11 January 2012
C
orner
O
ffice
Interaction with the CEO
the
The 3C success story: CRAMS, Chemistry, Collaboration
Expect 20-25% topline growth, sustaining profitability for next two years
Divi's Laboratories
The management is confident of delivering 20-25% topline growth for the next two
years and maintaining EBITDA margins.
DIVI will be a key beneficiary of increased outsourcing from India, leading to 18%
earnings CAGR over FY11-13E.
We estimate RoCE and RoE of 25%+ for the next few years. Reiterate Buy, with a
price target of INR910 (20x FY13E EPS).
Dr Murali Divi
Chairman & Managing Director
Dr Divi
holds a doctorate degree
in Pharmaceutical Sciences. He
has extensive experience of over
30 years in the Active
pharmaceutical ingredients
industry. He is a member of
American Institute of Chemical
Engineers, American Chemical
Society, American Cosmetic
Society and American
Pharmaceutical Association.
We met Dr Murali Divi, CMD and Mr Kishore Babu, CFO of Divi's Laboratories
(DIVI). Key takeaways.
Differentiated CRAMS player:
DIVI's key USPs are (1) strong chemistry skills,
(2) low cost, flexible manufacturing process, (3) focused operations and product
portfolio, and (4) clear strategy of not filing patent challenges (collaborative
approach). These factors have helped DIVI to establish strong customer
relationships, leading to scale-up of its CRAMS and API businesses over the
last five years and simultaneously helping to sustain higher profitability and
return ratios. They have also helped the company to differentiate itself from
other Indian CRAMS players.
Guidance - 20-25% topline growth, sustaining profitability:
The management
is confident of delivering 20-25% topline growth for the next two years and
maintaining EBITDA margins. Tax rate for FY12 and FY13 will be 20% and 19%, respectively.
CRAMS business - well positioned:
This space offers a large opportunity, driven by innovators facing increasing
cost pressures and their reducing focus on manufacturing. DIVI is well positioned, given (1) its strong relationships
with innovators, (2) presence across the CRAMS value chain, and (3) its ability to support the innovator in late
life-cycle strategies. Innovators are comfortable working with DIVI, as it does not challenge innovator patents.
API business - profitability higher than peers:
Unlike other API players, DIVI earns strong margins in this business
due to its global cost and market leadership in some APIs (global market share of 50-70%), its ability to increase
prices, and strong backward integration.
Valuation and view:
DIVI will be a key beneficiary of increased outsourcing from India, leading to 18% earnings
CAGR over FY11-13E. We estimate RoCE and RoE of 25%+ for the next few years, led by traction in the high-margin
CRAMS business, sustained profitability in the API business and incremental contribution from the new SEZ. The
stock trades at 22.2x FY12E and 17.5x FY13E earnings. Reiterate
Buy,
with a price target of INR910 (20x FY13E EPS).
Stock Info
CMP (INR) - 10 Jan. 2012 794
Bloomberg
DIVI IN
Equity Shares (m)
132.7
52-Week Range (INR) 843/582
1,6,12 Rel. Perf. (%)
9/11/43
M.Cap.(INR b)/(USD b) 105/2
Financial and valuation summary
Year
End
03/10A
03/11A
03/12E
03/13E
Net Sales
PAT
(INR M) (INR M)
9,416
13,071
16,417
19,895
3,403
4,293
4,737
6,026
EPS
(INR)
25.8
32.4
35.7
45.4
EPS
Gr. (%)
-19.9
25.7
10.3
27.2
P/E
(X)
-
24.5
22.2
17.5
P/BV
(X)
-
5.9
5.0
4.2
RoE
(%)
24.7
25.9
24.3
26.0
RoCE
(%)
27.3
28.2
30.1
32.0
EV/
Sales
-
8.1
6.4
5.3
EV/
EBITDA
-
21.4
17.7
13.8
Nimish Desai
(NimishDesai@MotilalOswal.com); +91 22 3982 5406
Amit Shah
(Amit.Shah@MotilalOswal.com); +91 22 3982 5423

C
orner
O
ffice
Differentiated CRAMS player
DIVI's key USPs include:
Strong chemistry skills, which enable it to develop and commercialize more
efficient chemical processes for its customers
Low cost and flexible manufacturing process, which enables the company to remain
competitive and offer flexibility to its customers in order processing
Focused operations - DIVI restricts itself to the API and intermediates business,
and has not ventured into formulations
Focused product portfolio - It looks at only those product opportunities where it
can achieve cost and market leadership (niche approach), and
Non-infringing strategy - Clear strategy of not going for patent challenges
(collaborative approach).
