Divis laboratories q1_fy11_08_28_2010

For Private Circulation only

FIRST GLOBAL
www.firstglobal.in
India Research

Sector: Pharmaceuticals
What Happened Last Quarter
Divi’s Laboratories Ltd. (DIVI.IN/DIVI.BO)
Moderate Outperform (CMP: Rs.744.8, Mkt Cap: Rs.97.3 bn (US $2.1 bn), Aug 27, '10)
Relevant Index: CNX Nifty Index: 5,408.7 (Aug 27, ’10)

All set to step back on the growth trajectory in FY11…
Current valuation leaves sufficient room for multiple expansion,
considering industry best EBIDTA margin of 40%+…
Last report’s recommendation: Moderate Outperform (MP: Rs.749.1, Jun 04, 2010)
Relevant Index: CNX Nifty index: 5,135.5 (Jun 04, 2010)
Relative Performance since last rating change: CNX Nifty Index: up 10.4%. DIVI: up 20.5%

August 28, 2010
TO ACCESS FIRST GLOBAL RESEARCH ON BLOOMBERG, TYPE FGSL <GO>

Research Contact: Associate Director, Research: Hitesh Kuvelkar Mob. +91 9833 732633
Email: hitesh.kuvelkar@fglobal.com
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Research Note issued by First Global Securities Ltd., India
First Global (UK) Ltd. is a member of London Stock Exchange and is regulated by
Financial Services Authority (FSA), UK
First Global Stockbroking is a member of Bombay Stock Exchange & National Stock Exchange, India
IMPORTANT DISCLOSURES CAN BE FOUND AT THE END OF THIS REPORT

FIRST GLOBAL www.firstglobal.in
India Research

Price and Rating History Chart
Ratings Key
B = Buy BD = Buy at Declines OP = Outperform
Positive Ratings S-OP = Sector MO-OP = Moderate
M-OP = Market Outperform
Outperform Outperform
Neutral Ratings H = Hold MP = Market Perform SP = Sector Perform
S = Sell SS = Sell into Strength UP = Underperform
Negative Ratings
A = Avoid MO-UP = Moderate Underperform S-UP = Sector Underperform
ST: Short Term MT: Medium Term LT: Long Term

Divi’s Laboratories Ltd. (DIVI.IN/DIVI.BO)
1-Jan-2004 =100 (LHS) 970
280

30-Oct-07 6-Jun-08 27-Aug-10 870
OP OP MO-OP
30-Jul-08 4-Jun-10
28-Jan-08 MO-OP 770
230 OP
OP 1-Feb-10
15-Dec-09
MO-OP 670
8-Jun-09 ST-MP
OP
180
4-Apr-08 2-Jul-09 570

(INR)
22-Jun-07 OP OP
OP 5-Nov-09 470
130 4-Aug-09ST-MP
30-Jan-09 ST-MP 370
OP

270
80

170

30 70
1-Jan- 17- 22- 4-Feb- 15- 27- 13- 24-Jul- 4-Dec- 20- 31- 11- 29- 10- 27- 17-Jul- 1-Dec- 20- 26-
04 May- Sep-04 05 Jun-05 Oct-05 Mar- 06 06 Apr- Aug- Jan-08 May- Oct-08 Feb-09 09 09 Apr- Aug-
04 06 07 07 08 10 10
Relative to NIFTY (LHS) FG Reco DIVISLAB Share Price (RHS)

