification of procurement along with existing long-term contracts with key suppliers.” Net profit nearly doubled to Rs 902 crore in Q3FY22 supported by higher revenues and robust operating performance. Net profit was up 49% sequentially in the December 2021 quarter.

Molnupiravir logs in strong growth numbers
Divi’s Labs stock gained 23% over the past year, even with a 16% fall in the last three months of 2021. The stock slipped 8% intraday on November 5, post-Pfizer’s announcement of its anti-Covid drug, Paxlovid, with higher efficacy compared to Merck’s Molnupiravir. Divi’s Labs is the authorized manufacturer for Molnupiravir API in India for Merck. Investors were disappointed as the Molnupiravir opportunity seemed uncertain and unclear in the near term. But the opportunity does seem to have paid off for Divi’s Labs. As per Merck’s Q4CY21 result press release, Molnupiravir was the fourth-largest drug by sales in Q4CY21. Molnupiravir sales were $952 million in December 2021 quarter and Merck expects the star anti-Covid drug to touch roughly $5-6 billion sales in CY22.
Divi’s Labs received fast-track projects of anti-Covid drugs from big US and European pharma companies in Q2FY21. Molnupiravir-Merck project was one of them. The company is bound by a confidentiality agreement with Merck and cannot disclose Molnupiravir sales. However, the management indicated that the Molnupiravir project started contributing to the top-line from Q2FY22. Custom synthesis anti-Covid fast track projects (essentially contract manufacturing services) has been a strong growth opportunity for the company, boosting revenues over the past three quarters.
Will growth driven by custom synthesis be sustainable?
While generic API revenue growth has moderated over the past three quarters due to high FY21 base and Chinese companies back in business, the custom synthesis segment maintains the growth tempo.

The custom synthesis segment constituted 60% of total revenues in Q3FY22 followed by generic API and nutraceuticals contributing 33% and 7% respectively.

Custom synthesis revenues at Rs 1,496 crore rose 120% YoY in Q3FY22. Generic API revenues came in at Rs 831 crore (down 5% YoY) and nutraceuticals revenues at Rs 166 crore (up 14% YoY) in December 2021 Quarter. Custom synthesis contribution increased from 40% in Q3FY21 to 60% in total revenue mix in December 2021 quarter.

Speaking on higher custom synthesis revenue contribution, Divi said, “In API generics, we decide what to produce, how much to produce, when to produce. In custom synthesis, the customer demands how much quantity we need to produce and supply at the required time”. Custom synthesis segment performance depends on product movement and sales performance of clients rather than products offered by the company, said Divi. Custom synthesis revenues grew 70% YoY in 9MFY22 mainly driven by anti-Covid-19 fast track projects. But will this growth momentum be maintained?

The Covid drug arena is dynamic and has evolved over the past two years. New Covid-19 strains led to the development of varied therapies like antiviral vaccinations and recently launched oral anti-viral Covid-19 pills. According to Divi, “Requirement of the newer drugs is probably coming much faster to work on the variants.” The order of the day is how quickly we accommodate a new product, develop, manufacture and supply to the customer, said Divi. The SARS-CoV-2 virus continues to evolve leading to the emergence of variants that require aggressive vaccination drives across the world and the development of newer drugs. As per World Health Organization (WHO), in addition to Omicron BA.1 and BA.2, a new sublineage of Omicron, BA.3 has emerged. According to various scientific groups, drug combinations might be a more effective treatment for newer strains of Covid-19 rather than a single antiviral medication.
Divi’s Labs is favorably placed in the global CRAMs industry to exploit the fast-evolving anti-Covid-19 drug market. The company is associated with 12 out of the top 20 global Big Pharma companies for contract manufacturing services for more than 10 years. Divi’s Labs is currently working at 80-85% capacity and out of a total 1,700 reactors, 300 reactors are available to accommodate 2-3 new Covid-19 drugs, said Divi.
Long-term growth for generic API looks promising
According to the management, the company lost neither volumes nor clients in its generic API business. We would like to maintain the generic and CS revenue mix at around 50:50, but it is wishful thinking, said Divi. Higher demand for CRAMs services led to higher custom synthesis revenues in 9MFY22. Divi said that preference is first given to Big Pharma custom synthesis clients and generic API production is adjusted to attain maximum productivity.

The company is working to boost its generic API business. In addition to its 30 commercialized APIs, additional 10 APIs are in various stages of research & development. The company intends to add new products going off-patent between FY23-24, a $ 20 billion opportunity. Divi’s has also ventured into sartans, a $20-25 billion opportunity and contrast media APIs, a $4-6 billion opportunity growing currently at 15-25%. The US government recently banned a few Chinese API manufacturers in February 2022. And US and EU pharma companies de-risking their API supplies is more good news for Indian API manufacturers like Divi’s Labs.
Capacity needs to be augmented to accommodate upcoming Covid/non-Covid growth opportunities. Awaiting possession of the Kakinada plant, Divi said, “We have about 200 acres of land at Unit-I (Hyderabad) and 150 acres of land at Unit-II (Visakhapatnam), we can invest here and will never lose an opportunity”.