These factors have helped DIVI to establish strong customer relationships, leading to
scale-up of its CRAMS and API businesses over the last five years and simultaneously
helping to sustain higher profitability and return ratios. They have also helped the
company to differentiate itself from other Indian CRAMS players.
the
Frontrunner in Indian CRAMS sector
DIVI is one of the oldest companies in the Indian Contract Research & Manufacturing
Services (CRAMS) segment. By virtue of its long-standing presence, DIVI has managed
to establish itself in this segment, with CRAMS contribution increasing from 22% in
FY06 to 47% in FY11. It services all the top-10 global innovator companies and has
become a prominent player in providing custom synthesis services from India. It
collaborates with innovator companies all through the early drug development stage
to the commercialization stage. In the process, it has successfully transitioned from a
pure API supplier to a leading CRAMS company from India.
Revenue mix - significant ramp-up in CRAMS contribution
(%)
Generi cs
CRAMS
Neutra ceuti ca l s
2 4 5
43 48
78 85 78 78 74 72 72
57 49
51 49 49 49 45
Divi's: Revenue mix (INR m)
Generi cs
CRAMS
Neutraceuti cal s
1,248
200
-
5,072
5,100
FY08
5,580
4,454
6,023
FY09
4,604
FY10
6,350
FY11
8,001
9,041
621
358
6,100
669
9,606
7,747
22 15 22 19 23 23 22
4
6
47 47 47 47 48
-
3,074
849
2,761
FY06
4,074
FY07
FY12E FY13E
Source: Company/MOSL
Commercialization of R&D projects has driven CRAMS growth
DIVI collaborates with the innovator when a new chemical entity (NCE) is under
development, providing the innovator research and chemistry custom services. In
the last few years, the growth in DIVI's CRAMS business has been partly driven by
commercialization of such projects.
11 January 2012
2

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CRAMS - Number of new launches
the
13
11
8
5
5
5
FY06
FY07
FY08
FY09
FY10
FY11
Source: Company/MOSL
Strong relationships with innovators and generics companies
By virtue of its long-standing presence in the CRAMS segment, strong chemistry skills
and its collaborative approach (it does not challenge/infringe innovator patents),
DIVI has managed to establish strong relationships with many large global innovators.
It has relationships with the top 10 global innovator companies as well as with the top
global generics companies.
DIVI generally collaborates with the innovator at the NCE development stage and
partners the innovator right up to the late life cycle management stage of the product.
Post patent expiry, DIVI also partners with large generics players for supply of APIs.
We believe that it is imperative for any CRAMS player to have a presence across the
value chain because:
Presence in contract research helps build strong relationships with innovators at
the development stage itself.
Presence in contract manufacturing ensures scalability of the CRAMS business
since it is at this stage that supply volumes scale up.
We believe that besides the much-needed chemistry skills, its strong relationships
with innovators will help DIVI to record strong double-digit growth in the CRAMS
business in the coming years. Our expectation of strong growth in the CRAMS business
is underpinned by the fact that innovators are likely to increase outsourcing from
Indian players in their quest for cost control and faster project turnaround.
Among the most profitable companies in Indian Healthcare
Divi's Labs features among the most profitable companies in the Indian Healthcare
sector, with EBITDA margin of 36-38%, backed by its strong chemistry skills and custom
synthesis presence. It has the largest portfolio of highly profitable custom synthesis
projects in India.
