Why are brokers downgrading the stock of Divi’s Labs

Divi’s Laboratories share price hit a 52-week low of Rs 3,361 on 10th November 2022. In fact, if you compare the stock of Divi’s Labs with the high price of Rs5,093, the stock is down nearly 40% from the high price, showing a lot of price damage. That is not common in the case of Divi’s Labs, which is known to be a rather stable stock. The stock has been weak for the last few months but in the aftermath of the second quarter results declared by Divi’s Laboratories, the stock has cracked sharply to touch a new 52-week low. In fact, if you just look at the below table of Divi stock price in November the damage is evident.

Data Source: NSE

The stock of Divi’s Labs has lost 13% since the start of November after the results for Q2FY23 disappointed the street. It also led to several brokers downgrading the stock from BUY to HOLD, while some brokers even downsized the stock from BUY to SELL, considering the negative cues coming from the high frequency indicators surrounding the stock. But first let us look at the quarterly numbers of Divi’s Labs for the latest quarter. The profit after tax (PAT) fell by 18% on a yoy basis at Rs494 crore, but what actually spooked the markets was that on a sequential quarter on quarter basis, the profits actually fell by a whopping 30%.

Let us focus on the top line of the company for the latest quarter. The total revenues of Divi’s Labs for Q2FY23 fell by 6.7% on a yoy basis to Rs1,854 core. Once again, the bigger disappointment was the 17.8% fall on a sequential quarter on quarter basis. In short, profits and revenues were below analyst expectations. Revenues came in at Rs1,854 crore against analyst expectations of revenues at Rs2,074 core. Even the profits came in at Rs494 crore against the analyst expectation of Rs558 crore. It was not just the fall in profits but the top line and bottom line lagging market expectations that really hit the stock.

For the quarter, Divi’s reported 3arnings before interest, taxes, depreciation and amortization (EBITDA) margins at 33.5%. That is a full 767 basis points lower than the last year similar quarter and was largely on account of higher energy and transportation and input costs. Apart from being a miss on revenues and profits, the sharp fall in the EBITDA margins is going to raise some various serious questions about the ability of the company to sustain such premium valuations in the market. Divi’s Labs is into specialized active pharma ingredients (APIs) and that business has been seeing weak demand in the recent past.

ICICI Securities is among the broking firms to downgrade the stock quite sharply from BUY to HOLD. Its contention is that the peak benefits of the post-COVID period have been fully realized by Divi’s Labs and going ahead it would be more of normalized growth for the company. Also generics is seeing tough competition in the US markets and that is also an overhang for the stock. However, this is a company that has survived tough times and has been one of the most valuable pharma stories to come out of Hyderabad in the last few years and has rarely disappointed shareholders. 

Some of the positives for Divi are that it is building capacity in a few more niche APIs basis the evolving demand scenario. Of course, the ex-China in generics is still huge and is worth billions of dollars. That is not going anywhere in a hurry.  The other big opportunity for Divi is the $20 billion in molecules that would be going off-patent between FY23 and FY25. There are still some big triggers for the stock like the prospects for commercialisation of new API and for custom synthesis (CS). It has been making steady progress on new DMF (Drug Master File) filings and that is likely to be another medium term trigger for Divi.