Sun Pharmaceuticals: Buy

Sun's track record with earlier acquisitions and the possibility of improvement in overall margins on complete integration of Taro, paint a positive growth picture.



The ongoing correction is a good opportunity to add the blue-chip Sun Pharmaceuticals stock to your portfolio. At the current market price of Rs 418, the stock trades at about 20 times its likely FY-12 per share earnings. While this may leave little headroom for the stock price to appreciate in the near term, the likely improvement in the financials of Taro, robust product pipeline and strong balance-sheet with $845 million (about Rs 3800 crore) cash on books suggest strong growth prospects. On-time launches of generic Eloxatin, Prandin and Taxotere in the US too could act as positive triggers for the stock.

Consolidation of Taro's numbers into its financials and the expected poor performance of Caraco, however, can keep the company's earnings under pressure in the near-term. A long-term outlook therefore is a must.

Earnings scorecard

In the just-ended December quarter, Sun posted an impressive 57 per cent Y-O-Y growth in its consolidated revenues. Contraction in operating margins to 28 per cent (36 per cent last year) due to a surge in staff costs (due to Taro) and other expenses, besides inflated depreciation (again due to Taro) suppressed the profit growth to a mere 3 per cent. The management however has upped its sales growth guidance to 42 per cent from the earlier 35 per cent. While this seems somewhat conservative — considering that the company has grown at about 46 per cent in the nine-months to December 2010 — it also highlights the near-term uncertainty on Taro's contributions. Sun's impressive track record on acquisitions, however, provides confidence in this regard.

During the quarter, Sun filed ANDAs for five products, making it a total of 13 ANDAs for the year so far (between Sun and Caraco). In view of the ongoing remediation process at some of its sites, it has lowered it ANDA target for the year from 30 to about 20-22 now. Even so, the company has among the largest pipelines of drug applications. It currently has ANDAs for 369 products filed (including Taro), of which 220 have been approved (as of December 10). The favourable verdict in the patent challenge cases in Eloxatin and Prandin in the US lower courts is also a positive. While the company isn't planning on immediate launches — it is evaluating risk-return trade-offs for the same — the development is undeniably a positive.

Taro holds the key

For the December quarter, Taro reported sales of about $102 million, up by 23 per cent over the same period last year. Higher provisioning for taxes, however, ate into its profits, lowering it by about 95 per cent, to $4.4 million. Integration of Taro's financials into that of Sun, therefore, can pressure the company's overall margins (Taro's margins are considerably lower than that of Sun's) for some time to come.

But since there were significant differences in the audited numbers of CY-2008 (compared to unaudited performance numbers), clarity on Taro would emerge only when the audited CY-2009 and CY-2010 results are made public. A large one-off expense or provisioning in Taro in the next couple of quarters, however, cannot be ruled out. That said, Sun's track record with earlier acquisitions, the likelihood of it launching Taro's products in other world markets and the possibility of improvement in overall margins on complete integration of Taro, paint a positive picture on growth.

Challenges at Caraco remain

Caraco, Sun's listed subsidiary in the US, reported sales of $40.4 million, down 22 per cent from the same quarter last year due to a 29 per cent drop in the sales of distributed products.

This was mainly due to the reduction in Para-IV sales as in the corresponding quarter last year; the company had registered Para-IV sales from Pantoprazole and Ethyol. It recorded a net loss of $3.0 million during the quarter. For the nine months ended December 2010, Caraco reported sales of $268.2 million and net loss of $3.3 million.

As for the FDA overhang over its manufacturing facility, there still is no clear solution, though the remediation process is still on. Caraco management believes that it will take significant time before it reaches its previous level of manufacturing in its Detroit facility. Caraco sales, therefore, can be expected to be lower in Q4 given the lack of one-offs and likely chargeback on generic Protonix. Sun, however, is taking steps to set up its own sales force in the US for marketing and distributing its products and has offered to take Caraco private.



Going strong



Sun reported a 20 per cent growth in domestic formulation during the quarter (40 of total sales), helped by nine product launches. For the nine-months ended December 2010, it reported a higher growth of about 43 per cent, helped primarily by the low base of last year (due to change in distribution policy). It has so far launched 30 products this year. The company now holds a market share of 3.7 per cent in the domestic market. As per IMS ORG report, the Indian pharma market grew by 17 per cent in 2010 while Sun Pharma managed 18 per cent growth, suggesting market share gains.

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