11 January 2012
3

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Indian Pharmaceuticals Sector: EBITDA margin, RoCE and RoE
Company
Aventis Pharma
Biocon
Cadila Health
Cipla
Divis Labs
Dishman Pharma
Dr Reddy’ s Labs
GSK Pharma
Glenmark Pharma
IPCA Ltd
Jubilant Organosys
Lupin
Ranbaxy Labs
Sun Pharma
Opto Circuits
Torrent Pharma
Strides Arcolab
FY09
18.9
20.1
20.7
23.3
43.9
24.6
21.8
34.8
16.2
20.6
19.2
17.2
11.3
44.6
31.6
16.3
6.8
EBITDA Margins (%)
FY10
FY11
15.2
13.2
19.9
21.2
21.7
22.2
24.5
20.9
43.0
37.6
22.3
16.4
20.2
20.9
35.0
34.9
24.2
20.1
21.3
19.8
20.9
15.2
18.0
18.7
9.4
20.8
33.2
34.4
34.0
28.0
18.5
14.4
14.3
19.3
FY09
31.9
6.2
23.6
17.1
40.6
15.2
-2.9
44.0
8.0
22.4
8.2
25.6
9.8
31.6
37.4
28.1
3.0
RoCE (%)
FY10
26.3
15.6
26.4
20.6
27.3
11.4
2.6
43.0
12.7
24.0
12.7
27.5
9.8
18.7
28.5
28.7
8.1
FY11
23.6
19.3
30.5
15.8
28.2
8.1
16.7
44.8
13.4
22.7
6.0
25.1
15.9
23.4
24.1
24.1
11.9
RoE (%)
FY09
FY10
FY11
20.4
17.1
15.5
6.2
16.7
18.1
26.9
35.4
37.5
17.9
17.0
14.5
39.6
24.7
25.9
22.7
15.3
9.7
-12.3
2.5
24.1
29.1
28.7
30.1
7.0
14.1
17.4
28.3
26.8
22.8
22.5
24.4
10.5
37.1
34.1
29.3
7.2
4.4
19.4
30.2
12.8
16.2
51.7
33.9
30.4
42.0
36.2
29.2
-8.5
9.9
11.6
Source: Companies/MOSL
the
Generic API business - a cash cow
DIVI has a strong generic API business and enjoys worldwide cost and market share
leadership in some of its marketed products. This has helped the company to maintain
higher profitability than its peers in this business. Key products where DIVI enjoys
strong global positioning include:
1. Naproxen
2. Dextromethorphan
3. Levetiracetam
4. Nabumetone
Many of the APIs that DIVI manufacturers are older generation products, where patents
have expired and the industry has gone through the entire cycle of generics entry
(leading to higher competition and lower prices) and subsequent consolidation.
Despite being a late entrant in some of these products, DIVI now commands a majority
share of the global market, led by its low cost of manufacturing and exit of certain
competitors. It currently has a pipeline of 41 drug master files (DMFs) filed with the
US FDA, certificate of suitability (CoS) for 12 products with the European Directorate
and dossiers for 28 products with other countries. We expect this business to record
19% revenue CAGR over FY11-13, led mainly by expanded capacities and price increases
for key APIs and new generic API launches.
11 January 2012
4

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ffice
APIs - Number of new launches
the
8
6
4
2
FY06
FY07
FY08
FY09
4
2
FY10
FY11
Source: Company/MOSL
Carotenoids - yet to ramp up
DIVI is targeting Carotenoids as an additional growth driver in the coming years. It is
targeting the global synthetic Carotenoids market by tying up with food companies
and feed manufacturers. The global Carotenoids market - including food, feed and
pharmaceuticals - is estimated at ~USD1b. Europe accounts for almost half of this
market and the US accounts for ~20%. Feed will continue to dominate Carotenoids
demand for the next few years. This business has high entry barriers because of
complexities in manufacturing.
