We downgrade Divi’s Laboratories to neutral from overweight but revise target price higher to R1,974 from R1,718 earlier. We believe while the ex-gDiovan business is steady, the stock which has had a very strong run (up 30% in three months), is fully valued. At the current price, it is trading at a 29x FY15 and 23x FY16 estimates. We roll forward our target price while making adjustments – increasing generic sales but reducing operating margin forecasts (FY15e margin cut by 300 bps). We value Divi’s at 22x (earlier 21x), which is 1x PE and in line with the current valuations, at Sep-16e EPS of R89.7 to arrive at our new target.
Net profit beat estimate by 14% driven by a robust sales beat of 20%. Sales too were well ahead of estimates on the back of higher contribution of gDiovan, which Divi’s is supplying to Ranbaxy during the six-month exclusivity in the US market. EBITDA margin at 36.8% was 330 bps lower than our estimate, which implies that gDiovan margins are low for Divi’s.
Given higher supplies of Valsartan (gDiovan) in Q2, generic share is higher at 54% while custom synthesis is at 46%. Post Q3, gDiovan should be immaterial, in our view. The company attributes the lower margin in the quarter to this higher generic mix. Divi’s continues to maintain 20% sales growth guidance for FY15 with margins close to the H1 level of 37%. At 20% sales growth, implied sales growth for H2 is just 8%. We believe while this guidance is conservative, margin should continue to remain depressed as certain costs such as power are expected to increase.