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Sun Pharma: Right chemistry in place; good growth visibility Detailed Report

12 September 2013 Annual Report Update | Sector: Healthcare

Sun Pharma
BSE Sensex 19,997 S&P CNX 5,913

CMP: INR562

TP: INR600

Buy

Right chemistry in place; good growth visibility

Continued focus on differentiated offerings, maintaining cost leadership We went through Sun Pharmaceutical Industries (SUNP) annual report for FY13. Our key takeaways:
Stock Info Bloomberg Equity Shares (m) 52-Week Range (INR) 1, 6, 12 Rel.Per (%) M.Cap. (INR b) M.Cap. (USD b) SUNP IN 2,071.1 581/328 -8/-14/18 1,164.4 18.4

Well charted strategy provides good growth visibility

SUNPs FY13 annual report provides good visibility on the key growth levers from its important markets like US and India. The company intends to continue focusing on (1) developing complex and differentiated products, and (2) maintaining cost leadership through vertical integration. It will adopt a conservative approach towards inorganic initiatives.

Financials: URL seen a value buy; working capital days reduced

Consolidation of URL Pharma: SUNPs cash flows indicate that the acquisition price paid for URL Pharma was USD71m, implying a valuation of 0.4x EV/Sales as per our assumption. Lower-than-expected acquisition cost coupled with faster-than-expected ramp-up at URL will shorten the estimated payback period for the acquisition. URL Pharma was consolidated for 55 days in 4QFY13. For this period, it reported sales of USD33m, with PAT margin of ~15%. Hedges: SUNP has outstanding hedges of USD300m, for which it has made provisions of INR1.29b. Working capital: Net working capital days stood at 112 at the end of March 2013 against 146 at the end of March 2012. Spin-off of India business: SUNP has spun off its India business into a 100% subsidiary, Sun Pharma Laboratories, which reported sales of INR27.4b, with a negative PBT of INR1.4b. The new structure might help SUNP to reduce overall effective tax rate, going forward.

Financial Snapshot (INR B) Y/E March 2013 2014E 2015E Net Sales EBITDA Adj PAT EPS (INR) Gr. (%) BV/Sh. (INR) RoE (%) RoCE (%) P/E (x) P/BV (x) 112.4 153.4 176.5 48.3 32.8 15.8 41 72 24.1 31.5 35.5 7.8 66.7 43.2 20.9 32 82 27.0 26.0 26.9 6.9 72.8 48.8 23.6 13 104 25.3 38.3 23.9 5.4

Shareholding pattern % As on Promoter Dom. Inst Foreign Others Jun-13 Mar-13 Jun-12 63.7 3.2 22.9 10.2 63.7 3.4 22.7 10.2 63.7 5.3 20.6 10.4

Other highlights
Managerial changes: Mr Israel Makov was appointed Chairman of the company in FY13. Ms Vidhi Shanghvi, daughter of founder, Mr Dilip Shanghvi, joined the company from 9 November 2012. USFDA clearances/approvals: The USFDA gave clearance to Caraco for manufacturing three products, post inspection of its facilities and confirmed that it is now in compliance with USFDA cGMP requirements. SUNP received a total of 20 ANDA approvals from the USFDA during the year, including that for Doxorubicin Liposomal Injection.

Stock Performance (1-year)

Valuation and view

We believe the US will continue to be the core earnings driver for SUNP, with support from India and RoW. We estimate 22% CAGR in core EPS over FY13-15. The stock trades at 26.9x FY14E and 23.9x FY15E core EPS. Maintain Buy with a target price of INR600. Alok Dalal(Alok.Dalal@MotilalOswal.com);+91 22 3982 5584 22 3982 5423 Hardick Bora(Hardick.Bora@MotilalOswal.com);+91

Investors are advised to refer through disclosures made at the end of the Research Report.