DIVI commissioned its Carotenoids facility in FY09 and has identified six Carotenoids
- Beta-carotene, Lycopene, Astaxanthin, Apocarotenal, Lutein and Canthaxanthin - as
its key products in this segment. The USD1b global Carotenoids market is estimated
to grow at 10-15% per annum. DIVI intends to offer comparable quality Carotenoids,
but at a significantly lower price (due to its low cost of manufacturing). Currently, two
players - DSM and BASF - that collectively command a market share of 90-95%, lead
this market. We believe that it may not be easy for an unknown player like DIVI to
gain significant market share (despite the cost advantage) in the short term.
Strong capex imparts visibility to future growth
DIVI has undertaken a capex of INR2b (spread over FY11-12) on an SEZ. Past track
record indicates that the company generally does not undertake large capex without
visibility of customer contracts. Given the limited information shared by the
management on such contracts (due to confidentiality reasons), we track capex as a
lead indicator of future growth for DIVI. The capex on the SEZ is likely to come up for
utilization from FY13 onwards and will fully ramp up in FY14, driving topline growth.
Strong guidance reflects management confidence
The management has guided sustenance of 20-25% topline growth over the next two
years, while retaining EBITDA margin at historic levels of 36-38%. We believe that the
strong guidance is partly based on the management's expectation of revenue
contribution from the new SEZ. We estimate topline CAGR of 23.4% for FY11-13 and
average EBITDA margin of 37.4% in this period, led mainly by 25% revenue CAGR in
the CRAMS business.
11 January 2012
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FY12 Guidance
Parameter
Topline growth (%)
Guidance
25
Remarks
Recovery in CRAMS business coupled with new launches in
API segment, ramp-up in Neutraceuticals to drive top-line
growth. We estimate FY12E top-line growth of 25.5% at
INR16.4b.
Management has guided sustaining EBITDA margins at FY11
levels of 37.6%. We estimate 36.4% margins
Our estimates factor-in tax rate of 20%
Resumption of capex implies up-tick in customer sourcing
Source: Company/MOSL
the
EBITDA Margins (%)
Tax rate (%)
Capex (INR b)
37.6
20
1.75
Fixed rate contracts will restrict benefits from a favorable currency
Despite ~92% of revenue coming from exports and 60-70% of revenue denominated
in USD, DIVI will only partly benefit from the recent depreciation of the INR v/s the
USD, as many of its large contracts carry a fixed exchange rate clause. We believe that
~50% of DIVI's overall sales fall in this category. The remaining 50% will benefit from
a favorable currency. However, as 30-35% of raw material is imported, the positive
impact of a favorable currency will be tempered by the higher cost of such inputs.
Free cash flows likely to improve from FY13
While DIVI has been generating free cash flows for the past few years, these have
declined in the recent past due to a combination of pressure on business in FY11 (due
to customer inventory de-stocking) and the new INR2b capex on the SEZ. We note
that the high capex cycle is coming to an end by FY12 and improved capacity utilization
should lead to higher free cash flows from FY13.
Free cash flows (INR m)
Cash flow impacted due to customer
inventory de-stocking & large capex
3,576
1,942
2,472
1,322
6,045
4,484
FY09
FY10
FY11
FY12E
FY13E
FY14E
Source: Company/MOSL
Strong return ratios; expect gradual improvement over next two years
Divi's has always enjoyed high profitability which has led to the company recording
strong return ratios. While they have declined from their peak of 40%+ recorded in
FY07-09 period, the company still commands strong return ratios. The decline from
the 40%+ to the current 25-30% is attributed mainly to adverse working capital,
customer inventory de-stocking and capex. We believe that RoCE and RoE are likely
to gradually improve over the next two years led mainly by increased utilization of
the new SEZ and relatively lower capex requirements and a minor improvement in
working capital.
