Robust growth potential and superior margin profile justify the valuation premium to the industry.

Sun Pharma’s stock has delivered returns in excess of 17 per cent in the last six months compared to the 9.1 per cent gain of the Nifty during the same period. Despite the sharp run up, improved growth visibility in the US on account of recent acquisitions and growing strength in India make the Sun Pharma stock a good buying opportunity from a one-to-two year perspective.

At the current market price of Rs 786, the stock trades at 21.8 times its FY14 earnings.

Robust growth potential and superior margin profile justify the over 20 per cent valuation premium to the industry.

Taro, a key strength

US remains a key market for Sun, accounting for more than half its revenues. In addition to a stable base business, acquisition of Israel-based Taro Pharma strengthened the company’s footing in this market. Taro, with a dermatology focussed portfolio, has ramped up its revenues and profits significantly since Sun’s acquisition in 2010.

This was made possible by price increases in key products, which more than compensated for the slide in volumes.

While Taro’s revenues rose 27 per cent in the last nine months, net profit grew over 37 per cent compared with the same period last year.

Operating margins expanded by 8.6 percentage points year-on-year to 55.1 per cent for the nine month period ended December.

But, increasing competition in the dermatology space may risk Taro’s revenues and margins in the medium term.

Sun Pharma, which holds 66 per cent in Taro, recently terminated its proposal to acquire the balance 34 per cent in Taro, after the latter’s shareholders demanded a higher price. Sun’s management believed that paying a price higher than $39.5 a share may not be in the best interest of Sun’s shareholders. With cash in excess of Rs 6,500 crore, Sun is exploring inorganic opportunities in the US and other emerging markets.

In addition to Taro, supplies of J&J’s anti-cancer drug Doxil’s generic equivalent bolstered Sun’s US revenues this fiscal.

The company was given temporary importation permission to supply the drug to the US market, due to short supply of the innovator’s product.

Sun’s generic filing for this product was recently approved by the US Food and Drug Administration (FDA).

With no other approved supplier, this may be a good opportunity for Sun in the near term. Besides, Sun and Taro collectively have 142 product filings in the US awaiting FDA approval.

Acquisitions give a leg up

In November last year, Sun acquired the US-based specialty dermatology company DUSA Pharma for a consideration of $230 million (Rs 1,242 crore).

With US FDA approved facilities and capabilities in photodynamic skin treatment, the DUSA acquisition has given Sun an entry into the niche dermatological treatment devices space.

Sun recently acquired the generic business of US-based URL Pharma from Japanese major Takeda Pharma. URL has a portfolio of 107 products with filings of 230 ANDAs (Abbreviated New Drug Application) in the US market. Over the last few years, URL rejigged its strategy to focus on branded and differentiated products.

Under the new management, URL is likely to renew focus on the generic business. Sun’s management is confident of bettering URL’s prospects through cost control and improved efficiency.

Steady domestic business

Last April, Sun ranked fourth in the domestic market. Robust growth over the last nine months helped the company race ahead of Glaxo Smithkline Pharma to the third position currently.

With a 4.8 per cent share in the market, Sun commands leadership in key chronic therapies such as neuro-psychiatry, anti-diabetes, ophthalmology and cardio-vascular.

Even as the industry is grappling with delays in new product approvals due to regulatory tightening, Sun managed to launch 22 new products in the last nine months. This should help Sun sustain steady growth in the medium term.

The domestic sales grew at 7.2 per cent during the nine month period ended December 2012, compared with the same period last year. The slow growth was due to changes in the accounting treatment for sales returns and discounts.

Discounts and returns, which were earlier shown as expenses, are now reduced from the sales. Adjusting for these changes, growth remained strong at 20 per cent in the last nine months.

Sun’s revenues in the rest-of-the world (emerging) markets continued to gain strength in the current fiscal, posting growth of 24 per cent in the last nine months.

The active pharma ingredient business also grew at a healthy 27 per cent in the first nine months of the fiscal.

The company’s consolidated revenues grew 45 per cent to Rs 8,213 crore for the nine month period ended December.

Operating margins improved by 4.5 percentage points to 45 per cent during the first nine months, compared to the same period last year.

Net profit growth moderated to 13 per cent during this period on account of higher tax outgo.

(This article was published on February 16, 2013)
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