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Sun Pharma: Formulation led growth - Views on News from Equitymaster
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Sun Pharma: Formulation led growth
Jul 23, 2007

Performance summary
  • Revenues grow by 23% YoY led by the 26% YoY growth in domestic sales and 18% YoY growth in exports

  • Operating margins contract by 120 basis points (1.2%) due to rise in raw material costs (as percentage of sales)

  • PAT grows by 29% YoY on the back of the healthy revenue growth and a considerably higher other income

  • Caraco reports a 43% YoY growth in sales and a 70% YoY growth in net profits

  • Sun Pharma proposes to raise Rs 35 bn for future acquisitions in the international generics market

Consolidated snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 5,112 6,275 22.8%
Expenditure 3,301 4,127 25.0%
Operating profit (EBIDTA) 1,811 2,148 18.6%
Operating profit margin (%) 35.4% 34.2%  
Other income 274 606 121.1%
Depreciation 202 226 11.9%
Profit before tax 1,883 2,528 34.2%
Tax 2 98 6440.0%
Minority interest 115 158 38.1%
Profit after tax/ (loss) 1,767 2,272 28.6%
Net profit margin (%) 34.6% 36.2%  
No. of shares (m) 186.1 197.1  
Diluted earnings per share (Rs)*   41.8  
P/E ratio (x)*   23.8  
(* on a trailing 12-month basis)

What is the company’s business?
Sun Pharma holds a 3.3% 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 FY07. 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 1QFY08?
Revenues – Both segments deliver: Sun Pharma recorded a healthy 23% YoY topline growth during the quarter, led by both the domestic (up 26% YoY) and exports (up 18% YoY) businesses. Caraco’s robust topline growth at 43% YoY during the quarter enabled Sun Pharma’s export formulations to grow by 21% YoY. This growth is commendable given the fact that the US has been facing severe pricing pressure. At the end of the quarter, Sun Pharma had 83 ANDAs awaiting US FDA approval in the US market. The latter includes 8 tentative approvals (5 from Sun Pharma and 3 from Caraco).

As regards the domestic business, formulations grew by 26% 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. Launch of 9 new products during the quarter were also instrumental in bolstering the growth in the domestic market.

Revenue break-up
(Rs m) 1QFY07 1QFY08 Change
Domestic      
Formulations 2,918 3,669 25.7%
Bulk 218 274 25.7%
Others 3 4 40.0%
Total (A) 3,139 3,947 25.7%
Exports      
Formulations 1,601 1,939 21.1%
Bulk 601 663 10.4%
Others 7 5 -29.6%
Total (B) 2,209 2,607 18.0%
Grand Total ((A)+(B)) 5,348 6,554 22.5%

Shrinkage in operating margins: Margins during the quarter have contracted by 120 basis points (1.2%) owing to a rise in raw material costs (as percentage of sales). Staff costs and other expenditure, however, witnessed a decline. Going forward, we expect operating margins to improve given the fact that Sun Pharma has hived off the innovative R&D business into a separate company. An improvement in product mix is also expected to contribute to the margin expansion going forward. However, investors should note that this is excluding the impact of the acquisition of Taro, as we believe that post the integration, the margins of Sun Pharma are likely to come under pressure.

Cost break-up
(% of sales) 1QFY07 1QFY08
Raw material costs 30.3% 32.6%
Staff cost 12.1% 11.8%
Other expenditure 22.2% 21.3%

Outpacing the topline: Led by a strong performance at the topline and the operating level, the 29% YoY growth in the bottomline has surpassed both the topline and the operating profit growth. A higher other income has also played a part in boosting the bottomline.

Quarterly trend
(%) 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Net sales growth 40.5% 31.1% 29.1% 27.1% 33.8% 22.8%
Operating profit margin 23.9% 35.4% 31.9% 32.1% 28.4% 34.2%
Net profit margin 35.2% 29.9% 34.8% 36.8% 39.0% 36.2%

What to expect?
At the current price of Rs 995, the stock is trading at a multiple of 21.7 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. As on April 30, 2007, Sun Pharma floated a separate listed entity called Sun Pharma Advanced Research Company (SPARC), which will carry out the innovative R&D activities of the company. This company was listed on the bourses last week. This demerger is expected to contribute to the margin expansion going forward. Investors should, however, note that the numbers do not reflect the financials of Taro as clarity has yet to emerge on this front.

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