12% optimistic return matches what nifty as an Index can return. why would anyone buy such a risky bet? More like 15-18% and minimum 10% should be the return when we are investing in individual companies because of the concentration risk
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Wanted to talk about this wonderful business Divi’s but never got the chance since the price it was trading was too high. Let’s go to Divi’s details:
- Divis is a pharmaceutical player involved in primarily 3 lines of businesses: Generic API manufacturing, Custom Synthesis and Nutraceutical
- As is a folklore, Dr Murli Divi started this company after working with Dr Reddy’s. In the first avatar, they were the consultants to the Pharma players and used to provide the consultancy for optimal production process
- Slowly they started putting up their own machinery. Since they had years of expertise in providing consultancy for cost optimisation, they started manufacturing naproxen at much lower cost vis a vis competitors
- Coming to the revenue mix, out of the revenues of 9000 cr, 630 cr attributes to nutraceutical. For the remaining, 41% gets attributed to generics (3431 cr) and 59% to custom synthesis (4938 cr)
- The company is having 2 units for manufacturing in Hyderabad and Vizag. The first manufacturing comprises of 2 units and the second manufacturing comprises of 4 units
- The company focusses on process chemistry and revisits the processes to produce API after fixed intervals. This process detailing leads to the lowest cost of API
- This is another reason that the company focusses on just a limited set of 30 API’s as compared to 100’s by competitors. Another 10 are in the pipeline
- These small set helps the firm to keep the focus on optimising production costs. Also, Naproxen & Dextromethorphan contributes to the significant amount of sales. Divis has 90% market share in naproxen and 70% in Dextromethorphan
- Newer generics like Pregabalin, Methylamine currently has 20-30% market share which can go to 60-70% market share
- So there is a trend in Divis playbook. Master the production process of the focussed API so that no other player is able to match its cost and thus dominate the market share
- Then there is another division of custom synthesis where Divis partner with big Pharma and manufactures API for innovator drugs and drugs under clinical trials
- This is the part which is having high margins since the big Pharma players are able to cough good money for the quality, no conflicts of interest. Innovator drugs API cost is 2% of final drug price
- Whereas generic API forms ~50% of final drug price. This shows the importance of cost optimisations in generics whereas ability to protect IP for big Pharma in case of custom synthesis
- As per the latest concall, generics and custom synthesis contribute 55% and 45% of the product mix respectively. The land at Kakinada for the third plant has been allotted to the company.
- In the latest quarter, the OPM was the lowest at 25% in the recent 7 years history. As per the management, the volumes for the generics are increasing and going to pre-covid levels
- Also raw material cost is easing. The pricing would improve in the coming quarter. But we have to wait and see the OPM in coming quarter
- Regarding the new technologies, the company is working on vapor-phased chemistry, continuous flow chemistry, photochemistry and Gadolinium compounds, which are the MRI contrast media agents
- The market size of MRI contrast agents stand at currently $6 Bn. With the focus on cost optimisation, there is a high probability that Divis would bee able to garner the significant market share
- The concall highlighted that the iodine recovery in contrast media is $75 per kg as opposed to $25 per kg giving it a significant competitive advantage. Once clearances are given, big Pharma can leverage these savings
- Coming to Sales, this increased 7x from 2011 to 2022. Further the OPM is consistent at 35%. There was a recent jump in OPM due to capacity utilisation for covid drug API. But this seems to get normalised
- The company is able to convert its profits to cash in timely manner. This is highlighted as shown in the following exhibit
- Coming to working capital cycle, the company’s cash conversion cycle is upwards of 300 days. The major reason is the inventory which the company has to stock.
- Manufacturing takes place in batches and not JIT. The manufactured API’s are stored in storage facility from where the demand comes and the API’s are shipped
- Regarding subsidiaries, the company operate two subsidiaries which are wholly owned: One in USA and other in Europe. They are engaged in customer development and marketing
- As shown in the screenshot of related party transaction, the company paid 8.7 cr as a rent to Divis properties which is controlled by KMP. Also Murali Divi took 110 cr as remuneration and short term benefit
- On the Sartans end, Divis is the only awkward integrated manufacturer. They make own Ortho Tolyl Benzonitrile using photochemistry and thus having the lowest cost in the world
- Competitive Advantages for the company includes its patented manufacturing processes which produces the lowest cost API’s, its focus on revisiting the chemistry and improving it to optimize costs
- Another advantage includes the economy of scales enjoyed in some key API’s which further keeps the pricing competitive.