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Well charted strategy provides good growth visibility

After a chi evi ng USD2b i n s a l es i n FY13, SUNP ha s l a i d out a cl ea r s tra tegy for i ts next l eg of growth:

To generate sustainable revenues and free cash flows from differentiated product offerings, with focus on chronic therapies in India and other emerging markets. To focus on developing complex and differentiated products, while taking a conservative approach towards inorganic initiatives. To maintain cost leadership through vertically integrated capabilities and optimize operational expenses.
US as % of sales

US Market | Size: USD322b

Outlook Projected to grow at 1-4% CAGR over 2012-16 to reach USD350b-380b by 2016. Growth would be slow due to expiration of patents worth USD73b over 201316. This is, in fact, positive for generic drug makers like SUNP. SUNPs strategy Focus on complex generics, including injectables and differentiated dosage forms. Significant portion of this pipeline being backward integrated through in-house API capabilities. Manufacturing capabilities across a wide array of dosage forms will enable SUNP to tap multiple opportunities. Focus on growing recently acquired DUSA and URL Pharma, and enhancing their profitability.
US generic sales (INR m) driven by acquisitions and new launches
105,812 92,987 61,538 34,714 15,475 22,538 11,117

FY09

FY10

FY11

FY12

FY13

FY14E

FY15E

Source: MOSL, Company Note: Taro's US revenue consolidated from FY11 onwards; DUSA & URL from 4QFY13 onwards

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India as % of sales

Indian Formulations Market | Size: USD14b

Outlook Expected to grow at a CAGR of 14-17% over 2012-16. Growth will be driven by increased healthcare spending, rising income levels, rapid urbanization and increasing healthcare insurance. SUNPs strategy SUNP is sharpening its focus on building brands and strengthening customer relationships. It continues to strengthen its product portfolio and increase in-licensing products. Going ahead, SUNP will continue to concentrate on the chronic segments, which offer stable returns and ensure competitive long-term stability.

Domestic formulations sales (INR m) sustained momentum

Source: MOSL, Company

RoW as % of sales

Pharmerging Markets | Size: USD180b

Outlook Projected to grow at 12-15% CAGR over 2012-16 to USD310b-350b. The key contributing countries will be Brazil, Russia, China, Mexico and South Africa. Rising income and increased access to medicines will be a common trend driving growth in these markets. SUNPs strategy The focus ahead will be to leverage on the chronic portfolio to enhance presence in key emerging markets. In addition, SUNP is focusing on expanding its presence to new geographies. Some of the focus markets for the future include Latin America, Russia & CIS, China, South Africa, etc. SUNP plans to replicate its specialty product basket in these markets, including technology-based products.

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RoW sales (INR m) to grow at 22% CAGR over FY13-15

Source: MOSL, Company Note: Taro's emerging market sales consolidated from FY12 onwards

APIs as % of sales

Active Pharmaceutical Ingredients (APIs) | Size: USD100b

Outlook Projected to grow at 8-10% over the next few years. The API market is highly fragmented and is expected to witness consolidation. Growth will be fueled by patent expiries, greater outsourcing and demand for potent and biogeneric APIs. SUNPs strategy Focus on ensuring long-term competitiveness of the formulations business through strong backward integration. Establish long-term contracts with customers in regulated markets for sustainable revenue growth and margins.

API sales (INR m) subdued growth due to high captive consumption

Source: MOSL, Company

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EBITDA and EBITDA margin trend

Healthy free cash generation to continue

Source: MOSL, Company

Source: MOSL, Company

Working capital trend

Growing cash & cash equivalents

Source: MOSL, Company

Source: MOSL, Company

Financials: Working capital days reduced; new structure could help save tax
Consolidation of URL Pharma: SUNPs cash flows indicate that INR16.4b (USD301m) was spent on the acquisition of subsidiaries in FY13. It acquired Dusa Pharma for USD230m, which indicates that the acquisition price paid for URL Pharma was USD71m, implying a valuation of 0.4x EV/Sales as per our assumption. Recent price increases taken in doxycycline hyclate will enhance profitability for the subsidiary. Lower-than-expected acquisition cost coupled with faster-than-expected ramp-up at URL will shorten the estimated payback period for the acquisition. URL Pharma was consolidated for 55 days in 4QFY13. For this period, it reported sales of USD33m, with PAT margin of ~15%. Hedges: SUNP has outstanding hedges of USD300m, for which it has made provisions of INR1.29b. Intangible assets: Intangible assets (ex-goodwill) increased from INR3bn to INR13.5bn mainly due to the Dusa Pharma acquisition. Working capital: Net working capital days stood at 112 at the end of March 2013 against 146 at the end of March 2012. Interest income: SUNPs interest income was INR2.4b, implying a yield of 5.8% on its cash of INR40.6b. The yield is lower due to low yield at Taro. Excluding Taro, the yield is ~7.5%.

