Divislab


(Donald Francis) #61

A charitable view to think on this - Procedures by FDA have been made more stringent. Respected names have been caught (sometimes repeatedly) on this front. This otherwise competent Management will shape up. Its a business process reality today!!

A less-charitable (impartial?) view to think on this - As Pat Dorsey and other Gurus have repeatedly pointed to - “How transparently upfront does the Management communicate in difficult times?” - brings Management Transparency quality rating to the fore.

It goes without saying that Divi’s Management has been found woefully short in Upfront Communication. But again, do we expect all our invested businesses to behave completely upfront - there are degrees of-course!

And this is where it has started worrying some folks more - as these can’t be termed “inadvertent” slip ups. Although in the latest instance, this was corrected the next day - there was a big “material” slip in communication again - from the back to back notifications submitted to Stock Exchanges on Mar 21 and Mar 22 today.

Mar 21 Update: USFDA Import Alert issued under [Clauses 66-40] on 20th Mar 2017
Mar 22 Update: Clarification: USFDA Import Alert was issued under two Clauses 66-40 and Clauses 99-32

Quoted, as is from above FDA docs
Clause 99-32
Import Alert Name:
“DETENTION WITHOUT PHYSICAL EXAMINATION OF PRODUCTS FROM FIRMS REFUSING FDA FOREIGN ESTABLISHMENT INSPECTION”

The refusal to permit inspection of a foreign facility or provide reasonable access to FDA’s inspectional personnel, combined with other evidence, provides an appearance that the firm’s products are manufactured, processed, or packed under insanitary conditions.

Will again revert on implications/severity of Import Alert issued under Clauses 99-32 - from interaction with domain experts


(Abhishek Basumallick) #62

My 2 cents worth…
There are a few decision points on Divi’s at this point in time, IMHO.

  • Is the management capable and trustworthy even in an updated US FDA environment?
  • Can they fix this import alert in a reasonable timespan (2-3 years)?
  • Will there be a ripple effect on its other plants / products?

At a broad level we need to answer these questions.

There are 2 sides that is important in a negative news situation like this - the business side and the stock side. In my experience it’s always best to stand apart and let the stock price play itself out for sometime. The stock price is not going to run away anywhere in the next 3-6 months, which will give enough time to see the various news flow, steps the management is taking and management commentary.


(sta) #63

I agree.Something similar happened in ipca. Every one was confident about the management. Then European ban came. And they are still struggling.


(ANANT JAIN) #65

Divis management has always been limited in its communication, whether it is a bug or feature is for an investor to take a call. There are always managements who do not communicate routinely and neither do they meet investors irrespective of times, except during AGM or other official events.,IMO this does not make them less efficient or any lesser mgmt. as long as they are consistent. I would love to know what Pat Dorsey or other Gurus says about those managements who do not communicate at all except during AGM or other official events and public disclosures.

Not quoting 99-32 is a miss but I wouldn’t pass judgments on management on a single miss which was corrected next day. I would love to see more examples before being judgmental.

Having said the above I do agree management in this instance has been giving interviews to news channels which I feel is totally unwarranted and should be reprimanded. A public press release or disclosure would have been the right way to go about.


(Sunnytv) #66

I find these situations fascinating and demonstrates how contradictory and difficult investing is. From the other thread on HM, one way to look at it is

  • what do I know what others don’t know ? (In this instance nothing)
  • what edge do I have ( except time nothing much)
  • from a short term price perspective, what’s the risk in losing money- probably high, longer term probably low
    so we don’t have much information to go by, other than a leap of faith and a general sense of probability that things might sort out over the next few years based in the past.

But at the same time, if you wait for the dust to settle, everyone figures it out and the bargain is gone. It’s a bad idea to catch falling knives, but if it’s a well made knife and not a cheap Chinese one, May be worth it: HM says we are paid to catch good falling knives and not wait for things to settle ( might be meant for funds not for retail investors)

This is essentially the same situation of nestle maggi fiasco or jand J panadol fiasco- how do you make a decision at that other than by a leap of faith? How could you buy nestle when it was sub 5000 at the height of maggi issue- no knew what was going on, there is no way anyone could have special edge or knew more than others. It is a leap of faith and trust in the brand name and company. I don’t know if that’s a good way of investing

I am not sure whether we overplay the managment card a bit too much nowadays: I didn’t buy maruti when the manager was burned to death when it was 900 odd ( my logic was bad governance) and now it has multiplied three or four times. Everyone was gung-ho about slamming Infosys when the son came into the picture and governance was the most common word in the papers- it has doubled or more from that level.

What I am trying to tell is, there is no way in these type of situations to know what the future holds. At a certain price, we use our experience and gut feeling and make a bet when the probability is your side. No amount of debating will solve the conundrum of what the future holds in these situations.