- 100% IP compliance and focus on advanced reactions which cannot be built in house for big Pharma is another advantage
- Key risks include the dilution of R&D culture set buy Dr Divi once his children succeed. This is the biggest forte for Divis. Big Pharma moving their synthesis in-house is another key risk
- Competitors making the cost of API’s optimised by focussing on R&D is another key risk.
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Divis lab has corrected a lot since its high levels. the company fundamentally is good. but, is it still a good buy for long term at these levels? my holding is currently almost 20% down in divis.
I struggle with this a lot too. When our holding is down 10-20% or more, we doubt whether we should put more money into the counter that is showing a negative return. However, it has mostly helped to allocate more to the discounted stock as long as the reason for the discount is not due to a material deterioration in the earning potential of the company.
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Try to understand the business, growth triggers. You will get all your answers.
I have done fundamental analysis, but I am not well versed in it. I am not sure if at macro level some thing changed (CHina) or not. I am looking to take out the money, just want to understand when it is expected to go up or further going down?
I feel margins will remain under pressure for the next few quarters, in the latest concall management had mentioned that there is price pressure and inventory is an another issue.
They have received clearance for kakinada expansion and they have decide to do an overall capex of 1000 crore, though not specific for kakinada which may show in revenue by FY25
I don’t feel there are any business triggers in the short term and for the next 3-4 quaters the stock will remain under pressure.
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Divi’s Laboratories Limited Q4 FY '23 Earnings Conference Call May 20, 2023 - Rephrased Notes:
Q3/4 of FY23 operating margin less than 25%, and gross margin is also in the range of 57%, which has never been the case over last 10-year period. Any specific unprecedented condition? it is the general course that took place:
- The anti-COVID drug a one-time opportunity gave us a good push in the sales and PAT.
- Raw materials were procured at higher prices. We do not keep normally more than three-month stocks, but we had kept six months, nine months stock of raw materials anticipating problems from China, COVID and various things. As of now, using a mix of both the materials. Probably, go back to our normal gross margin of 67%, 68% towards the year end.
- Pricing pressures in the generic market. People who had huge stock, destocking them, price pressures, raw materials where we procured at higher prices until they get stock out and be replaced with the materials that come with lower prices.
Custom Synthesis:
- Two custom synthesis projects that were supposed to commission either end of Q4 or Q1 is what you had said in our last earnings call. So, what’s the update on that?
- 1st one: Sartan, already gone into commercial production and commercial supply. It will add up in our coming quarters.
- 2nd one, qualifications are complete. The ramp up of production is happening for supplying in the quarter. I think both will reflect from the coming quarters.
- Are seeing several other opportunities in custom synthesis projects from big pharma, never seen so many opportunities.
Generic products:
- For traditional and the established (60% to 70% market share products like naproxen, dextromethorphan, gabapentin), the material price is the issue for some of the products and market is not the issue. Some of our customers have large volume stocks of dosage forms due to COVID, I think they’re destocking and once that is over, the price pressures should disappear.
- Other generic products (where market share is 20%, 30%), the capacities are increased substantially to become number 2 or number 1 in the market. Qualifications are completed and commercial sales have started. It will take at least 4~8 quarters to see the full benefits.
- Contrast media:
- Non-gadolinium products: Iodine cost is a significant part. If the Iodine prices were to go down, why the end customer to shift to a new supplier? Growth is minimum of 10% and 10% of let us say 2,500 tons to 5,000 tons of each contrast media requiring 200 tons to 300 tons a year extra quantity. Now either they must install new capacity or they must outsource. We have an advantage of creating capacity at low cost, already technologies are in place, drug master files are in place and there is an advantage of the Iodine recovery, which brings the cost down.
- Gadolinium (MRI contrast media): Where are we in the development? Developed process for some of them and we are developing processes. There are two or three customers who are in the gadolinium compounds. We are in discussions with them. MRI compounds changing from gadolinium to other metals, there also we are heavily involved with the customers as well as our own research to development of processes at our own labs.
- Can we expect a revenue for media agents in first quarter? They have invested enough with tech transfer and everything and then validations are completed, commercial ramp-up is already in progress. So, I think I would leave at that.
- Should become the leader in the next 2~3 years just like every generic product we are in.
Others:
- Tax rate? Reaching to the closing of SEZ and SEZ benefit, expect the tax to be around 25%, 27%.