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Spin-off of India business: SUNP has spun off its India business into a 100% subsidiary, Sun Pharma Laboratories, which reported sales of INR27.4b, with a negative PBT of INR1.4b. The new structure might help SUNP to reduce overall effective tax rate, going forward. Consultancy fees: SUNPs consultancy fees doubled in FY13 to INR1.5b. Loans and advances: Long-term loans and advances increased 40% to INR8.4b. However, as a percentage of sales, long-term loans and advances remain unchanged at 7.4%. Capex: Capex for FY13 including acquisitions of Dusa Pharma and URL Pharma was INR8.5b. Patent infringement litigation: For FY13, SUNP made a provision of INR5.8b towards settlement for patent infringement litigation related to generic versions of Protonix.

Other highlights
Acquisition of Dusa Pharma: SUNP acquired Dusa Pharma for USD230m. This provides it with access to Levulan (Aminolevulinic Acid HCl) photodynamic therapy for the treatment of non-hyperkeratotic actinic keratoses or AKs of the face or scalp. Additionally, Dusas BLU-U treatment has been approved by USFDA for the treatment of moderate inflammatory acne vulgaris and general dermatological conditions. This is SUNPs first major initiative in establishing its presence in the US specialty pharma market. Acquisition of URL Pharma: Through its subsidiary, Caraco, SUNP acquired URL Pharmas non-colcrys business from Takeda for an undisclosed amount. This acquisition expands SUNPs product basket in the US generics market. URL Pharma has 107 ANDAs pending approval with the USFDA. USFDA clearances/approvals: The USFDA gave clearance to Caraco for manufacturing three products, post inspection of its facilities and confirmed that it is now in compliance with USFDA cGMP requirements. SUNP received a total of 20 ANDA approvals from the USFDA during the year, including that for Doxorubicin Liposomal Injection. Prandin judgment: The US courts ruled in favor of Caraco in its patent litigation against Novo Nordisk over Caracos generic version of Prandin, Repaglinide Tablets. The final USFDA approval for this product was received in June 2013. Being the First-to-File Para-IV filer, SUNP launched the product with 180 days of marketing exclusivity in the US market. Managerial changes: Mr Israel Makov was appointed Chairman of the company in FY13. Ms Vidhi Shanghvi, daughter of founder, Mr Dilip Shanghvi, joined the company from 9 November 2012.

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Valuation and view

We believe the US will remain the core earnings driver for SUNP, with support from India and RoW. While Taro had played a key role in shaping SUNP's US performance over the last two years, SUNPs own pipeline continues to grow at over 20% annually. We assume flat revenue growth for Taro over FY13-15, but with over 130 ANDAs awaiting approval, SUNP can sustain the current growth momentum in the US through its own pipeline of products. We model revenue CAGR of 30% for SUNPs own pipeline and believe that there could be positive surprises on this front. While India formulations will see a slowdown in FY14, impacted by the New Pricing Policy, we expect growth to rebound to historical levels of 16-18% in FY15. We estimate 22% CAGR in core EPS over FY13-15. The stock trades at 26.9x FY14E and 23.9x FY15E core EPS. We value SUNPs core business at INR588/share (25x FY15E EPS) and Para-IV pipeline including generic Doxil and Prandin at INR12/share, giving us a target price of INR600 7% upside. Strong earnings growth coupled with superior execution track record makes SUNP an attractive investment opportunity; maintain Buy.