11 January 2012
6

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Strong return ratios
RoCE (%)
47.2
40.0
49.5
26.8
22.4
43.5
39.6
27.3
24.7
28.2
25.9
40.6
30.1
32.0
RoE (%)
the
24.3
26.0
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
Source: Company/MOSL
Valuation and outlook
We remain positive on the prospects of pharmaceutical outsourcing from India, given
the unique combination of low cost and chemistry skills that India offers. We expect
DIVI to be a key beneficiary of the increased pharmaceutical outsourcing from India,
given its strong relationships with global innovator pharmaceutical companies.
Expect 18% earnings CAGR over FY11-13; Buy:
We estimate topline CAGR of 23.4%
over FY11-13 and average EBITDA margin of 37.4% in this period, led mainly by 25%
revenue CAGR in the CRAMS business. EPS CAGR for the period is likely to be 18%. EPS
growth would be lower than topline growth due to significant increase in effective
tax rate from 9% in FY11 to 19% in FY13. We estimate RoCE and RoE of 25%+ for the
next few years, led by traction in the high-margin CRAMS business and incremental
contribution from the Carotenoids business. The stock trades at 22.2x FY12E and 17.5x
FY13E earnings.. We reiterate
Buy,
with a price target of INR910 (20x FY13E EPS).
Divi's: Revenue model
(INR M)
Generic Products
% of sales
CRAMS
% of sales
Carotenoids
% of sales
Total
FY08
5,400
52
5,072
48
-
-
10,472
FY09
6,023
51
5,580
47
200
2
11,803
FY10
4,604
49
4,454
47
358
4
9,416
FY11
6,350
49
6,100
47
621
5
13,071
FY12E
FY13E
FY11-13
CAGR (%)
19.3
8,001
9,041
49
45
7,747
9,606
25.5
47
48
669
1,248
41.8
4
6
16,417
19,895
23.4
Source: Company/MOSL
Divi's: One year forward P/E band
32
25
18
11
4
11.2
20.1
P/E (x)
Avg(x)
Pea k(x)
Mi n(x)
30.3
17.6
11 January 2012
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Financials and Valuation
Income Statement
Y/E March
Net Sales
Change (%)
EBITDA
Margin (%)
Depreciation
EBIT
Int. and Finance Charges
Other Income - Rec.
PBT before EO Expense
PBT after EO Expense
Current Tax
Deferred Tax
Tax Rate (%)
Reported PAT
PAT Adj for EO Items
Change (%)
Margin (%)
2008
10,328
42.6
4,201
40.7
357
3,845
102
32
3,775
3,775
194
105
7.9
3,476
3,476
81.1
33.7
2009
11,803
14.3
5,178
43.9
479
4,700
72
-145
4,482
4,482
266
50
7.0
4,166
4,166
19.9
35 .3
2010
9,416
-20.2
4,053
43.0
515
3,538
28
343
3,853
3,853
408
42
11.7
3,403
3,403
-18.3
36.1
2011
13,071
38.8
4,915
37.6
534
4,381
22
365
4,724
4,724
405
26
9.1
4,293
4,293
26.1
32.8
the
(INR Million)
2012E
16,417
25.6
5,968
36.4
655
5,313
35
644
5,922
5,922
1,184
0
20.0
4,737
4,737
10.4
28.9
2013E
19,895
21.2
7,619
38.3
722
6,897
44
586
7,439
7,439
1,413
0
19.0
6,026
6,026
27.2
30.3
Balance Sheet
Y/E March
Equity Share Capital
Total Reserves
Net Worth
Deferred liabilities
Total Loans
Capital Employed
Gross Block
Less: Accum. Deprn.
Net Fixed Assets
Capital WIP
Investments
Curr. Assets
Inventory
Account Receivables
Cash and Bank Balance
Loans & Advances
Curr. Liability & Prov.
