6 March 2014
Update | Sector: Healthcare
Divi's Laboratories
BSE Sensex
21,514
S&P CNX
6,401
CMP: INR1,434
TP: INR1,745
Buy
Full steam ahead
USFDA inspection - key near term trigger, higher dividend payout likely
Stock Info
Bloomberg
Equity Shares (m)
52-Week Range (INR)
1, 6, 12 Rel. Per (%)
M.Cap. (INR b)
M.Cap. (USD b)
DIVI IN
132.7
1,459/905
0/35/27
190.3
3.1
Financial Snapshot (INR Billion)
Y/E March
2014E 2015E 2016E
Sales
EBITDA
Net Profit
Adj. EPS (INR)
EPS Gr. (%)
BV/Sh. (INR)
RoE (%)
RoCE (%)
P/E (x)
P/BV (x)
25.5
10.4
8.2
61.9
36.4
29.9
38.2
23.2
6.4
31.4
12.5
9.4
70.7
14.3
28.9
36.7
20.3
5.4
37.9
15.3
11.6
87.2
23.4
30.5
38.8
16.4
4.7
Strong operational performance has been driven by growth in existing
business. USFDA approval to further drive growth.
Management does not expect major capex over the next two to three
years, as the focus will remain on sweating recently-expanded capacities.
In the absence of any attractive expansion avenues, DIVI may consider
increasing its dividend payout, going forward.
With a healthy order book and robust business outlook, management is
confident of growing sales by at least 20% next year, with EBITDA margin
of at least 40%. We expect earnings to post 20% CAGR over FY14E-16E.
Reiterate Buy and retain as top pick in mid cap space.
Business outlook remains strong, preferred partner in CRAMs
Despite declining R&D productivity in the innovator pipeline, consolidation at
the top and threat from patent cliff, DIVI remains confident of its business
outlook. It continues to be the preferred partner for most of the top pharma
MNCs. Over the years, DIVI has added value in the R&D process for its partners
and presently enjoys preference over other less established CRAM players. In
the generic APIs segment, a focused approach since inception enabled the
company to develop superior chemistry skills, which enables it to retain
significant market share along with high profitability in some of the mature
molecules like Naproxen. DIVI believes it is possible to replicate a similar model
in certain molecules that recently lost patent protection.
225.5 264.4 308.0
Shareholding pattern %
As on
Dec-13 Sep-13 Dec-12
Promoter
Dom. Inst
Foreign
Others
55.8
16.8
10.2
17.2
55.8
16.7
9.6
17.9
55.8
16.9
10.1
17.2
Financial health to improve further, higher dividend payout likely
DIVI does not expect any significant capex to grow its revenue by 15-20% over
the next three years. Overall current capacity utilization remains at 70-75% and
is likely to scale up with the USFDA approval for DSN SEZ. Management also
expects the EBITDA margin to sustain at 40% in the medium term,
notwithstanding any unfavorable currency movement. Hence, it is open to an
increase in dividend payout, going forward.
Stock Performance (1-year)
Comfortable valuations despite recent run-up, reiterate Buy
We believe DIVI has created a sustainable business model by maintaining a
focused business strategy which revolves around respecting IPRs and refraining
from manufacturing formulations. This is reflected in its consistency in
achieving above industry profitability and return ratios. Further, with an
expected improvement in dividend payout, we believe that DIVI should at least
trade at sector average valuations. Hence, we have increased our target
multiple to 20x (earlier 18x) on FY16E EPS. We reiterate a
Buy
with a revised
target price of INR1,745 and retain DIVI as our top pick in the mid cap space.
Alok Dalal
(Alok.Dalal@MotilalOswal.com); +91 22 3982 5584
Hardick Bora
(Hardick.Bora@MotilalOswal.com); +91 22 3982 5423
Investors are advised to refer through disclosures made at the end of the Research Report.