Represents an Upgrade

Represents a Downgrade

Represents Reiteration of Existing Rating

Details of First Global’s Rating System given at the end of the report

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India Research

Financial Snapshot (Standalone)
Key Financials
(YE Mar 31st) (Rs. mn) FY07 FY08 FY09 FY10 FY11E FY12E
Total Revenue 7,356 10,391 11,952 9,376 11,902 14,091
Revenue Grwoth (Y-oY) 88.9% 41.3% 15.0% -21.6% 26.9% 18.4%
EBIDTA 2,460 4,169 4,904 4,119 5,332 6,385
EBIDTA Growth (Y-o-Y) 110.8% 69.5% 17.6% -16.0% 29.5% 19.8%
Net Profit 1,918 3,536 4,245 3,442 4,373 5,267
Net Profit Growth (Y-o-Y) 172.1% 84.4% 20.1% -18.9% 27.0% 20.4%
Net Profit Excl. extra-ordinaries 1,917 3,536 4,240 3,408 4,373 5,267
Net Profit Growth Excl. extra-ordinaries (Y-o-Y) 172.5% 84.4% 19.9% -19.6% 28.3% 20.4%
Shareholders Equity 5,420 8,740 12,618 15,421 18,202 21,333
Number of Diluted shares(mn) 65 65 65 131 132 132
Key Operating Ratios
(YE Mar 31st) FY07 FY08 FY09 FY10 FY11E FY12E
Diluted EPS Excl. extra-ordinaries (Rs.) 14.68 27.07 32.47 26.10 33.09 39.86
Diluted EPS Excl. extra-ordinaries Growth (Y-o-Y) 172.5% 84.4% 19.9% -19.6% 26.8% 20.4%
CEPS Excl. extra-ordinaries (Rs.) 16.4 29.8 36.1 30.0 37.0 44.9
EBIDTA (%) 33.9% 40.4% 41.2% 44.3% 45.1% 45.6%
NPM (%) 26.4% 34.2% 35.6% 36.7% 37.0% 37.6%
Tax/PBT (%) 15.4% 8.1% 7.4% 11.4% 13.6% 11.9%
RoE (%) 43.4% 49.9% 39.7% 24.3% 26.0% 26.6%
RoCE (%) 31.9% 41.3% 35.7% 22.3% 24.2% 25.1%
Book Value per share (Rs.) 41.5 66.9 96.6 118.1 137.7 161.4
Debt/Equity (x) 0.28 0.10 0.04 0.02 0.02 0.01
Dividend Payout Ratio (%) 7% 7% 9% 23% 18% 15%
Free Cash Flow Analysis
(YE Mar 31st) (Rs. mn) FY07 FY08 FY09 FY10 FY11E FY12E
Operating Cash Flows 1,438 2,716 2,472 3,359 5,075 4,782
Capex 1,467 1,762 970 557 2,000 500
Investments - Strategic 2 0 0 0 0 0
Total Free Cash Flows (156) 1,415 1,708 3,344 3,107 4,314
Valuation Ratios
P/E (x) 22.5 18.7
P/BV (x) 5.4 4.6
P/CEPS (x) 20.1 16.6
EV/EBIDTA (x) 18.2 14.8
Net cash/Mkt cap 1.6% 4.0%
Market Cap./ Sales (x) 8.3 7.0
Dividend Yield(%) 0.8% 0.8%

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India Research

Market Cap. and Enterprise Value Data as on August 27, 2010
Current Market Price (Rs.) 745
No. of Basic Shares (mn) 131
Rs bn US$ bn
Market Cap 97.3 2.08
Total Debt* 0.3 0.01
Cash & Cash Equivalents* 0.1 0.00
Enterprise Value 97.5 2.08
* Debt & Cash & Cash Equivalents as of FY 10 ,INR Exchange Rate 46.86
DuPont Model
EBIDTA/Sales (%) 34% 40% 41% 44% 45% 46%
Sales/Operating Assets (x) 1.2 1.2 1.1 0.8 1.0 1.1
EBIDTA/Operating Assets (%) 39.7% 50.1% 46.0% 34.7% 43.2% 48.1%
Operating Assets/ Net Assets(x) 1.0 1.0 0.9 0.8 0.7 0.6
Net Earnings/ EBIDTA (%) 78% 85% 86% 83% 82% 82%
Net Assets/ Equity (x) 1.4 1.2 1.1 1.1 1.1 1.0
Return on Equity (%) 43.4% 49.9% 39.7% 24.3% 26.0% 26.6%
Common Sized Profit & Loss Account
Total Revenues 100% 100% 100% 100% 100% 100%
Net Raw Material Consumed 44.7% 39.8% 37.3% 31.8% 36.5% 36.0%
Power & Fuel 3.4% 3.7% 4.2% 4.9% 0.0% 0.0%
Manufacturing Expenses 3.0% 2.5% 2.4% 2.9% 2.7% 2.6%
Personnel 4.2% 4.9% 5.2% 7.4% 7.0% 7.0%
Advertisement and sales promotion Exp. 6.9% 5.6% 5.8% 7.1% 7.0% 7.0%
Miscelleaneous Exp 4.0% 3.1% 3.9% 1.6% 1.7% 1.8%
EBITDA 33.9% 40.4% 41.2% 44.3% 45.1% 45.6%
Depreciation and Amortization 3.1% 3.5% 4.0% 5.5% 4.4% 4.7%
Interest 1.5% 1.0% 0.6% 0.3% 0.2% 0.1%
Net Profit 26.4% 34.2% 35.7% 37.0% 37.0% 37.6%
Net Profit Excl. extra-ordinaries 26.4% 34.2% 35.6% 36.7% 37.0% 37.6%
* A stock split took place in FY08 in the ratio 1:5 taking the face value per share from the earlier Rs.10/share to
Rs.2/share. The previous year EPS figures have been adjusted for the same
# A bonus issue of 1:1 was exercised in Q1FY10 and hence the share capital and EPS figures of previous years have
been adjusted for the same

