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Sun Pharma: ‘Formulating’ growth story - Views on News from Equitymaster
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Sun Pharma: ‘Formulating’ growth story
Jan 29, 2007

Performance summary
Sun Pharma has reported a strong set of numbers for the third quarter and nine months ended December 2006. For the quarter, the topline has grown at a robust pace, led by both its domestic and export formulations businesses. Operating margins have contracted marginally due to a rise in raw material costs and staff costs (as percentage of sales). Despite this, the bottomline growth has been robust, duly aided by higher sales, increase in other income and a lower tax outgo.

Consolidated snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 4,247 5,400 27.1% 12,301 15,879 29.1%
Expenditure 2,867 3,667 27.9% 8,296 10,626 28.1%
Operating profit (EBIDTA) 1,380 1,733 25.6% 4,005 5,253 31.1%
Operating profit margin (%) 32.5% 32.1%   32.6% 33.1%  
Other income 363 636 74.9% 912 1,311 43.8%
Depreciation 177 212 19.8% 426 617 44.9%
Profit before tax 1,567 2,157 37.7% 4,491 5,947 32.4%
Tax 70 (29)   126 (49)  
Minority interest 33 198 505.8% 62 376 509.1%
Profit after tax/ (loss) 1,464 1,989 35.8% 4,303 5,620 30.6%
Net profit margin (%) 34.5% 36.8%   35.0% 35.4%  
No. of shares (m) 185.5 190.1   185.5 190.1  
Diluted earnings per share (Rs)*         37.3  
P/E ratio (x)*         27.5  
(* on a trailing 12-month basis)            

What is the company’s business?
Sun Pharma holds a 3.2% share of the domestic pharma market (as per the latest ORG IMS MAT data) and has a strong presence in the lifestyle therapeutic segment such as cardiology, neurology and diabetology. It started focusing on the exports market by acquiring Caraco Pharma in the US in FY02. Further, it has increased its stake in the latter to 75% at present, thus taking over the majority control. Exports contributed to around 43% to the company’s revenues in 9mFY07. With the help of Caraco, the company has been able to grow its US business, which brings in synergies in terms of backward integration in both manufacturing and R&D.

What has driven performance in 3QFY07?
Exports drive topline: Sun Pharma recorded a robust 27% YoY topline growth during the quarter, largely led by its exports business, which contributed 43% to the total sales of the company. Caraco’s robust topline growth at 51% YoY during the quarter enabled Sun Pharma’s export formulations to grow by 48% YoY. This growth is commendable given the fact that the US has been facing severe pricing pressure. At present, Sun Pharma has 31 ANDA approvals in the US market with 61 ANDAs awaiting US FDA approval. The latter includes 7 tentative approvals (5 from Sun Pharma and 2 from Caraco). Some of the important approvals that the company received during the quarter include ‘Plenytoin’ and a tentative approval for ‘Amifostine’ injection for which Sun Pharma enjoys first-to-file status.

As regards the domestic business, formulations grew by 19% YoY driven by the core therapeutic segments of psychiatry, neurology, cardiology, diabetology and gastroenterology. These segments contributed around 71% to the domestic formulations sales during the quarter.

Revenue break-up
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Domestic            
Formulations 2,476 2,935 18.5% 7,464 8,687 16.4%
Bulk 187 227 21.4% 671 723 7.7%
Others - 6   0 10  
Total (A) 2,662 3,168 19.0% 8,136 9,421 15.8%
Exports            
Formulations 1,302 1,927 48.0% 3,510 5,324 51.7%
Bulk 525 556 5.9% 1,424 1,883 32.2%
Others 0 7   0 20  
Total (B) 1,827 2,490 36.3% 4,935 7,227 46.5%
Grand Total ((A)+(B)) 4,489 5,658 26.0% 13,071 16,648 27.4%

Margins under pressure: Margins during the quarter have marginally contracted by 40 basis points on the back of an increase in raw material costs and staff costs (as percentage of sales). The company has managed to keep its other overheads under control. Going forward, we expect operating margins to improve as Sun Pharma hives off the innovative R&D business into a separate company (process is expected to be completed by the end of FY07).

Cost break-up
(% of sales) 3QFY06 3QFY07 9mFY06 9mFY07
Raw material costs 29.3% 31.4% 32.6% 30.8%
Staff cost 11.4% 12.2% 10.5% 11.9%
Other expenditure 26.8% 24.4% 24.4% 24.2%

Outpacing the topline: Led by a strong performance at the topline level, the 36% YoY growth in the bottomline has surpassed the topline growth, despite the pressure on operating margins. A lower tax outgo and higher other income have largely contributed in boosting the bottomline.

Quarterly trend
(%) 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07
Net sales growth 41.5% 35.0% 40.5% 31.1% 29.1% 27.1%
Operating profit margin 33.5% 34.8% 23.9% 35.4% 31.9% 32.1%
Net profit margin 35.0% 34.6% 35.2% 29.9% 34.8% 36.8%

What to expect?
At the current price of Rs 1,024, the stock is trading at a multiple of 22.3 times our estimated FY09 earnings. Sun Pharma’s domestic formulations business is likely to witness strong growth going forward, due to the company’s focus on the lifestyle segment and technologically complex products. In the international arena, branded formulation sales to the CIS countries, China, South East Asia, South Africa and the Middle East are expected to pick up momentum.

As far as the US markets are concerned, Sun Pharma is in a position to leverage its cost advantage in manufacturing and R&D by launching new drugs through Caraco Pharma. However, the pricing pressure in the US is likely to be an area of concern going forward. Sun Pharma is planning to float a separate listed entity, which will carry out the innovative R&D activities of the company. The demerger process is expected to be completed by the end of the fiscal, contributing to margin expansion going forward. Thus, while we are positive about the growth prospects of the company, valuations are the current juncture appear stretched and hence we advise investors to exercise caution.

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