Stock Pick From The Healthcare Sector

Reaping Benefits

• The company has one of the best EBITDA margins in the industry.
• It enjoys debt-free status in a high interest rate regime.
• Operating leverage is expected going ahead.

The INR has recovered partially from its lifetime low, but still there is no assurance that it will stay at the current levels for a long time. As the risk of the capital outflow remains very high, rupee depreciation and companies benefiting from it should be the theme for investment picks. Divis Laboratories is one company offering such opportunity, as over 90 per cent of its sales come from the export markets. The company’s balance sheet is strong, with negligible debt and no major capex plans ahead. If one had invested in this counter in 2010, then including dividends, one would have made gains at a CAGR of 15 per cent at the CMP, which we believe is decent.

Divis Laboratories (DLL) is a manufacturer of active pharma ingredients and intermediates for innovator drug companies. It also manufactures specialty chemicals like peptides and nutraceuticals. The company has four manufacturing units with a capacity of 7743 cubic metres, as well as four research centres located in Andhra Pradesh. Of the four manufacturing facilities, three are located in Special Economic Zone (SEZ) areas, among which the Chippada unit enjoys 50 per cent tax exemption and the DSN SEZ unit enjoys 100 per cent tax exemption until FY18.

The company has positioned itself as India’s leading player in the Contract Research and Manufacturing Services (CRAMs) segment and enjoys a strong relationship with its customers. It has two business segments, i.e. Custom Synthesis and Active Pharma Ingredients (API). APIs are the largest revenue drivers, bringing in 95 per cent of the company’s total revenues.90 per cent of DLL’s sales come from the exports market, with more than 75 per cent revenues coming in from the regulated markets,where the demand for the generic drugs is high and is still on the rise

Located in Andhra Pradesh, DLL has been bearing the brunt of power cuts, which have led to a rise in the power and fuel costs. However, there are signs that the scenario may ease as the government has lifted power cuts from August 1, 2013. This is expected to result in higher operating profits for the company going ahead.

The US FDA audit of its DSN SEZ manufacturing facility would be a key catalyst for the company. DLL has a total of five blocks, two of which are already approved by the US regulatory authority. The remaining three would be audited in the second half of the current fiscal. Once these blocks are approved, the capacity utilisation would peak, which would mean a higher operating leverage and a rise in its EBITDA margins. This would lead to an improvement in the return ratios as well.

The balance sheet of the company carries negligible debt, which gives us comfort in recommending this scrip. It also has unhedged forex positions, which means that it will book full benefits of rupee depreciation. On the financial front, the company reported 15 per cent growth in revenues, which touched Rs 2123 crore in FY13. Its net profit grew at 12 per cent to Rs 611 crore. The EBITDA margins were at 40 per cent, one of the best in the industry.

On the valuations front, the stock is trading at a price-to-earnings ratio 15x its FY15 expected EPS of Rs 64, which is quite less for a Large-Cap pharma stock. Investors could consider buying this stock at its CMP, with a one-year price target of Rs 1100.