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India Research

What Happened Last Quarter…
Divi’s Laboratories Ltd. (DIVI.IN/DIVI.BO) appear to have a delivered a robust performance in Q1
FY11 on the face of it, with the topline up 25% Y-o-Y, the EBIDTA margin expanding by 170 basis
points Y-o-Y to 39% and the net profit increasing 46% Y-o-Y. However, much of this strong growth
in the quarter came on the back of a low base effect. The company’s net earnings at Rs.863 mn in Q1
FY11 came in lower than the expectation of Rs.900 mn-1.0 bn. A sequential comparison of the
numbers for Q1 FY11 reveals that the company’s performance was not that impressive and
the topline and bottomline actually declined sequentially by 15% and 34% respectively. The
company’s performance in Q1 FY11 was impacted by adjustments related to inventory de-stocking
issues (associated with a few of its global clients) that was witnessed in the 9-months ending FY10.
However, most of the issues were resolved in Q4 FY10 and the company is now gradually coming
back on track, with management stating that it was only an aberration.
Management confirmed that there is a gradual pick up in customers and remains confident of the
company stepping back on the growth trajectory in the coming quarters. Divi’s now expects a
quarterly topline run rate of Rs.3 bn+, going forward. This was against revenues of Rs.2.6 bn
recorded in Q1FY11. For now, we are maintaining our estimates for FY11 and continue to expect an
EPS of Rs.33.1, marking a healthy growth of
27%. At 22x our FY11E earnings, the stock
At 22x our FY11E earnings, the stock trades at a trades at a moderate premium to the industry
moderate premium to the industry forward P/E
forward P/E average of 21x, and believe that
average of 21x, and believe that the stock deserves
to trade at higher multiples, considering the the stock deserves to trade at higher multiples,
company’s EBIDTA margin of 40%+, which considering the company’s EBIDTA margin
remains the best in the Indian Pharma space … of 40%+, which remains the best in the Indian
Pharma space. Moreover, in spite of the
…in spite of the ongoing pressure, the company
ongoing pressure, the company has
has maintained a tight control on its working
capital, reduced its debt and improved its cash
maintained a tight control on its working
position. In view of the company’s strong topline capital, reduced its debt and improved its cash
and bottomline growth prospects for FY11, we position. In view of the company’s strong
reiterate our rating of ‘Moderate Outperform’ topline and bottomline growth prospects for
view on Divi’s Laboratories FY11, we reiterate our rating of ‘Moderate
Outperform’ view on Divi’s Laboratories.

4

India Research

Comparative Valuations - Indian Pharma peers

Y-o-Y
EPS P/E P/S P/BV EV/EBITDA EV/Sales RoE RoCE EBITDA Growth (%)
Company (Rs.) (x) (x) (x) (x) (x) (%) (%) (%)
EPS Revenues
FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E FY11E FY11E FY11E (FY11E/FY10E)
Sun Pharma 65.2 73.5 23.6 20.9 7.9 6.7 4.6 4.3 22.8 19.1 7.8 6.6 21% 20% 34% 13% 18%
Glenmark 12.3 17.4 22.1 15.5 2.7 2.2 3.1 2.6 13.2 9.8 3.4 2.6 18% 13% 26% 42% 24%
Ranbaxy* 7.8 24.5 55.2 18.8 2.5 2.2 4.6 4.0 30.5 11.0 2.9 2.5 22% 13% 22% 194% 15%
Dr.Reddy’s 55.4 64.9 21.7 18.5 2.8 2.5 4.6 3.8 13.1 11.0 2.9 2.5 23% 17% 22% 17% 12%
Cipla 12.6 14.5 25.3 22.0 4.6 4.2 4.4 3.8 19.1 16.4 4.6 4.2 18% 16% 26% 15% 10%
Biocon@ 14.8 17.9 19.5 16.1 2.4 2.0 3.3 2.8 12.6 10.0 2.4 2.0 18% 15% 21% 21% 18%
Lupin 76.7 94.9 23.4 18.9 3.4 2.8 9.2 7.6 19.5 15.7 3.5 2.9 43% 28% 19% 24% 20%
Divi’s 26.1 33.1 28.5 22.5 10.4 8.3 6.3 5.4 23.6 18.2 10.5 8.2 26% 24% 45% 27% 27%
Orchid Pharma -14.5 12.6 NA 15.5 0.7 0.8 0.5 0.5 NA 4.4 1.2 0.9 3% 4% 20% NM -5%
Jubilant Org 26.2 29.9 12.5 11.0 1.3 1.2 3.3 2.9 10.5 9.0 2.2 1.9 28% 11% 21% 14% 11%
Average 28.3 20.2 4.6 3.9 4.8 4.0 22.0 16.1 4.7 4.0 23% 17% 25% 43% 21%