(Donald Francis) #67

Great to see good constructive participation - exposing assumptions behind our decision-making is a great way to see what we may be missing/found wanting on - as others also expose their assumptions.

At the same time, again a request to folks who already have minds made-up either way - either to take a leap of faith or abstain totally - to hold their horses, and not clutter up the thread. Let those who want to examine the issue at a deeper level - learn from the exercise. Not everyone is as experienced as you may be - a large part of the community among us learners may find the exchanges meaningful - not sure if everyone understands the business well. I certainly have many more questions on the business side of things.

So let’s shift focus back to the business - I am deliberately putting on the devil’s advocate hat (we need more) - to convince myself if it is worth taking that leap of faith - and why? A concentrated guy like me with 8-10 businesses can’t afford to do broad-strokes investing. If this business has to enter my Portfolio, its gotta dislodge 1 or 2 existing ones from their perch.

Please allow further scrutiny :slight_smile:


Despite the first-rate numbers, a couple of things stood out for me. And I want more knowledgable folks to help comment/suggest the correct ways of thinking about this

1.I do not find Divis a low capital-intensity business, or good on asset turns like couple of friends have mentioned. I find Divi’s is a very Capital Intensive business - both on Fixed Capital intensity and Working Capital intensity.

In fact in my limited scrutiny of good-to-great businesses, this is the first time I am seeing a combination - when both Working Capital demands and Fixed Capital Demands on the business growing is very high.

2.If this business actually enjoys all the good things (in the forseeable future too) - huge longevity, unquestioned competitive strengths, great demonstrated earnings quality (as we all know - EBIT and Returns, and thus EPA) - why has the market failed to value it richly over such a long period of time?

We all agree that over the long-term Mr Market is pretty efficient in assigning Value. And if this business has been offered at 19-23x multiple times - since it became a well-discovered business, there might be a reason, behind?

I have always found it immensely beneficial to WONDER why certain businesses in my Portfolio/and Outside have been valued highly after 5-6 years by Mr Market - have always learnt from such endeavours every year - those curious about this aspect, may like to join me in understanding this aspect better


(Donald Francis) #68

Now, for this other concept (new to me) that I am trying to get a handle on - Threshold Margin or Value Neutral Operating Margin

I liked the way MIchael Mauboussin talks about this aspect in the Base Rate Book , but so far havent been able to draw impact-conclusions.

The threshold margin is the level of operating profit margin at which a company earns its cost of capital. To break even in terms of economic value, a company with higher capital intensity requires a higher operating profit margin than a company with lower capital intensity. So threshold margin is an analytically sound way to make the connection between sales growth, profits, and value creation.

Those who are familiar with this concept and its implications may like to help me. The only observation I have been able to make so far (checking data-points for other businesses) is that all things being equal - for a Capital-Intensive business, the Threshold margin is quite close to the normalised EBIT margins. Higher the EBIT Margin, higher the required Threshold Margin :slight_smile:

So I can make it out that for Divi’s to continue to keep a good pace of Value Creation up - its imperative that it maintains high EBIT levels.

How does this aspect impact future Value Creation - in the current situation with ?

  • capacity constraints being faced, brownfield expansions impacted, lower Sales, lower margins, expanded costs in quality systems infrastructure/compliance.

If you factor in EBIT Margins lowering by 300 basis points, how does this picture look?

I am struggling with these questions - any help is appreciated. I believe there is still a lot to learn in the Investment Maturity Curve - many incremental concepts we can learn to harness and enhance understanding of how a business creates Value - not just this Divi’s situation!

Will come back with questions on Product/Revenue segments - after I get a better handle on them/competitive scenario.


(Omprakash ) #69

I’m not from financial background . Still i would try to present my way of interpretation here .

Let’s assume Nil growth scenario with the present asset base and incremental investment rate ( FA+WC ) of 50 percent from here . 600*10 = 6000 crore . EBIDTA @ 40 percent would be 2400 crore > COC & ROIC of > 25

The value created by growth depends on two factors

  1. The first is the profitability of the incremental capital employed . The greater the amount by which incremental returns exceed cost of capital ( COC ) , the greater will be the value created by each penny invested . I think best way to assume the things would be to check whether company is investing capital into low margin accretive projects just for the sake of growth . Here it is not the case .

  2. The second factor is the amount of capital that can be employed to earn this higher returns . This depends on how fast the company can grow ( Or newly invested business can grow )

@Donald , probably if you can modify the data by adding numerator ( operating earnings ) , picture would emerge more succinctly

Last ten years data again indicates similar trend . Total incremental asset base was 3000 crore and if we assume 40 percent EBIDTA , then 1200 crores operating earnings indicates direction of capex .

High margins and low asset turn is good business , may be not so great like staples


(Arindam) #71

Thanks @OM_1417. If we take the data above, Working Capital Intensity has been very high - historically at close to 50% most of the times. Last 9 year average shown as 53%. So what is the reason for assuming Fixed Capital + Working Capital rate to be 50%?

