Divi's Labs Ltd: A bet on Make in India

The Indian pharmaceutical industry is valued at ₹4.03 lakh crore as of 2022, making it the 3rd largest in the world. The medical sector is plagued by a disease of its own, however!

Imports… Or rather, India’s ₹16,038 crore pharma imports from China, to be precise!

Even the Government of India has started taking hefty steps to curb India’s Chinese drug addiction! Steps worth ₹9,940 crore in the form of Production Linked Incentive schemes in July 2020. Seems “Make in India” has become less of a rallying cry and more of a cry for help for the Indian pharmaceutical industry.

So when a company goes full Shahrukh Khan from Swades, you can rest assured that the Indian markets would take favourably to such a player. So who is this chemist in the shiny white coat, and how did it thrive in an industry so dependent on bahar ka maal?

The Indian Pharmaceutical Industry

By 2024, the Indian pharmaceutical industry is projected to reach ₹5.3 lakh crore and double its current size to reach ₹10.6 lakh crore by 2030.

Speaking of international trade, apart from the Chinese import dependence, the pharmaceutical industry exports stood at ₹2.01 lakh crore in FY21 and ₹2.02 lakh crore in FY22. The US has been the primary buyer of Indian pharmaceuticals, with exports worth ₹34,962 crore reaching the States.

Although the exports seem to have hit a plateau of sorts in the last couple of years, India’s export capability in the pharmaceutical industry has seen a gradual uptick over the past years.

The pandemic and internal political tensions in China led to a manufacturing slowdown in China. This made the world realise that it could not stay dependent on one source for needs as important as medicine.

And where there is a need to replace China in terms of cheap labour or bulk production, nothing beats the manpower and industrial growth potential of India. However, India was already ailing from its dependence on China.

This is where the star of this article makes a not-so-grand but very vital entry. Meet Divi’s Laboratories.

Divi’s Laboratories: Formulated for Success

Divi’s Laboratories was founded by Murali Divi. Murali had earned a doctorate in pharmaceutical sciences from Kakatiya University.

After completing his doctorate, Murali moved to America, where he made his bone working as a senior in the research and development department of organisations like Fike Chemicals. All of this changed in 1984.

1984 marked the beginning of Murali’s advent into the Indian Pharmaceutical industry. Working as the managing director in the newly formed Dr Reddy’s Laboratories and working with the pharma newbie to acquire Cheminor.

Cheminor was a contract manufacturing company. The intent behind the acquisition was to use the company’s existing assets to turn the dying company into a manufacturing unit for Dr Reddy’s Laboratories.

After 6 years of working with Dr Reddy’s Laboratories, Murali decided to start a business of his own, and Divi’s laboratory was created.

So, let us meet Divi’s Laboratories.

The Divi’s Laboratories Success Story

Those who can't do, teach, or rather in Murali's case, consult. Divi's was still a newcomer in the pharma industry and had to start somewhere. So, Divi’s started off as a consultant to pharmaceutical businesses. They would recommend more effective chemical compositions and more efficient ways to produce said combinations.

During Divi’s Labs’ greenstick years, Murali found that India was a hub for outsourcing drug manufacturing. However, one problem that existed in this field was a deception of sorts.

The major drug manufacturers in India, including Murali’s previous associates at Dr Reddy’s Laboratories, had a little secret weapon named “Paragraph IV filings”. These filings gave the Indian manufacturers the ability to challenge the existing patent of a drug whose rights lay with the companies that outsourced the manufacturing of the drug. If the challenger won the dispute, they earned exclusive marketing rights to generics of their own using the original company’s research that created the drug in the first place.

This meant that Indian manufacturers were often locking horns with bigger clients like Abbott, Pfizer and the like. As a result, the bigger clients were administered a bitter dose of betrayal by their Indian manufacturers.

This unscrupulous yet legal activity went on till 1994 when India became a member of the TRIPS agreement, and Murali realised the struggle faced by foreign drug creators. Indian manufacturers used reverse engineering to unravel the formulation used by foreign brands and challenged the patent with more efficient production methods.

While this meant that the Indian manufacturers earned exclusive profits from the marketing of these more efficient formulations, the threat to their intellectual properties did not sit well with the foreign companies. So, in a way, the Indian drug manufacturers were pretty much screwing over their paymasters.

Murali’s solution to the problem was simple, non-participation. Divi’s never entered the formulation business. The idea was to build trust around the fact that Divi’s would be the brand that posed no threat to the foreign company’s intellectual property.

Which is why, to this date, Divi’s has not entered the formulations market. For those unaware, formulations are what the final medicine is called in the pharmaceutical industry.

So, India’s leading pharmaceutical company does not produce medicines. What on the green earth does it do, then?

Let us find out.

Divi’s Laboratories’ Business Model

Divi’s Laboratories’ entire business and the secret to its success is the fact that it never entered the formulation business. During the early years of Divi’s, the company engaged in manufacturing APIs. The business had low revenue potential, but it was a low-hanging fruit for Murali, all thanks to his history with Cheminor.

