Analyst call tracker: Analysts increasingly bearish on Divi's Labs, Dr Reddy's

According to analysts the core business and new initiatives of the pharma companies are not enough to justify the expensive valuations

Divi’s Laboratories and Dr Reddy’s Labs are two pharma companies that have seen a pessimistic outlook in Moneycontrol’s analyst call tracker. ‘Buy’ calls on Divi’s Laboratories stock fell to six from 14, while that on Dr Reddy’s Laboratories fell to 18 from 36, as valuations appear to have run ahead of the limited growth opportunities.

While Divi’s stock has had a decent year with returns of 9.6 percent YTD, the company's revenues in the quarter ending June did not meet analysts’ expectations. The company’s Q1FY24 revenue fell 21.1 percent YoY to Rs 1,778 crore, with EBITDA falling 40.5 percent YoY to Rs 5,040 crore and the net profit falling 49.3 percent to Rs 356 crore. The on-year fall is from a high base formed by supply of molecules used for Covid treatment.

Divi's Labs shares closed at Rs 3697.2 on October 5.

Revenue from generic business fell 8.1 percent YoY to Rs 944 crore while custom business was down 45.1 percent YoY to Rs 656 crore. Custom synthesis makes up 40 percent of business sales while generic drugs make up the remaining 60 percent.

According to Elara Capital, Divi’s Laboratories has an expensive valuation at 57.7x FY24E and 49.5x FY25E core earnings; this is significantly higher than pre-Covid range of 25-28x. The company’s EBITDA margin improved to 28.3 percent in Q1FY24, from the 23-25 percent range in H2FY23; but it is still below pre-Covid range of 33-38 percent. Elara Capital said that the company's new initiatives, such as using active pharmaceutical ingredients (API) used in imaging contrasts, and nutraceutical products along with new projects in the custom synthesis business, are not enough.

“We reduce our FY24E core EPS by four percent, but maintain FY25E/26E estimates. The stock trades at 58.1x FY24E core EPS of Rs 61.5. We reiterate ‘sell’. We raise our target price to Rs 2,199 from Rs 1,980, which is 28x FY25E core EPS of Rs 71.6 plus cash per share of Rs 193.” said Elara in a note.

Systematix institutional equities changed its rating from ‘hold’ to ‘sell’ with a price target of Rs 2,681 based on 30x FY25E EPS. The reasons for the change in recommendation were the changes in the macro environment where growth opportunity for custom synthesis business is getting reduced.

Follow our live blog for all market action

Dr Reddy's stock has had a stellar year with 27.6 percent YTD return, with the company reporting strong April-June results driven by North American business sales. The company’s Q1FY24 consolidated revenue increased by 29.1 percent YoY to Rs 6,758 crore while profit increased 18.2 percent YoY to Rs 1,405 crore. gRevlimid, a drug used to treat myeloma - a type of blood cancer - made up the majority of the company’s North American sales.

According to Antique Stock Broking’s estimates, four products - gVascepa, gCiprodex, gLexiscan, and gSuboxone will deliver 12-15 percent of core North American revenue in FY24. The broker expects tough competition in this category as other companies are gearing to launch similar products. Additionally, out of over 100 products listed as being in shortage by USFDA in America, the company has just five products with low estimated market value, so the company won’t have much gains in the North American business.

Antique downgraded Dr Reddy's stock to ‘sell’ from ‘hold’ with a target of Rs 4,658 valuing the company at 19x on FY25 EPS.

Elara Capital maintained its ‘Reduce’ rating on Dr Reddy's stock, but increased the target price to Rs 5,579 “based on 17x FY25E core earnings of Rs 299 plus cash per share of Rs 496”, the broker said. The broker also expects  little upside to the stock due to the recent rally.

Shares of Dr Reddy's Laboratories closed at Rs 5407.25 on October 5, rising by 27.68 percent YTD.