Don’t you think the lower assumed rate - distorts understanding?


(Omprakash ) #72

My assumption was about incremental working capital :grinning:


(Arindam) #73

Yes we are talking about Incremental Working Capital requirement only.

The data seems to show that Incremental Working Capital Rate 9 year average is 53%. Incremental Working Capital required over 9 years/Incremental Sales over last 9 years.

Should we not take much higher Inremental Rates for Fixed Assets+Working Capital? And then the picture doesn’t look so good?


(Omprakash ) #75

@arindam Ideally what you mentioned is right . Company which has credible history of generating superior returns on very high asset base , indicates some strategy .May be they need to maintain inventory to support leadership in generics .Last ten year average dividend distribution has been 30-35 percent , that is the reason for the assumption of 50 percent . Let’s assume 70 percent incremental investment rate . If company could generate higher margins on that base , picture could be even better . So ROCE would reflect better picture here .

As @Donald mentioned , its imperative to generate similar or more margins . That’s where i think it would be more helpful to focus on what can drive the business , margins over longer periods by leaving capital allocation decision to management .

So the key question would be about endurance and key risks


#77

Guys,

Despite requests several times - "let’s wait till the dust settles down" argument - is being recirculated in different ways repeatedly - sometimes by the same guys, and sometimes by others who are picking up late on the new interest in thread, and may not have followed the discussion flow.

Several folks have articulated this well. You will agree that this aspect has been drilled home - with sufficient clarity. Firther repeats are non-value additive. In order to reduce the clutter (non value-additive repetitions) we are constrained to delete such repititions.

Request is to allow the discussion to take a business investigation direction, sustanability of high margins, competitive situation, product/revenue segmentation and the like - unhindered.

Thanks for your co-operation.


(hsay) #78

I am pretty new to investing in pharma stocks and it attracted my attention only due to their recent lackluster performance compared to the broader markets. The analysis on this thread is very educating. But, I was wondering if there are certain questions on which a more educated guess can be made that may help with decision making.

For example it is widely reported that the current unit under inspection contributes 20% of U.S. revenue for the firm. Given that some APIs are exempted for now, and since in at least one of them the company is a market leader (as far as i can make out). The direct revenue impact may be less than 20% (say 15%, unfortunately I couldn’t find API wise revenue contribution numbers anywhere). But I guess base case scenario assuming a minimum of 15% fall in revenue solely due to actions on this facility is reasonable…

In terms of cascading effect is it possible for someone to shed light on how often such an action leads to

a. Other facilities of the company brought under inspection (considering some of the comments from FDA in the 483 point to company officials being already aware of the issues with respect to quality). I believe this the original 483 from the FDA website: https://www.fda.gov/downloads/Drugs/GuidanceComplianceRegulatoryInformation/CDERFOIAElectronicReadingRoom/UCM534816.pdf. Considering the nature of these findings, if other facilities are not brought into inspection that may in itself be a positive development as their might not be further dampening of revenue. But if that is not the case revenues may face further fall

b.How often has it been seen in the past that such a case leads to other regulators (say EU/ U.K) waking up to carry out their own inspections as well which may result in further fall in revenues.

c.How does the FDA action affect the company’s ability to bring out new products. If there is no sustainable damage to its ability due to this particular case then the growth from these products may provide some cushion to the company in the next 2-3 years (I am assuming that is the best case scenario for this issue to be resolved as of now).

Around its peak price around Aug '2016 markets were pricing 20-25% growth. The company last traded at its current price of 610 around june 14. That is 642 sales in jun '14 v/s dec '16 quarter sales of 976.50 and 167.93 june net profit v/s dec net profit of 268.32. That is about 35-40% de-growth in numbers.

So essentially in June 14 the price of around 600 was pricing in those numbers + 20% growth
So the question is what is today’s price pricing in?
a. better numbers than the ones in june 14 + further de-growth or
b. same numbers as in june 14 + flat or lower growth.

Either way it seems the current price may be factoring in a fall of more than 15-20% in revenues/ profits (closer to 30-40% or more). If the prices fall further it would be factoring an even bigger de-growth and/or longer recovery period.This is of course not accurate but only a rough gauge of value being assigned by the market.I have not mentioned other scenarios because they would be more optimistic and will only indicate that at the current price the stock is undervalued.

I personally feel in current scenario, analysis of past financial numbers is incomplete without considering these more qualitative factors. But the ultimate question to answer is this: Is it possible that the company will face a scenario of say 60-70% de-growth due to cascading effect of these factors. As that would mean significantly lower prices than the current price. But if that is unlikely then it could be a value buy.

Personally considering these factors and taking into account my analysis as per elliott wave theory on the long term charts below. I have zeroed in on how to play this for my portfolio.