*For Ranbaxy, the financial year is December ending, as against March ending for other companies. Hence, for
Ranbaxy, FY10E=CY09 and FY11E=CY10

* The earnings are excluded for extra ordinaries and forex related losses or gain

NM – Not Meaningful

5

India Research

Quarterly Result Analysis
YE March FY11 FY10 Y-o-Y FY10 Q-o-Q FY 10 FY 09 Y-o-Y
(Rs. mn) Q1 Q1 % Q4 % 12M 12M %
Total Revenue 2,653 2,122 25.0% 3,121 -15.0% 9,467 12,035 -21.3%
Less: Total Expenditure
Net Raw Material consumed 1,015 819 23.9% 991 2.5% 2,960 4,436 -33.3%
Manufacturing Expenses 212 171 24.1% 185 14.7% 717 787 -8.9%
Other Expenses 223 165 34.9% 251 -11.1% 813 1,160 -29.9%
Personnel 174 179 -2.8% 177 -1.9% 685 619 10.6%
Total Expenditure 1,625 1,335 21.7% 1,604 1.3% 5,174 7,002 -26.1%
EBIDTA 1,028 787 30.6% 1,518 -32.2% 4,292 5,033 -14.7%
Less: Depreciation 131 129 1.9% 123 6.8% 515 478 7.6%
EBIT 897 659 36.2% 1,395 -35.7% 3,778 4,555 -17.1%
Less: Interest 6 8 -33.7% -28 -119.4% 28 72 -61.8%
Profit Before Extraordinary items and Tax 892 650 37.1% 1,423 -37.3% 3,750 4,483 -16.3%
Other Income 49 29 71.9% 35 38.4% 133 101 32.1%
Less: Extraordinary Expense (net) 0 0 -540 0 0
Profit Before Tax 941 679 38.6% 1,999 -52.9% 3,883 4,583 -15.3%
Less: Total Tax 78 89 -12.7% 158 -50.8% 441 339 30.2%
Profit After Tax 863 590 46.4% 1,841 -53.1% 3,442 4,245 -18.9%
Proforma Net Profit 863 590 46.4% 1,300 -33.6% 3,442 4,245 -18.9%
Shares Outstanding (mn) 132 130 132 131 130 0.3%
Reported Diluted EPS (Rs.) 6.52 4.55 43.3% 14.09 -53.7% 26.35 32.46 -18.8%
Proforma Diluted EPS (Rs.) 6.53 4.55 43.6% 9.84 -33.6% 26.32 32.54 -19.1%
Margin
RM/Net Sales 38.3% 38.6% 31.7% 31.3% 36.9%
Purchase of Finished Goods 8.0% 8.1% 5.9% 7.6% 6.5%
Other Expenses./Net Sales 8.4% 7.8% 8.0% 8.6% 9.6%
Personnel/Net Sales 6.5% 8.4% 5.7% 7.2% 5.1%
EBIDTA Margin 38.8% 37.1% 48.6% 45.3% 41.8%
Proforma NPM 32.5% 27.8% 41.7% 36.4% 35.3%
Effective Tax Rate 8.3% 13.1% 7.9% 11.4% 7.4%

- In Q1 FY11, the company’s total revenue at Rs.2.65 bn was up 25% Y-o-Y, due to a low base
effect, but down 15% sequentially. For the 9-months ending FY09, Divi’s witnessed a
slowdown in orders, as clients reduced their inventory level. According to the company, the
impact of de-stocking by global innovators has played out and it expects business to be step
back on track, going forward.

- Revenue from the carotenoid segment came in at Rs.180 mn in the quarter, up from Rs.130
mn recorded in Q4 FY10. Divi’s expects the segment to record revenue of Rs.750 mn in Q2
FY11, as against Rs.340 mn reported for the full year FY10.

- The EBITDA margin declined significantly to 39% on a sequential basis, due to a change in
the company’s product mix, with a higher proportion of sales from generic APIs.

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India Research

- In FY10, Divi’s added seven products to its portfolio, two in generic APIs and five in
custom synthesis.

