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Sun Pharma: Consistency is the key!

Oct 20, 2006

Performance summary
Sun Pharma has reported a strong set of numbers for the second quarter and half year ended September 2006. For the quarter, the topline has grown at a robust pace, led by both its domestic formulations business and export sales. Operating margins have contracted due to a rise in staff costs and other expenditure. Despite this, the bottomline growth has been strong - aided by higher sales, increase in other income and a lower tax outgo.

Consolidated snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 4,152 5,362 29.1% 8,053 10,478 30.1%
Expenditure 2,808 3,654 30.1% 5,429 6,959 28.2%
Operating profit (EBIDTA) 1,344 1,708 27.1% 2,625 3,519 34.1%
Operating profit margin (%) 32.4% 31.9%   32.6% 33.6%  
Other income 264 402 51.9% 548 676 23.2%
Depreciation 130 204 56.6% 249 405 62.6%
Profit before tax 1,478 1,906 29.0% 2,924 3,790 29.6%
Tax 23 (22)   56 (20)  
Minority interest (23) 64   29 178 512.7%
Profit after tax/ (loss) 1,478 1,864 26.1% 2,839 3,632 27.9%
Net profit margin (%) 35.6% 34.8%   35.2% 34.7%  
No. of shares (m) 185.5 186.7   185.5 186.7  
Diluted earnings per share (Rs)*         35.3  
P/E ratio (x)*         26.1  
(* 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 May 2006 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 1HFY07. 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 2QFY07?
Exports drive topline: Sun Pharma recorded a robust 29% YoY topline growth during the quarter, largely led by its exports business, which contributed 45% to the total sales of the company. Caraco’s robust topline growth at 43% YoY during the quarter enabled Sun Pharma’s export formulations to grow by 49% YoY. This growth is commendable given the fact that the US has been facing severe pricing pressure. At present, Sun Pharma has 28 products in the US market, out of which 23 belong to Caraco. As of date, Caraco has 17 ANDAs pending US FDA approval, while Sun Pharma has 39 filings pending approval. This takes the total ANDAs pending approval to 56, out of which the company has received tentative approvals for 8 ANDAs. Some of the important approvals that the company received during the quarter include ‘Ondansetron’, ‘Gabapentin’ and a tentative approval for ‘Amifostine’ injection for which Sun Pharma enjoys first-to-file status.

As regards the domestic business, formulations grew by 15% YoY driven by the core therapeutic segments of psychiatry, neurology, cardiology, diabetology and gastroenterology. These segments contributed 71% to the domestic formulations sales during the quarter.

Revenue break-up
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Formulations 2,463 2,834 15.1% 4,989 5,753 15.3%
Bulk 255 278 9.3% 485 497 2.5%
Others 0 1   0 4  
Total (A) 2,718 3,114 14.6% 5,474 6,253 14.2%
Formulations 1,204 1,796 49.2% 2,209 3,397 53.8%
Bulk 517 726 40.4% 899 1,327 47.6%
Others - 6   - 13  
Total (B) 1,721 2,528 46.9% 3,108 4,738 52.4%
Grand Total ((A)+(B)) 4,439 5,642 27.1% 8,581 10,991 28.1%

Pressure on operating margins: Margins during the quarter have marginally contracted by 50 basis points on the back of an increase in staff costs and other expenditure as a percentage of sales. The company managed to keep its raw material costs 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) 2QFY06 2QFY07 1HFY06 1HFY07
Raw material costs 33.7% 31.9% 34.3% 30.6%
Staff cost 10.6% 11.5% 7.6% 11.8%
Other expenditure 23.3% 24.7% 23.1% 24.1%

Bottomline in line with topline: Led by a strong performance at the topline level, the bottomline has clocked an impressive 26% YoY growth, despite the pressure on operating margins. A lower tax outgo and increase in other income have also lent a hand in boosting the bottomline.

Quarterly trend
(%) 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net sales growth 38.3% 41.5% 35.0% 40.5% 31.1% 29.1%
Operating profit margin 35.0% 33.5% 34.8% 23.9% 35.4% 31.9%
Net profit margin 35.3% 35.0% 34.6% 35.2% 29.9% 34.8%

What to expect?
At the current price of Rs 922, the stock is trading at a price to earnings multiple of 21.3 times our estimated FY09 earnings, which is at the higher end of the valuation spectrum. 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. While we had factored the impact of the same in our FY07 estimates (especially on the operating margins front), there has been a delay in the demerger process, which is now scheduled to be completed by the end of the fiscal. This means that the impact of the same will be reflected in the company’s FY08 numbers and we will have to revise our estimates accordingly.

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