If this labeling here is correct the price of 482 shouldn’t be violated. Wave 4 is an expanded flat correction and the fall from August 2016 peak is part of the C wave (within wave 4). This fall has a five wave structure which seems to be working in a 5th wave. The prices are also approaching a crucial long term trend line. Although it remains to be seen if it holds. I would probably look to enter if the prices bounce off after testing the trendline and will have a stop loss of 482 (20-25% risk).

If the prices in fact head to 482. It would actually signify markets pricing in a bigger de-growth and either new adverse news would have hit the counter already or may be on the way. In which case I believe the company will likely be grappling with these issues for a couple of years and the stock may go into a slumber for some time.

If however the prices manage to go over 711 (March 21 high), either substantial time would have passed (which would mean probability of some of the cascading effects materializing would have subsided) or we may see some +ve news hitting the counter (or on the way). Either way I would probably add to the position as we get more clarity on some of these points.

This is probably the only way I could see myself playing this contrarian call.

Disc: No investment as of now. Likely to enter as described.


(vgutti) #79

Currently it is trading at key support level 610 if it is fail to hold 610 then next key support is at 470.


(Donald Francis) #80

List of Exempted Products - 22 Mar Divi’s Filing

Request VP Pharma Information experts to take this forward and provide Market Size/Competitive Info as possible. It is quite possible they may get further exemptions - keeping this data-set updated will give us a better handle on share of Exempted and Non-Exempted APIs.

Our experience has been - the best time to keep updating on Business/Competitive understanding of a Business is when the Price is expected to go nowhere - so next 3-6 months is a great time to attempt a more granular understanding of the business through Product/Revenue Segments and Competitive situation, and more


(Kiran K) #81

Cocall details to discuss US FDA import alert details

http://corporates.bseindia.com/xml-data/corpfiling/AttachLive/577b65ad-0c8c-4c1c-9885-3034a25d03d1.pdf


(bbbhutra) #83

I believe one of the reason for the exemption of few of these was because 3-4 of these products have a great market share in their respective category and hence maybe they did it for the greater good.


(nandu02) #84

Hi Om

Thank you for the in-depth analysis on this stock. Its got me upto pace with Divi’s business model.

I hate to interrupt this thread with a “newbie” question, but, still, here it goes:

I used to always think that the Share Capital increasing over time meant that the stock was being diluted. And that was the same assumption I had about Divi’s Lab, till I saw your post where you say that “With nil equity dilution after ipo…”. Now I realize that this share capital increase occurred because of share splitting rather than share dilution.

My question is simply how can I know just by looking at the balance sheet if shares have been diluted, or shares have been split? It doesn’t have to be Om who has to reply to this. Anyone with time for Novice can reply :slight_smile: I usually try googling all the questions I have regarding such topics (I don’t have a finance background, and most terminology used here is alien to me), but I couldn’t find any real answer to this question, and hence I have posted here.

Thanks in advance

N


(Parag) #85

Amazing thread and treasure trove of knowledge from both side (who want to buy and who are concerned about buying). There are other threads, where the whole discussion revolves around supporting buying stock. However, this thread has the healthy dose of skepticism which is great to a learning experience (Howard Mark has a great definition about an experience- “Experience is what you get when do not get what you want”).

Small Anecdote- I have read a similar case in one of the books(I think it was Competitive Advantage of Nations) many years back, and the story stuck with me and it is relevant here. So please bear with me.

After world war two, Japanese companies started exporting products in a major way to the US. At that time Japanese products were not renowned for quality as they are now. In fact, one could compare the quality of Japanese products to Made in Chana quality (not great). Japanese started selling more and more products to the US, but there were not earning much money. The reason- US consumer would return fault product, which would then be shipped to Japan by sea and then resend to the customer in the US. The whole refund cycle had dented a heavy blow to Japanese companies profitability. To solve this problem, Japanese companies took radical solution- “ To make product quality so high that the product won’t be return” and slowly but surely Japanese products started dominating the US and other Europian market.

The same thing could happen for Pharma companies after all the whole sector is grappling with intense FDA inspection. Sooner’ or later pharma companies will realize that it better to be high in quality standard than to fall victim to FDA and lose their reputation and market shares, but it may take time.

If it takes few years to rectify the FDA warnings, so there will be uncertainty surrounding the stock. From fund manager’s perspective (who can buy/sell a large quantity of shared), why would they purchase a stock which is unlikely to outperform the market for next 6-12 month? In fact, if there is a correction in the market- they are tempted to sell it rather than buy it IMO.

I am sure the same (or similar) situation- FDA warning- has happened to IPCA Lab and Wockhardt has faced the FDA heat more than few in last 10 years. Does anybody know how much time- on average- it takes to rectify the issue? After rectification, does the company regain profitability/market share?