Divi's Laboratories
Business outlook remains strong, preferred partner in CRAMs
Despite the declining productivity, consolidation between innovators and threat
from patent cliff, the business outlook for DIVI looks robust. In a bid to lower the
R&D cost burden, Big Pharma is actively tying up with research partners. With strict
adherence to cGMP, compliance to patent regulations, quality standards and on-
time deliveries, company has been able to further strengthen its relationship with
some of the leading MNCs.
R&D productivity for innovators continues to decline, trend in outsourcing
to continue
R&D productivity for most of the top MNC pharma companies has been declining
over the past decade. This is reflected in the slowdown in NDAs/BLAs approvals
(New Drug Application/Biologic License Application) by the USFDA and increasing
R&D cost to develop new drugs. Hence, these large MNCs are actively tying up with
research partners to lower their R&D cost burden. While the exact number of
contracts and their nature is not known, we believe there is enough scope for DIVI
to grow its custom synthesis business, given the vast R&D pipeline of innovators
(refer exhibit 3).
Exhibit 1: Slowing pace of NDA/BLA approval v/s filings
Exhibit 2: Increasing cost to develop a new drug
Source: USFDA, Company, MOSL
Source: PhRMNA 2013 Profile, MOSL, * Constant Dollars, year 2000
Exhibit 3: Pipeline of major pharma MNCs
Company
Pfizer
Roche
Merck & Co.
GSK
Sanofi
Eli Lilly
Phase 1
31
38
N/A
27
23
26
Phase 2
24
38
20
47
14
25
Phase 3
20
29
13
31
11
8
Registration
6
7
9
11
1
4
As of
Nov-13
Dec-13
Oct-13
Mar-13
Feb-14
Jan-14
Source: Company, MOSL
Total
81
112
42
116
49
63
Differentiated CRAMS player, huge entry barriers in DIVI’s space
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
6 March 2014
2

Divi's Laboratories
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 helped DIVI to establish strong customer relationships, leading to
scale-up of its CRAMS and API businesses over the last five years and simultaneously
sustain higher profitability and return ratios. They also helped the company to
differentiate from other Indian CRAMS players.
DIVI not just an executor but adds value to its partner
DIVI generally collaborates with the innovator at the NCE development stage and
partners the innovator right up to the late lifecycle 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 as:
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 as
it is at this stage that supply volumes scale up.
In the last few years, growth in DIVI's CRAMS business has been partly driven by
commercialization of such projects.
Exhibit 4:
CRAMS - No. of new launches
Source: Company, MOSL
Generic API business - a cash cow
A focused approach since inception enabled the company to develop superior
chemistry skills, which enables it to retain significant market share along with high
profitability in some of the mature molecules. Key products where DIVI enjoys
strong global positioning include Naproxen, Dextromethorphan, Diltiazem and
Levetiracetam.
Many of the APIs that DIVI manufactures are older generation products, where
patents have expired and the industry has gone through the entire cycle of generics
entry and subsequent consolidation. Despite being a late entrant in some of these
products, DIVI commands a majority share of the global market, led by its low cost
of manufacturing and exit of certain competitors. It is possible to replicate a similar
model in some of the molecules that recently lost patent protection. It has a
6 March 2014
3

Divi's Laboratories
pipeline of 44 drug master files (DMFs) filed with the USFDA and certificate of
suitability (CoS) for 16 products with the European Directorate.
Exhibit 5:
APIs - No. of new launches
Source: Company, MOSL
Strong operational performance expected in medium term
We expect the company to post 22% revenue CAGR over FY14E-16E, largely driven
by increasing capacity utilization from DSN SEZ this year (subject to USFDA
inspection and approval). Three of the five manufacturing blocks of the said facility
are expected to be inspected by the USFDA in the beginning of FY15 and DIVI is
expected to achieve peak sales of INR8-10b by FY16E (INR3.5b in 9MFY14).
Management indicated that the business is likely to tilt towards generic API business
over the next few years.
Exhibit 6:
Revenue mix (INR m)
Exhibit 7:
Revenue mix (%)
Source: Company, MOSL
Source: Company, MOSL
Capex phase over, time for free cash flows to come
Company does not foresee any significant capex to grow its revenue by 15-20% over
the next three years. Overall current capacity utilization remains at 70-75% and is
expected to scale up with the USFDA approval for DSN SEZ. Management also
expects the EBITDA margin to sustain at 40% in the medium term, notwithstanding
any unfavorable currency movement. Thus, it is open to increasing the dividend
payout, going forward.
6 March 2014
4