- Divi’s spent Rs.540 mn on capital expenditure in FY10 and expects to spend Rs.2.5 bn
towards the new SEZ for creating additional capacities, as its existing capacities are likely to
near full utilization by the end of FY11. The SEZ is expected to be complete by the end of
FY11.

- The tax rate for the quarter was lower due to EoU and SEZ benefits.

- Loans, which stood at Rs.328 mn in FY10, declined further to Rs.290 mn in Q1 FY11.

Scope exists for upward revision to our FY11 estimates
The overall strength of Divi’s was evident in its ability to maintain an EBIDTA margin of 45%+ in
FY10, in spite of the global economic downturn and de-stocking pressure faced from its key clients
in the 9-months ending FY10. Since FY08, Divi’s has managed to post an EBIDTA margin of 40%+.
And now, with these global pressures easing out and with the business getting back on track , we
believe that Divi’s would be able to maintain a 40%+ EBIDTA margin going forward…

Quote:

“Once the global economic situation normalizes in FY11 and orders begin to pick up from Q4
FY10 onwards, we believe that there will be significant scope for further EBIDTA margin
expansion. However, on a pretty conservative basis, we still estimate an EBIDTA margin of just
45% for FY11, as compared to a margin of 44% recorded in FY10 , marking an improvement of
80 basis points Y-o-Y, which, we believe, the company will be able to surpass comfortably. Hence,
there exists scope for a significant upside to our FY11E estimates.”

Unquote:

(First Global’s, “Divi’s Laboratories Ltd.: Well positioned to step back on the growth trajectory in
FY11; upgrade to Moderate Outperform”, dated February 2, 2010).

Just as we had expected, the company’s EBIDTA margin for FY10 stood at a healthy 44%, which we
expect to improve further to 45% in FY11. However, the EBIDTA margin for Q1 FY11 came in at
39%, as the company’s topline witnessed a delayed effect of the inventory destocking issues faced in
the 9-months ending FY10. Nevertheless, we expect the company’s overall business to step back on
track in the coming quarters and hence, continue to expect a topline and bottomline growth of 27%
each for FY11. This was against a negative topline and bottomline growth recorded in FY10.We are
also maintaining our earlier EBIDTA margin estimate of 45% for FY11.

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India Research

IMPORTANT DISCLOSURES
Price Target
Price targets (if any) are derived from a subjective and/or quantitative analysis of financial and
nonfinancial data of the concerned company using a combination of P/E, P/Sales, earnings growth,
and its stock price history.

The risks that may impede achievement of the price target/investment thesis are –

Upsides on the clinical research front/pipeline setbacks

Faster than expected uptake of both the CCS and API business

Ability to bring in strong sales from carotenoids and peptides

Litigation setbacks

8

India Research

First Global’s Rating System
Our rating system consists of three categories of ratings: Positive, Neutral and Negative. Within each
of these categories, the rating may be absolute or relative. When assigning an absolute rating, the
price target, if any, and the time period for the achievement of this price target, are given in the
report. Similarly when assigning a relative rating, it will be with respect to certain market/sector
index and for a certain period of time, both of which are specified in the report.

Rating in this report is relative to: CNX Nifty Index

Positive Ratings
(i) Buy (B) – This rating means that we expect the stock price to move up and achieve our specified
price target, if any, over the specified time period.
(ii) Buy at Declines (BD) – This rating means that we expect the stock to provide a better (lower)
entry price and then move up and achieve our specified price target, if any, over the specified time
period.
(iii) Outperform (OP) – This is a relative rating, which means that we expect the stock price to
outperform the specified market/sector index over the specified time period.

Neutral Ratings
(i) Hold (H) – This rating means that we expect no substantial move in the stock price over the
specified time period.
(ii) Marketperform (MP) – This is a relative rating, which means that we expect the stock price to
perform in line with the performance of the specified market/sector index over the specified time
period.

Negative Ratings
(i) Sell (S) – This rating means that we expect the stock price to go down and achieve our specified
price target, if any, over the specified time period.
(ii) Sell into Strength (SS) – This rating means that we expect the stock to provide a better (higher)
exit price in the short term, by going up. Thereafter, we expect it to move down and achieve our
specified price target, if any, over the specified time period.
(iii) Underperform (UP) – This is a relative rating, which means that we expect the stock price to
underperform the specified market/sector index over the specified time period.
(iv) Avoid (A) – This rating means that the valuation concerns and/or the risks and uncertainties
related to the stock are such that we do not recommend considering the stock for investment
purposes.

9

India Research

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