Shares of Divis Labs fell over 11 percent, hitting 28-month low at Rs 768.45 per share intraday on regulatory concerns. The stock fell 22 percent on Friday, losing 33 percent in last three days. Analysts say recent US Food and Drug Administration (USFDA) Form 483 shows some serious observations which could potentially escalate to warning letter/import alert.
On December 7, 2016, the US Food and Drug Administration (USFDA) had issued form 483 with five observations against Divi's Laboratories' unit at Chippada Village in Visakhapatnam of Andhra Pradesh. The USFDA inspected the company’s unit from November 29 to December 6, 2016. Observation letter highlighted instances of disregard of unknown impurities without specific justification and sighting of unexplained coloured products at various stages of API manufacturing. Divis' Unit 2 facility was last inspected in February 2016 with no form 483s being issued. The company's Unit 1 facility (located at Hyderabad) has no pending 483s (but was last inspected in 2014).
The observations may spell trouble for unit 2 plant located at Vizag but analysts have not yet de-rated it. Motilal Oswal says that the plant is a critical for the company, accounting for 60-65 percent of total sales. US accounted for 32 percent of Divis' total sales in FY16. It estimates that US sales from the Unit 2 account for 15-20 percent of total sales.
Maintaining neutral rating, the brokerage firm expects the stock to remain range bound in the near term until more clarity emerges on these 483 observations but slashed target price of Rs 975 per share.
"If we assume that US sales from the Unit 2 become zero in FY18 with negative operating leverage of 300-500bp on EBITDA margins, then FY18E earnings per share (EPS) would come down to Rs 35-36. On a going concern basis too, large capex addition and delay in commencement of the facility could keep growth under check till FY19E. However, its strong balance sheet (net cash surplus) and high return ratios provide valuation cushion," it says in a note. According to Motilal Oswal, one of the biggest challenges for Divis in near term would be to provide confidence to its existing client set. "It is very important that Divis does not lose its key clients in the US and EU because of these 483," it adds.HSBC maintains hold rating with a reduced target of Rs 934 per share. It estimates 10 percent of total company’s sales will be under threat if Form 483 issues escalate to import alert. It cut FY17/18/19 EPS estimates by 1.6 percent/6.9 percent/6.8 percent mainly in view of possible shutdowns and higher potential costs involved in remediation of any issues.At 09:43 hrs Divis Laboratories was quoting at Rs 770.40, down Rs 95.70, or 11.05 percent on the BSE.
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