Divi’s Labs Rating ‘Hold’: Results were a slight miss on estimates

We downgrade our rating to Hold. Our PT moves from Rs 5,624 to Rs 5,563.

Divi’s Q2FY22 revenue/EBITDA missed our estimates by 2%/3% but PAT was a beat on lower taxes. Pfizer’s COVID-19 oral drug candidate Paxlovid shows efficacy of 89% and could pose a risk to Divi’s Molnupiravir prospects. Surging raw materials prices are likely to restrain margin profile. The stock trades at an expensive valuation, and we do not see major upside for the stock from here. We downgrade our rating to Hold. Our PT moves from Rs 5,624 to Rs 5,563.

Divi’s Q2FY22 gives a slight miss to our estimates: Divi’s Q2FY22 revenue of Rs 19.7 bn was 2% below our estimate, Ebitda of Rs 8.2 bn was 3% below while PAT of `6 bn was 4% above. Ebitda margins came in at 41.6% vs our expectation of 42%. During the quarter 88% of sales came from exports; US & EU accounted for 72% of total revenue.

Molnupiravir prospects dimming: As per mgmt commentary, COVID-19 anti-viral drug formulation opportunity is worth $70 bn where Merck’s Molnupiravir was the leading candidate. But last week Pfizer released interim data of phase 2/3 EPIC-HR study that said its candidate Paxlovid is found to reduce COVID-19 hospitalisation and deaths by 89%. In comparison, Merck’s Molnupiravir reduces hospitalisation or deaths due to COVID-19 by 50%.

In the latest earnings call, Merck had said it sees Molnupiravir opportunity at $5-7 bn and we believe this too could come under pressure due to Pfizer’s Paxlovid. In our view, Divi’s FY23 Molnupiravir opportunity is now significantly lower due to the better outcomes by Paxlovid.

Rising raw material prices a risk to margin: We had built in an uptrend margin profile for Divi’s on scale-up of its Molnupiravir project and debottlenecking benefits. However, we now factor in flat margins on account of the surge in raw material prices. Divi’s Q2FY22 reported 67% gross margin which was in-line with the previous quarter but the company may not be immune to increasing prices in coming quarters.

In our view, Divi’s Q2 margin was sustained on product mix and advance procurement of inventories, but the sustained high prices of key raw materials will eventually impact the firm. We now do not see a case for an improving margin profile for Divi’s and at best see the firm maintaining its current margins trend.

Trades expensive, downgrade to Hold: Divi’s trades at 48.4x FY23e EPS and is the most expensive Indian CDMO player; peers trade at: Syngene (44x), Gland (35.5x), Laurus (20x). Chinese peers which are expected to clock over 25% top-line growth are trading at 58x. Our FY22/23e EPS changes by -2%/-1%. We value the stock at 51.8x FY23e EPS with a PT of `5,563.