Divi's Laboratories
High level of profitability to sustain
Over a period of time, DIVI has sharpened its chemistry skill sets. After spending
increasing amount of time on mature molecules, company has been able to create
processes that result in higher yield. Management indicated that profitability in
Naproxen presently is much higher than what it was when first launched. Thus,
some molecules launched now could become as profitable and large like Naproxen
immediately. Hence, management is confident of sustaining the EBITDA margin at
40% in FY15.
Exhibit 8:
EBITDA margin to sustain
Source: Company, MOSL
No major capex outlined for next two years
Management does not plan to have significant capex outlined for the next two
years. The focus will be to increase the utilization of recently-expanded capacities. It
indicated that the overall capacity utilization is ~70-75%. Management also stated
that it will not scout for any inorganic opportunities to drive growth, unless the
potential acquisition provides complimenting talent and skills. Entry into any new
technology is likely to require limited investment as it would be developed in-house
first through internal accruals. Maintenance capex is expected to be INR600-700m.
Increasing free cash flow likely to be distributed to shareholders
Strong earnings growth and limited capex is likely to increase the excess free cash
flow at the company’s disposal. Management indicated that it is open to increasing
the dividend payout to shareholders. Current cash yield was indicated to be 7-7.5%.
Exhibit 9:
Limited capex requirement
Exhibit 10:
Increasing free cash flow (INR m)
Source: Company, MOSL
Source: Company, MOSL
6 March 2014
5

Divi's Laboratories
Exhibit 11:
Dividend payout expected to increase
Source: Company, MOSL
Comfortable valuations despite recent run-up, reiterate Buy
We believe DIVI has created a sustainable business model by maintaining a focused
business strategy which revolves around respecting IPRs and refraining from
manufacturing formulations. This is reflected in its consistency to achieve above
industry profitability and return ratios (refer exhibit 12). Further, with an expected
improvement in dividend payout, we believe that DIVI should at least trade at sector
average valuations. Hence, we have increased our target multiple to 20x (earlier
18x) on FY16E EPS. We reiterate a
Buy
with a revised target price of INR1,745 and
retain it as our top pick in the mid cap space.
Exhibit
12:
Indian pharmaceuticals sector: EBITDA margin, RoCE and RoE
EBITDA Margin (%)
RoE (%)
Company
FY11
FY12
FY13
FY11
FY12
Biocon
Cadila Healthcare
Cipla
Divi's Labs
Dr. Reddy's Labs
GSK Pharma*
Glenmark Pharma
IPCA Labs
Lupin
Ranbaxy
Sanofi India
Sun Pharma
Torrent Pharma
21.2
22.2
21.7
37.6
21.0
34.9
20.1
19.8
17.8
20.8
13.2
34.2
17.6
24.8
20.6
23.6
36.9
24.5
31.8
24.5
21.8
17.3
16.6
14.3
39.9
19.4
21.8
17.7
26.5
37.9
21.3
30.3
21.2
22.2
21.3
15.6
15.6
43.7
21.6
18.0
37.4
14.4
25.9
24.1
30.1
17.4
27.4
29.6
22.5
15.5
16.2
29.2
14.9
27.5
14.3
27.1
21.6
32.9
13.5
24.0
21.7
-101.3
17.3
21.5
29.7
FY13
12.1
23.7
12.7
26.0
20.7
33.7
18.1
23.1
22.5
31.4
14.8
22.5
35.8
FY11
19.2
30.4
15.7
28.2
16.8
44.8
13.4
25.6
25.3
18.4
23.6
23.6
24.4
RoCE (%)
FY12
13.0
22.9
18.0
34.1
19.7
47.9
11.4
24.1
24.6
20.9
25.3
30.4
28.8
FY13
17.8
17.9
19.4
33.1
17.2
49.4
16.1
25.2
33.3
21.0
21.5
31.5
33.5
Exhibit 13:
Above industry return ratios
Exhibit 14:
P/E (x)
Source: Bloomberg, Company, MOSL
Source: Bloomberg, Company, MOSL
6 March 2014
6

Divi's Laboratories
NOTES
6 March 2014
7

Divi's Laboratories
Financials and valuation
6 March 2014
8

Divi's Laboratories
Financials and valuation
6 March 2014
9

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DIVI'S LABORATORIES LTD
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Divi's Laboratories
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