Sun Pharma: Bright prospects

After the steep correction witnessed in the early part of the year, Indian equities staged a recovery beginning March. From the February lows, the BSE Sensex has gained about 14 per cent. But for pharma stocks, which are traditionally believed to be less volatile, the journey over the last nine months has not been smooth. The BSE Healthcare Index has shed over a per cent during the same period. Concerns over competition and regulatory action, particularly in key markets such as the US, have kept the stock prices low.

The issue of subpoena by the anti-trust division of the US Department of Justice in May 2016, initiating a probe into the anti-competitive practices by a group of generic drug makers in the US, including Indian makers such as Sun Pharma and Dr Reddy’s Laboratories, only added to the angst of investors, sending the stocks further down.

The stock of Sun Pharma has lost about 20 per cent since then and currently trades at 19 times its expected 2017-18 earnings. This implies an over 10 per cent discount to peers such as Dr Reddy’s Laboratories and over 20 per cent discount to its historical band of 21-23 times two-year forward earnings.

The current stock price seems to have more than priced in the regulatory concerns and delays in getting clearance for its Halol plant. Upsides from the recent acquisition of speciality ophthalmic company, Ocular Technologies Sarl, turnaround in Ranbaxy’s operations and anticipated clearance of the Halol facility by the US Food and Drug Administration (FDA) should keep Sun Pharma in good stead over the next two to three years. Investors can use the current price weakness to accumulate the stock.

In October 2016, Sun Pharma made public its decision to acquire the US-based specialty ophthalmology company, Ocular Technologies Sarl, for an upfront cash payment of $40 million (₹272 crore). The latter owns exclusive world-wide marketing rights for Seciera (Cyclosporine), which is an innovative drug used to treat dry eye disease. The drug is currently undergoing late stage clinical trials (phase III) and about 16 million people in the US itself are believed to have been suffering from dry eye disease.

Currently there are two drugs approved by the US drug regulator for this condition. Allergan flagship brand, Restasis, which is used for the same condition, clocked sales of about $670 million in the first half of 2016 in the US alone. In July 2016, Shire’s brand Xiidra, for the same indication, was approved by the US FDA.

Given the large addressable market, Seciera, if approved by the US FDA, will have a positive impact not only on Sun’s revenue but also its profitability, given that the profit margin on innovative products are very attractive. For instance, the gross margin (realisation minus raw material cost) may be upwards of 70 per cent, for most innovative products. Other products in Sun Pharma’s specialty ophthalmology portfolio include BromSite, for post-operative inflammation and pain in patients undergoing cataract surgery.

Sun Pharma recently launched the authorised generic version of four hypertension drug brands owned by Japanese drug maker Daiichi Sankyo pursuant to an agreement with the latter. These products — Benicar, Benicar HCT, Azor and Tribenzor — recorded sales of $ 2.5 billion in the US for the 12-month period ending August 2016, according to IMS Health. Sun Pharma will be the exclusive marketing partner for these products in the US. This should add to the company’s revenue and profitability over the next few quarters.

Integration of Ranbaxy’s operations, which led to a dilution in the company’s operating profit margin over the last couple of years, is expected to pay off over the next two years. From a little over 29 per cent in 2015-16, Sun Pharma’s operating profit margin should improve steadily over the next two years, thanks to the synergy from the Ranbaxy acquisition.

The company’s manufacturing facility at Halol (Gujarat), which has been under the US drug regulator’s scanner for quality issues and was served a warning letter last year, is expected to be inspected by end of the year. Successful inspection and re-approval of the facility, if it happens, will open doors for new launches in the US and will provide a leg up to the company’s overall performance. Sun Pharma currently has 144 products in the US that are awaiting regulatory approval.

While most concerns seem largely priced in at the current stock price levels, any negative surprise on the anti-trust probe by the DoJ or delays in Halol inspection can impact performance.

For the six months ended September 2016, Sun Pharma reported 18 per cent year-on-year growth in revenue to ₹15,771 crore. The company’s net profit witnessed a 2.7 times jump during the first half of the fiscal. This was aided by a low base on account of an exceptional charge last year and benefit from exclusive marketing rights for the generic version of anti-cancer drug Gleevec this year.

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