In the initial years, Divi’s revenue was majorly sourced from API manufacturing at around 90%. The portion of revenue from API manufacturing has fallen to around 50% since. The rest comes from custom synthesis, an activity that generates far higher revenues.

Divi’s also produces nutraceuticals, which are dietary supplements for both human and animal consumption. However, nutraceuticals are not a major source of revenue for the company.

So, instead of manufacturing the final medicine, Divi’s engages in the production of the raw materials needed to manufacture said medicine. The raw materials produced by Divi’s include the aforementioned APIs for generics and custom synthetic drugs that it produces for other drug companies.

Remember the Chinese dependence on Chinese imports? It is not just a disease that plagues the Indian pharma industry. While the abundance of labour made China a haven for mass production, its pandemic and politically induced lockdown made the east Asian country’s importers realise the need for diversification.

Divi’s also enhanced the efficiency of its production process. In an age when Indian drug manufacturers were using chemicals as catalysts for their production processes, Divi’s started using enzymes.

Chemicals were used because they made the production process less complex. However, the use of chemicals led to more waste, which led to greater pollution.

The use of enzymes made the process more efficient, and the reduction of waste led to a greener production chain as well.

Other strong points that Divi’s has in its arsenal are:

1. Divi’s has a backward integrated production line. This means that Divi’s produces the key raw material as well as the intermediate drug necessary for the production of formulations.
This means that the Indian manufacturers engaged in the production of formulations, as well as foreign manufacturers looking to switch the country of origin for their raw material needs, could eventually be added to Divi’s clientele.

2. Owing to its production of raw materials and intermediaries, Divi’s enjoys a majority market share of 60-70% in the top 10 products. Divi’s aims to next increase its market share in products that it only has a 20-30% market share.
Thanks to Divi’s strong position in the top drug products, it could potentially have the resources necessary to achieve the aforementioned increase in market share.

3. Since Divi’s solely focuses on the production of raw materials and intermediates, the production setup time is reduced, and the company is afforded scalability.
Divi’s does not need to constantly change its manufacturing procedure to meet the changing compositions of specific formulations. Bulk production also gives the company the benefit of economies of scale.

4. Divi’s is looking to enter Phase 2 and Phase 3 custom synthesis manufacturing in the near future. The company has set a benchmark in quick turnaround time when it comes to custom drug synthesis. It was the first company to finish a 100+ ton bulk order in under a year.

But it hasn’t been all happiness and sunshine for Divi’s. The pharma giant has had its fair share of chemical imbalances. In recent quarters, Divi’s margins have fallen from 44% to 33%.

Here are a few of the reasons for this tumble:

1. The majority of Divi’s sales come from concentrated products as well as a concentrated consumer base. The company’s top 5 products contribute to a majority of the company’s revenue. One such product is Naproxen, an arthritis relief drug.
Since the pharma industry is heavily regulated, changes in the legislature in regard to any product by Divi’s could seriously harm its revenue stream.
Similarly, due to the concentration of buyers, a change in buying patterns could also hurt the company’s bottom line.

2. The stringency in the pharma industry can be observed globally. Due to the concentration of American drug distributors in Indian manufacturers’ client list, the United States Food and Drug Administration is more strict when it comes to approvals of various applications and new product launches.
A failure or delay in the acquisition of these approvals could negatively impact the production process of Divi’s Laboratories’ offering.

3. While a majority of raw materials used by Divi’s faced some price instability, the same has stabilised in recent times. However, the raw materials Toluene, Lithium and Iodine still continue to see a rise in price.

4. Divi’s also has a ₹2,000 crore to ₹3,000 crore plan to establish a new unit in Kakinada. However, the plan is currently doing the loops of government offices as its stuck in a clearance battle.

To summarise, Divi’s has aspects that make it “too big to fail”. But, now it has to be aware of the phrase, “the bigger they are, the harder they fall”.

Divi’s COVID Rollercoaster

Of course, if we talk about the pharmaceutical industry and one of its biggest players, we would talk about the good ol’ pandemic.

The pandemic is long gone enough that we can say that, right?

Well, Divi’s did benefit from the demand for the Molnupiravir drug, as it was one of the ingredients used for the Covid-related drug. As the pandemic recedes, the need for the drug reduces, and the demand for Molnupiravir goes down as well.

Divi’s, being an exclusive supplier of the Molnupiravir drug, has caused its revenues to shrink as a result.

The Bottom Line

Divi’s Laboratory has an extensive past, both in terms of people involved with the organisation as well as feats performed by the organisation itself. One could even dare say that it has the makings of an industry leader.

The company is the third biggest in terms of market capitalisation. Its performance and potential do make it so prescribing it to your portfolio would have little to no side effects.

However, if you are already invested or plan to invest in the company, proper attention needs to be paid to the threats and risks that the organisation is exposed to.