CLSA believes Speciality Products should drive rerating for Sun Pharma

CLSA reiterates BUY rating with an unchanged target price of Rs 710. Success in specialty products should drive a rerating for Sun Pharma. Sun Pharma’s Q2 FY21 core PBT beats estimate by 28% driven by healthy revenue growth and cost control. Global specialty product sales rebounded 38% QoQ to U.S. $108 mn with sales of key products Ilymuya, Cequa and Odomzo back at pre Covid-19 levels. CLSA raised their FY21 EPS estimate 39% on back of its big beat Q2 FY21. With key products gaining traction and the majority of costs incurred, CLSA remains confident in the ramp-up of its specialty business in the coming years. A strong base business coupled with success in specialty products should drive a rerating.

Global specialty product sales rebounded 38% QoQ to U.S. $ 108 mn:

Global specialty sales (10% of overall sales, the majority in the U.S.) rose 38% QoQ to U.S. $ 108 mn with sales of key products Ilymuya, Cequa and Odomzo back at pre-Covid-19 levels. Sun Pharma gained market share in key products. This and better than expected sales for Taro led to 19% QoQ growth in overall U.S. revenue to U.S. $335 mn (6% beat). Sun Pharma took a 5% price increase in Ilumya recently.

Confident in specialty business ramp-up in the coming years:

The recent release of five years of safety data for Ilumya gives us confidence in a further pick-up in prescriptions not only in the U.S. but other markets globally (already seeing a strong response in the EU and Japan). With an anchor product in place in each focus therapy area (derma, ophthalmology and cancer), Sun Pharma remains committed to further investment in specialty products. As the specialty business ramps-up, CLSA expects its contribution to rise to 15% of EBITDA by FY23CL from nil today.

Sharekhan upgrades Sun Pharma to Buy from hold with a revised price target of Rs 612. Q2 performance was strong with revenue and earnings beating estimates. Management expects domestic formulations business to improve further led by new launches and a gradual improvement in the acute therapies, while the chronic segment is likely to grow strongly. Pick up in the specialty business and sturdy new product pipeline would enable US business growth. Improved growth prospects, healthy balance sheet, and improving return ratios would be key positives

Sun Pharma reported strong performance for the quarter with revenue and earnings coming ahead of estimates. Sales for the quarter stood at Rs 8553 cr, up 5.3% YoY, driven by 9% growth in exports while domestic revenue was flat on a YoY basis. However, sequentially, both India and U.S. revenue posted growth of 6% and 17% respectively. Operating profit margin (OPM) for the quarter stood at 27%, translating into a 500 bps YoY expansion because of a 280 bps YoY expansion in gross margin (due to favourable mix). Low interest cost coupled with tax refund (as against tax outgo in Q2FY2020) resulted in adjusted PAT, growing strongly by 82% YoY to Rs 1929 cr and was ahead of estimates.

India and the U.S. are the key markets for the company and constitute around 60% of the total topline. After four consecutive quarters of a decline, U.S. revenue grew by 4% YoY for the quarter largely backed by improvement in the specialty business and growth in new product launches. The outlook for the U.S. business has improved following a pick-up in the lucrative specialty business coupled with a strong product pipeline, which would unfold going ahead. Moreover, price erosion is largely stable in the U.S. generic business, which could also support growth. Domestic formulations business is on a strong footing backed by a sturdy growth in the chronic segment while the performance of the acute segment has been weak. The management expects the same to improve going ahead as doctor’s return to OPDs (Outdoor Patient Departments) and patient footfalls increase. Management sees the domestic formulations business to bounce back on account of new launches and gradual improvement in the prescriptions. Therefore, healthy growth outlook across both the key geographies and increasing penetration in other geographies would drive growth for Sun Pharma.

Key positives:

1)      After four consecutive quarters of decline, U.S. revenue has registered a 4% YoY growth, driven by improvement in the specialty business.
2)      Gross margin expanded by 280 bps YoY, aided by better product mix.
3)      OPM expanded by a sturdy 500 bps to 27%.

Key negatives:

1)      Other expenses were lower in Q2 FY21 and management has stated that savings in other expenses would not be sustained going ahead as the marketing activity picks up with easing of the lockdown. Therefore, operating expenses could rise.

Upgrades to Buy with a revised price target of Rs 612

Sun Pharma’s key geographies, U.S. and India are witnessing improved traction. Strong growth in chronic therapies along with likely improvement in acute therapies would fuel growth in the domestic formulations business. Moreover, a sturdy new product pipeline further provides visibility on India’s revenue growth. Improvement in the U.S. specialty business coupled with traction from new product launches would drive U.S. revenue upwards.

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Moreover, geographic expansion / increasing penetration for existing products would grow the base business. Q2 FY21 was a strong quarter for Sun Pharma with revenue and earnings coming ahead of estimates. Favourable mix has resulted in OPM expanding by 500 bps. Factoring in this, Sharekhan have revised upwards their earnings estimates for FY2021 and FY2022 by 7% and 5%, respectively. Sharekhan has also introduced FY2023 estimates in this note. At the CMP, the stock trades at 17.7x/15.8x its FY2022E/FY2023E EPS. Improved growth prospects, healthy balance sheet, and improving return ratios would be key positives.

Key risks:

1) Regulatory compliance risk including delay in product approvals.
2) Currency risk.