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Sun Pharma: The Caraco effect

Dec 16, 2005

Performance Summary
Sun Pharma’s second quarter and half year ended September 2005 results were a mixed bag. While the topline registered a robust growth both during the quarter and the half year, operating margins witnessed a decline during both the periods on the back of rising expenditure. However, a significant increase in other income coupled with healthy sales growth percolated down to the bottomline, which was up 48% and 53% YoY in 2QFY06 and 1HFY06 respectively.

Consolidated snapshot
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 2,985 4,223 41.5% 5,886 8,199 39.3%
Expenditure 1,815 2,808 54.7% 3,701 5,429 46.7%
Operating profit (EBIDTA) 1,169 1,415 21.0% 2,186 2,771 26.8%
Operating profit margin (%) 39.2% 33.5%   37.1% 33.8%  
Other income 10 193 1796.1% 43 402 826.7%
Interest 15 -   24 - -100.0%
Depreciation 96 130 35.1% 186 249 33.7%
Profit before tax 1,068 1,478 38.4% 2,019 2,924 44.8%
Tax 31 23 -24.9% 68 56 -18.2%
Minority interest 39 (23)   92 29 -68.4%
Profit after tax/ (loss) 999 1,478 48.0% 1,858 2,839 52.8%
Net profit margin (%) 33.5% 35.0%   31.6% 34.6%  
No. of shares (m) 185.5 185.5   185.5 185.5  
Diluted earnings per share (Rs)*       20.0 30.6  
P/E ratio (x)         23.2  
(* annualised)            

What is the company’s business?
Sun Pharma is a leading domestic pharma company with a 3.27% market share (as per Aug 2005 ORG IMS MAT data) and 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 increased its stake in Caraco Pharma in FY04 to 61% taking over majority control. Exports now contribute around 40% to the company’s revenues (FY05). With the help of its US subsidiary, the company has been able to grow its US business, which brings in synergies with Sun's business by backward integration in both manufacturing and R&D.

What has driven performance in 2QFY06?
Strong topline growth: Sun Pharma’s topline growth was fuelled by strong performance in its overall formulations business, which recorded an impressive 38% YoY growth during 2QFY06. Domestic formulations recorded a 36% YoY growth due to a healthy performance by its core therapeutic segments of psychiatry, neurology, cardiology, diabetology, and gastroenterology, which contribute 70% to the domestic formulations sales. During the quarter, formulations exports grew by a robust 40% YoY, which was basically due to a strong 29% YoY growth shown by Sun Pharma's US based subsidiary, Caraco Pharma. While revenues from the domestic bulk drugs segment witnessed a decline on the back of the company's increased focus on its formulations business, bulk drugs exports saw a considerable rise on account of higher sales to the regulated markets.

Revenue break-up
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Formulations 1,806 2,463 36.4% 3,549 4,989 40.6%
Bulk 293 255 -13.2% 544 485 -11.0%
Others 7 -   7 -  
Total (A) 2,107 2,718 29.0% 4,101 5,473 33.5%
Formulations 862 1,204 39.7% 1,687 2,209 31.0%
Bulk 226 517 128.7% 543 899 65.5%
Others - -   -    
Total (B) 1,088 1,721 58.2% 2,230 3,108 39.4%
Grand Total ((A)+(B)) 3,194 4,439 39.0% 6,331 8,581 35.6%

Margins under pressure: Operating margins declined by 570 basis points during the quarter driven by a rise in expenses on all fronts. It must be noted that during 1HFY06, the company acquired two manufacturing facilities at Hungary and Ohio, US. This led to an increase in raw material costs as a percentage of sales as these facilities have a different cost structure and the company is in the process of integrating purchasing with its central purchase function. These acquisitions also propelled a rise in staff costs as a percentage of sales due to an increase in staff and revisions made in salaries. Pricing pressure in the US generic market also played a role in the margins decline.

Cost break-up
(% of sales) 2QFY05 2QFY06 1HFY05 1HFY06
Raw material costs 26.1% 30.5% 28.6% 30.9%
Staff cost 9.6% 10.4% 9.6% 9.8%
Other expenditure 21.2% 22.9% 20.9% 22.7%

Bottomline scenario: A huge jump in other income and a lower minority interest provisioning coupled with a strong topline growth provided a boost to the bottomline. The increase in other income owing to a rise in interest income, which accrued on the FCCB funds parked with banks. As a result, bottomline for the quarter and the half-year grew by 48% YoY and 53% YoY respectively.

What to expect?
At the current price of Rs 710, the stock is trading at a price to earnings multiple of 23.2 times its annualised 1HFY06 earnings. With its US subsidiary now turning profitable, the company is in a position to leverage its cost advantage in manufacturing and R&D by launching new drugs through Caraco Pharma in the US markets. Also, being a dominant player in the lifestyle segment in the domestic market, the company is likely to see a good growth rate going forward, as these segments are currently amongst the fastest growing therapeutic segments in the domestic market.

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