Account Payables
Provisions
Net Current Assets
Appl. of Funds
2008
258
8,356
8,614
383
861
9,857
6,422
1,451
4,971
631
556
5,630
2,814
2,095
142
579
1,930
1,564
366
3,700
9,857
2009
259
12,155
12,414
432
526
13,372
7,828
1,929
5,899
195
1,718
7,671
4,213
2,660
148
650
2,110
1,621
489
5,561
13,372
2010
264
14,914
15,178
474
328
15,981
8,329
2,431
5,898
238
4,413
8,040
4,985
2,232
165
658
2,608
1,643
964
5,432
15,981
2011
265
17,710
17,975
500
230
18,706
8,857
2,958
5,899
1,293
5,256
10,299
5,717
3,674
177
731
4,042
2,424
1,618
6,257
18,706
(INR Million)
2012E
265
20,795
21,060
500
274
21,834
11,687
3,598
8,089
1,293
4,906
2013E
265
24,966
25,231
500
274
26,005
12,687
4,319
8,367
1,293
7,506
12,436
14,615
6,895
8,157
4,432
5,173
206
191
903
1,094
4,890
5,776
3,119
3,780
1,771
1,996
7,546
8,839
21,834
26,005
E: MOSL Estimates
11 January 2012
8

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Financials and Valuation
Ratios
Y/E March
Basic (INR)
EPS
Cash EPS
BV/Share
DPS
Payout (%)
Valuation (x)
P/E
Cash P/E
P/BV
EV/Sales
EV/EBITDA
Dividend Yield (%)
Return Ratios (%)
RoE
RoCE
Working Capital Ratios
Fixed Asset Turnover (x)
Debtor (Days)
Inventory (Days)
Working Capital Turnover (Days)
Leverage Ratio (x)
Current Ratio
Debt/Equity
2008
26.9
29.7
66.7
2.0
8.7
2009
32.2
35.9
95.8
3.0
10.9
2010
25.8
29.7
114.9
6.0
27.2
2011
32.4
36.4
135.6
10.0
36.2
2012E
35.7
40.7
158.8
10.6
34.9
2013E
45.4
50.9
190.2
12.0
30.8
the
24.5
21.8
5.9
8.1
21.4
1.3
22.2
19.5
5.0
6.4
17.7
1.3
17.5
15.6
4.2
5.3
13.8
1.5
49.5
47.2
39.6
40.6
24.7
27.3
25.9
28.2
24.3
30.1
26.0
32.0
2.4
74
99
126
2.2
82
130
167
1.6
88
193
204
2.2
104
160
170
2.3
100
153
163
2.4
96
150
159
2.9
0.1
3.6
0.0
3.1
0.0
2.5
0.0
2.5
0.0
2.5
0.0
Cash Flow Statement
Y/E March
Op.Profit/(Loss) bef. Tax
Interest/Dividends Recd.
Direct Taxes Paid
(Inc)/Dec in WC
CF from Operations
(inc)/dec in FA
(Pur)/Sale of Investments
CF from Investments
Change in networth
Inc/(Dec) in Debt
Interest Paid
Dividend Paid
CF from Fin. Activity
Inc/Dec of Cash
Add: Beginning Balance
Closing Balance
11 January 2012
2008
4,201
32
-194
-675
3,365
-1,764
-550
-2,314
20
-679
-102
-302
-1,081
-30
172
142
2009
5,178
-145
-266
-1,855
2,912
-971
-1,162
-2,133
89
-334
-72
-456
-773
6
142
148
2010
4,053
343
-408
145
4,133
-557
-2,695
-3,252
285
-198
-28
-925
-865
17
148
165
2011
4,915
365
-405
-813
4,062
-1,591
-844
-2,434
56
-98
-22
-1,552
-1,616
12
165
177
(INR Million)
2012E
5,968
644
-1,184
-1,260
4,167
-2,844
350
-2,494
0
44
-35
-1,652
-1,643
2013E
7,619
586
-1,413
-1,308
5,484
-1,000
-2,600
-3,600
0
0
-44
-1,855
-1,899
29
-15
177
206
206
191
E: MOSL Estimates
9

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