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Sun Pharma: Other income slows net - Views on News from Equitymaster
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Sun Pharma: Other income slows net
Oct 26, 2007

Performance summary
  • Revenues grow by 25% YoY during 2QFY08 led by the robust 31% YoY and 38% YoY growth in domestic and export formulations respectively.

  • Operating margins expand by an impressive 4.2% during the quarter, owing to a substantial fall in raw material and other expenditure (both as percentage of sales)

  • PAT grows by a relatively slower 17% YoY and is impacted by the reduction in other income.

  • Caraco reports a 46% YoY growth in sales and a 100% YoY growth in net profits for 2QFY08.

Consolidated snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 5,362 6,679 24.6% 10,478 12,954 23.6%
Expenditure 3,654 4,270 16.9% 6,959 8,396 20.7%
Operating profit (EBIDTA) 1,708 2,409 41.0% 3,519 4,558 29.5%
Operating profit margin (%) 31.9% 36.1%   33.6% 35.2%  
Other income 402 111 -72.4% 676 717 6.1%
Depreciation 204 230 12.7% 405 455 12.3%
Profit before tax 1,906 2,290 20.2% 3,790 4,819 27.2%
Tax (22) 1   (20) 99  
Minority interest 64 104 63.1% 178 262 47.1%
Profit after tax/ (loss) 1,864 2,186 17.2% 3,632 4,457 22.7%
Net profit margin (%) 34.8% 32.7%   34.7% 34.4%  
No. of shares (m) 186.7 199.2   186.7 199.2  
Diluted earnings per share (Rs)*         43.0  
P/E ratio (x)*         23.5  
(* 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 2QFY08?
Revenues – Formulations deliver: Sun Pharma recorded a healthy 25% YoY topline growth during the quarter, led by both the domestic (up 31% YoY) and exports (up 38% YoY) formulations businesses. Caraco’s (75% subsidiary) robust topline growth at 46% YoY during the quarter enabled Sun Pharma’s export formulations to grow at a healthy pace. This growth is commendable given the fact that the US has been facing severe pricing pressure. During the quarter, Sun Pharma received ANDA approvals for Wyeth’s ‘Protonix’, Novartis’ ‘Trileptal’ and ‘Exelon’. For these products, Sun Pharma has been granted 180 days of marketing exclusivity, which it shares with other first filers. The annual sales in the US of these 3 products have been pegged at US$ 3 bn. While Sun Pharma has launched generic ‘Trileptal’ tablets, it is still evaluating all its options for launching generic ‘Protonix’ (gastrointestinal) and ‘Exelon’ (indicated for Alzheimer’s), both of which are still under litigation. While the four strengths of ‘Exelon’ – 1.5 mg, 3 mg, 4.5 mg and 6 mg – have annual sales of around US$ 200 m in the US, the two strengths of ‘Protonix’ – 20 mg and 40 mg - generated sales of US$ 2.3 bn.

As far as ‘Effexor XR’ is concerned (an antidepressant), Sun Pharma has received a Covenant Not to Sue from Wyeth for the strengths 37.5 mg, 75 mg and 150 mg. These strengths of ‘Effexor’ capsules have annual sales of around US$ 2.6 bn in the US. Thus, Sun Pharma is likely to launch the product once it receives US FDA approval for the same. Between Sun Pharma and Caraco, 16 ANDAs corresponding to 13 products were approved during the first half. A total of 13 ANDAs corresponding to 11 products were filed during 2QFY08. With this, 87 ANDAs representing 71 products await USFDA approval, including 8 tentative approvals.

As regards the domestic business, formulations grew by 31% YoY, driven by the core therapeutic segments of psychiatry, neurology, cardiology, diabetology and gastroenterology. These segments contributed around 70% to the domestic formulations sales during the quarter. Launch of 21 new products during the first half were also instrumental in bolstering the growth in the domestic market.

Revenue break-up
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Domestic
Formulations 2,834 3,720 31.2% 5,753 7,389 28.4%
Bulk 278 211 -24.3% 497 485 -2.3%
Others 1 2 64.3% 4 6 48.7%
Total (A) 3,114 3,933 26.3% 6,253 7,880 26.0%
Exports
Formulations 1,796 2,478 38.0% 3,397 4,417 30.0%
Bulk 726 529 -27.2% 1,327 1,192 -10.2%
Others 6 6 -9.8% 13 11 -20.5%
Total (B) 2,528 3,013 19.2% 4,738 5,619 18.6%
Grand Total ((A)+(B)) 5,642 6,945 23.1% 10,991 13,499 22.8%

Cost break-up
(% of sales) 2QFY07 2QFY08 1HFY07 1HFY08
Raw material costs 29.5% 23.6% 28.0% 28.8%
Staff cost 11.5% 9.2% 11.8% 11.5%
Other expenditure 32.1% 21.8% 26.6% 24.5%
Improvement in operating margins: Operating margins expanded by 4.2% during 2QFY08, duly helped by the fall in raw material and other expenditure (as percentage of sales). Staff costs also witnessed a decline. The fall in raw material costs was attributed to the change in product mix with the proportion of formulations (enjoying higher margins as compared to APIs) increasing to 90% of overall sales, captive use of APIs and focus on high margin APIs. 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 could come under pressure.

Bottomline slows down: A sizeable 72% YoY drop in other income slammed the brakes on the bottomline, which grew by a relatively slower 17% YoY. Other income reduced due to the adverse impact of foreign exchange fluctuations and lower interest income as investment was made in acquiring 25% stake in Taro.

Quarterly trend
(%) 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales growth 31.1% 29.1% 27.1% 33.8% 22.8% 24.6%
Operating profit margin 35.4% 31.9% 32.1% 28.4% 34.2% 36.1%
Net profit margin 29.9% 34.8% 36.8% 39.0% 36.2% 32.7%

What to expect?
At the current price of Rs 1,010, the stock is trading at a multiple of 17.3 times our estimated FY10 earnings (excluding Taro). 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.

In the US generics market, 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 far as Taro is concerned, Sun Pharma currently has a 25% stake in the company and a shareholders meeting has been scheduled to discuss Sun Pharma’s acquisition of Taro. This meeting will be held on publication of the CY06 and 1HCY07 results by Taro, the date of which has not yet been declared. Thus, till such time, uncertainty with regards the acquisition remains.

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