Buy Divis Labs – Merrill Lynch

Merrill Lynch has put a BUY recommendation on Divis Labs. Divis 2Q PAT was 37% ahead of expectations driven by higher sales and a huge surprise in EBITDA margin (42.9% margin vs. MLe of 37.5%) driven by the Custom Manufacturing Services (CMS) business.

Divis high margin trend is largely driven by increasing CMS contribution, which we estimate to grow to 65% of revenues by FY09E vs. ~50% in FY07. ML expects overall margins to increase 240bp to 36.3% in FY08E and sustain at this level.

Divis’ likely launch of eight nutraceutical products under the “Vivital” brand is expected to start generating revenues from 3Q onwards and scaleup to at least US$40-45mn p.a. over the next three years.

Divis is expected to register a revenue CAGR (FY07-10E) in the CMS business. And EPS CAGR of 48% (FY07-10E) on the back of 37% revenue CAGR (FY07-10E) and impact of tax benefits. EPS expectations for FY2008 is Rs 48.4 and for FY09 is Rs 68.4. On the basis of sum of parts valuation, Merrill recommends a BUY with a target price of Rs 2,250.