Mar 22, 2013, 07.38 PM | Source: Moneycontrol.com
Nirmal Bang is bullish on Divis Laboratories (DLL) and has recommended buy rating on the stock with a target price of Rs 1276 in its March 22, 2013 research report.
, Nirmal Bang |
"DLL stock has shed 7% since its 3QFY13 results on concerns over high power costs at its Andhra Pradesh (AP) operations impacting margins. Our interaction with the company’s management leads us to believe that the market may be overestimating the impact of increased power costs and we believe the current valuation of 16xFY15E EPS (20% discount to its five-year average multiple) provides an attractive entry point for investors. We have factored in our revised inhouse call on the rupee-US dollar rate of Rs52.0/$ (from Rs55.5/$ earlier) in our estimates, leading to a 2% reduction in our FY14E EPS, but retained the Buy rating on DLL with a revised target price of Rs1,276 (from Rs1,302 earlier), valuing the stock at 21xFY14E EPS of Rs 60.7 (from Rs62.0 earlier).
Power supply situation grim in AP, but the street overestimates its impact: DLL has witnessed a sharp rise in power costs (up ~160bps YoY as a percentage of sales in the 9MFY13 period), owing to which its margins declined by~200bps consecutively for the past two quarters. Factoring in higher power costs and forex losses, we had revised our FY13E margin assumption downwards by 200bps post 2QFY13 results. While the power supply situation continues to remain grim in AP, we believe our margin assumption of 36% for FY13E (36.5% margin in the 9MFY13 period) provides sufficient buffer from any further fall in margins due to power cost escalation. Further, with a favourable currency movement (average rupee-US dollar rate so far in 4QFY13 at Rs54.1/$ versus Rs50.1/$ in 4QFY12), there can be an upside to our assumptions. As per our estimates, DLL’s operating profit is expected to rise by ~5% for every 10% fall in the rupee.
FY14 may usher in upside in margins: Our interaction with the management indicates that DLL may have to bear escalated power costs in the current quarter, but the margins in FY14 should start improving as the company has already signed a long-term agreement for power supply. Further, with the likely ramp-up at its Vizag facility (post the US Food and Drug Administration or USFDA inspection scheduled in 1QFY14 and subsequent clearance thereof of remaining two blocks of the DSN unit), we believe there exists significant scope for improvement in margins (DSN facility is currently operating at ~45% of its capacity, which is expected to go up to 85% as supplies to the US begin).
Strong FY14 guidance: DLL’s management has reiterated its guidance of a 22%-25% (assuming rupee-US dollar rate of Rs52.5-Rs53.0/$) revenue growth in FY14 (expects to achieve the higher end of its guidance if the USFDA’s approval comes in 1HFY14, and the lower-end of its guidance otherwise), along with expansion in margins. We have factored in the lower end of the management’s guidance, with a 100bps expansion in margins, which we think is reasonable (as explained above). Rupee fall is an upside risk to our estimates. Valuation: 4Q has historically been a very strong quarter for DLL and we expect the stock to rebound in the near term, given its steeply discounted valuation of 16xFY14E EPS.
Further, with major capex activity nearing its end, we expect strong free cash flow generation over the next two years (Rs4.9bn versus Rs4.9bn over the past five years), which coupled with strong earnings growth (27% earnings growth likely in FY14E) and expansion in RoE/RoCE by 160bps/220bps, respectively, will support valuation. We have retained our Buy rating on DLL with a target price of Rs 1, 276," says Nirmal Bang research report.
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