Divi’s Laboratories (DIVI) has been informed by the US FDA that it will lift the import alert under clause 99-32 on the company’s Unit-II at Visakhapatnam. The US FDA had issued an import alert under clauses 99-32 and 66-40 in March 2017, and then a warning letter in May for its Vishakhapatnam facility. Import alert under clause 99-32 typically comes when a company has not co-operated with the US FDA during inspection. Lifting of this clause may be seen as a sentiment positive; however, since the plant remains under import alert under clause 66-40, our estimates will not change.
We believe that the facility will need to go through a reinspection before coming back on track. Although exposure to the US market from Unit-2 stands at ~22% of total sales, management expects revenue loss to be restricted to ~5% of total sales because of the exempted product list and the increase in supply to ex-US markets.
We expect revenue loss of ~15%, given: risk of import alert from smaller regulators (including Health Canada, which has already asked for additional information post the US FDA inspection), risk of loss of business from existing clients, restricted supply from the Unit-2 products exempted list due to batch-by-batch testing requirement from third-party auditors.
Unit-1 accounts for 35% of total revenue, with its exposure to the US market at ~11% of total revenues. This plant was last inspected in June 2014, and an inspection is due over the coming few days.
It will be critical for the company to come out clear in this inspection (particularly since the US FDA had cited data integrity issues at Unit-2). DIVI has cash of ~Rs 17bn. There is a possibility of buyback/special dividend (like DRRD) in the near term, which could provide near-term support to the stock price. We expect the stock to remain range-bound in the near term, given the uncertainty related to impact of current import alert, resolution timeline and Unit-1 inspection results. We maintain Neutral with a target price of Rs 600.
On a going concern basis too, large capex addition and a delay in the commencement of facility should keep growth under check until FY19E. However, a strong balance sheet (net cash surplus) and high return ratios (RoE at ~29%) provide valuation cushion.