- Would you like to indicate some kind of growth trajectory on FY '24? We have been growing at double-digit growth. Even without the one-time opportunity of the COVID drug, we will continue growing at that rate double-digit growth.
- Kakinada (Unit 3, 500 acres of land): Phase 1 to start manufacturing nutraceuticals and advanced intermediates? Investment of INR 1,200 crores to INR 1,500 crores and expect to commercialize by end of '24 (CY). so that our existing production buildings at Unit 1 and Unit 2 will be freed to that extent whereby GMP, US FDA inspected, European FDA inspected buildings will be able to take advantage to produce the required quantities of new opportunities of custom synthesis and other generic products from fiscal year '25. Unit 3 project what we are envisaging now INR 1,200 crores to INR 1,500 crores. Phase 2, APIs which usually takes three to four years for the qualifications and US FDA inspection, clearance and then be able to sell.
- In discussions with several big pharmas for several products. So let’s wait for the next quarters to come out with that investments.
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Divi’s Laboratories Limited Q1 FY '24 Earnings Conference Call Aug 19, 2023 - Rephrased Notes:
1) Performance Summary:
a) Consolidated total income of Rs. 1,859 crores for the current quarter as against the income of Rs. 2,343 crores for the corresponding quarter previous year.
b) Exports for the quarter is about 86%. Exports to Europe and US is about 67%. Product
mix for the generics to custom synthesis is 60% and 40% respectively
c) 178 cr neutraceutical revenue (ARR of ~720 Cr as against 630cr last year)
2) On Margins:
a) Gross Margin improvement (from 58% in Q4FY23 to 61% in Q1FY24) due to softening of raw material prices and change in product mix.
b) Guidance of OM reversion to pre-Covid levels (35-40%). Going forward, see an improvement in
terms of margins and a slow growth. Compounds where capacities have been improved, filings have been done, margins should grow when clearance comes for Divis’s customers.
c) Impact of high cost inventory procured during Covid leading to elevated RM cost is now over as most of the materials consumed in Q1.
d) Better equipped (compared to other API manufacturers) to deal with cyclicality of RM prices such as solvents etc as Divis have equipment available, installed to recover, reuse with the right specifications whereas not many 000000companies are equipped to do that.
3) On Growth:
a) Seeing a flattish growth because of the after effects of Covid, where first the anti-infectives grew, then the antibiotics, thereafter the life saving and lifestyle medicines. Divis primarily into the Lifestyle market in the generic space. Indicating that improvements in growth rates for generics is anticipated.
b) Customs Synthesis: Working on several projects, any of them can become a blockbuster like Molnupiravir, can’t indicate with certainty when that’s likely to happen. Peptide building block is a (re)new opportunity (obesity, anti-glycemic compounds with these synthetic liquid-phase peptide
drugs.). Only customer approval (& no regulatory approval) needed for supplying building blocks (smaller molecules, less than 500) for the peptide blocks which go into making APIs. Finds application in anti diabetic and anti obesity medicine. Renewed interest in this segment as mode of application changed from IV to Oral.
c) Enhancing capacity of carotenoid (Neutraceutical) (Unit III at Kakinada) to meet additional demand (currently operating at 90-95% utilization). Contribution expected by Q1-Q2 of FY 25. Most of carotenoid RM is made by Divis themselves. Competition is there, but demand is robust.
d) Contrast Media:
(i) MRI (Gandolinium) Contrast Media - 2bn$ market, 2-3 players. Divis will be ready with their process scale up by end of FY 24. Thereafter 1 more year for filings and commercial. Any meaningful contribution to revenue only expected in Q4 FY25.
(ii) Iodine contrast media: 5 Bn $ market, 4 players including Divis
(iii) Currently in the contrast media space, major market controlled by the innovators. Innovators are connected with the instrument and supplies along with with it and thus control the market. Generic market growing rapidly in Asia and Africa markets. DIvis has generic contrast media product like Iopamidol. Thus opportunities in both generic and Custom Synthesis (innovators) in Contrast Media.
e) Not indicating any growth forecast. Company targetting 2000cr quarterly revenue with zero Covid drug sale to boost confidence in its ability to deliver.
f) Unit-3 greenfield project will initially manufacture starting materials, a few
nutraceutical APIs, advanced intermediates and complex chemistry APIs, thus freeing
up Unit-1 and Unit-2 facilities for new opportunities for custom synthesis and generic
products. Unit 1 and Unit 2 facilities are US FDA inspected.
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