Shishir AsthanaMoneycontrol Research
Divi’s Laboratories stock continued to be under pressure falling by 11.64 percent on Monday. Over the last two days the stock has lost nearly one-third in value, driven by fears over a US regulatory notice that questioned the company’s data filing.
The company had disclosed the information on December 7, but the market took little notice of the announcement. Perhaps it was because of its wording: In its notice to the stock exchanges Divi’s Lab said that it was ‘pleased’ to announce that its unit was inspected and the company was issued a Form 483 with 5 observations and that these would be responded to within the time permitted.
It was only after an analyst from broking firm Emkay pointed out the details that the investing community understood the gravity of the situation. The most damning observation on Divi’s is of falsifying laboratory records and documents and inconsistent guidance from the R&D division, said an HSBC report.
For an investor, the key question will be how big a problem these issues are, and whether Divi’s is worth investing now that it has lost Rs 10,000 crore in market capitalisation over the last two days. Its valuation certainly is compelling, especially when compared with other pharmaceutical companies.
After the fall, Divi’s trades at 15 times its FY18 revised earnings, based on HSBC estimates. Compare this with Cipla’s price earnings ratio of 22, Sun Pharma’s PE of 18 and Dr Reddy’s PE of 22. Divi’s used to command a premium over other players as it had a halo of quality manufacturing, governance and non-competing business model with respect to global pharma giants.
The current observations have ruined that halo. Thus, even if we assume that Divi’s will get the average PE as its peers, there is some room for appreciation by buying Divi’s at current level. Both HSBC and Motilal Oswal have reduced the expected PE from 22 to 18, reflecting the fall from grace among the analyst community.
However, a lot will depend on the impact of US FDA observations. Analysts are divided on what the company said in its interaction with them. While HSBC says that 10 percent of the company’s sales will be affected if the issue escalates to import alerts. Motilal Oswal on the other hand feels that an import alerts will result in its FY18 EPS coming down Rs 35-36 from Rs 51 presently, a sharp 30 percent impact. This drop is based on the assumption that the unit under inspection will post zero revenue from US sales.
At the other extreme is Philips Capital, which has upgraded Divi’s, saying that none of the issues raised by US FDA is critical and the company has adequately responded within the time limit. The broking firm maintains the company’s intimation to stock exchanges where it said that there will be no adverse impact on continuing operations. Philips Capital notes that the company has maintained its FY17 guidance.
Kewal Handa, managing partner at advisory firm Salus Lifecare and former managing director of Pfizer said that most of the objections raised are within management’s control and behavioural in nature.
Among these confusing signals is the uncertainty of the impact of the observation on Divi’s clients. The biggest challenge for the company will be to provide them confidence.
Divi’s management too needs to take the blame in failing to address uncertainty, especially with general investors. A short clarification to exchanges failed to clear doubts and a selective interaction with analysts has not helped.
Analyst expectations now are that the company may now use the depressed share price as an opportunity to buy back its shares. Divi’s is sitting on a cash pile of Rs 1,200 crore and can also announce a special dividend to allay investor fears.
While it may be prudent to wait for clarity on the Form 483 observations front, a possible corporate action might see investors willing to risk a punt.
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