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Financials and valuation

Income statement
Y/E March Net Sales Change (%) EBITDA EBITDA Margin (%) Depreciation EBIT Interest Other Income Extraordinary items PBT Tax Tax Rate (%) Min. Int. & Assoc. Share Reported PAT Adjusted PAT Change (%) Margins (%) 2010 40,075 -6 13,633 34.0 1,533 12,100 0 2,048 0 14,148 251 1.8 41 13,898 9,826 -27 25 2011 57,214 43 19,566 34.2 2,049 17,518 739 3,611 32 20,357 1,719 8.4 -913 18,638 14,952 52 25 2012 80,095 40 31,944 39.9 2,912 29,032 282 4,856 11 33,595 2,991 8.9 -3,855 30,604 27,125 81 29 2013 112,388 40 48,352 43.0 3,362 44,991 432 4,491 5,901 43,148 8,456 19.6 -4,863 34,693 37,638 39 29

(INR Million)
2014E 153,440 37 66,723 43.5 4,139 62,584 876 4,512 25,174 41,046 9,933 24.2 -5,107 31,113 48,325 28 28 2015E 176,540 15 72,796 41.2 4,403 68,393 876 5,872 0 73,389 13,210 18.0 -5,618 60,179 54,434 13 28

Balance sheet
Y/E March Share Capital Reserves Net Worth Debt Deferred Tax Total Capital Employed Gross Fixed Assets Less: Acc Depreciation Net Fixed Assets Capital WIP Investments Current Assets Inventory Debtors Cash & Bank Loans & Adv, Others Curr Liabs & Provns Curr. Liabilities Provisions Net Current Assets Total Assets 2010 1,036 77,254 78,289 1,712 -890 81,042 20,880 7,239 13,642 1,448 31,664 36,121 10,739 11,748 5,089 8,546 7,579 4,095 3,484 28,542 81,042 2011 1,036 93,798 94,833 3,717 -3,652 103,370 39,128 16,794 22,334 2,355 22,297 61,146 14,895 11,049 22,046 13,156 15,361 10,078 5,283 45,785 103,371 2012 1,036 120,628 121,663 2,739 -5,199 130,820 46,542 20,406 26,136 3,447 22,129 90,681 20,870 19,261 33,672 16,878 24,950 14,410 10,541 65,730 130,820 2013 1,036 148,862 149,897 2,072 -7,122 161,197 56,026 24,421 31,604 5,626 24,116 113,420 25,778 27,108 40,587 19,948 38,439 15,752 22,687 74,981 161,198

(INR Million)
2014E 2015E 2,071 2,071 167,598 213,678 169,669 215,749 1,343 1,343 -7,122 -7,122 185,348 237,045 63,839 28,560 35,279 3,313 70,495 32,963 37,532 2,157

26,116 28,116 143,020 192,755 34,242 36,865 49,056 22,857 47,250 23,814 23,436 42,839 42,384 81,338 26,193 48,384 23,409 24,975

95,770 144,371 185,348 237,045 E: MOSL Estimates

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Financials and valuation

Ratios
Y/E March Basic (INR) EPS Cash EPS Book Value DPS Payout (incl. Div. Tax.) Valuation(x) P/E Cash P/E Price / Book Value EV/Sales EV/EBITDA Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios (%) Asset Turnover (x) Debtors (No. of Days) Inventory (No. of Days) Creditors (No. of Days) Leverage Ratios (%) Net Debt/Equity (x) 2010 4.8 7.3 37.8 0.7 33.8 118.0 77.4 14.9 28.2 82.8 0.1 13.3 18.6 0.5 107.0 97.8 37.3 0.0 2011 6.8 9.8 45.8 0.9 28.2 82.9 57.6 12.3 19.6 57.4 0.2 16.2 23.6 0.6 70.5 95.0 64.3 0.0 2012 11.2 13.9 58.7 2.1 18.9 50.0 40.4 9.6 13.9 34.8 0.4 21.5 30.4 0.6 87.8 95.1 65.7 0.0 2013 15.8 16.0 72.4 2.5 32.2 35.5 35.1 7.8 9.8 22.8 0.4 24.1 31.5 0.7 88.0 83.7 51.2 0.0 2014E 20.9 14.6 81.9 3.0 15.0 26.9 38.6 6.9 7.1 16.3 0.5 27.0 26.0 0.8 87.7 81.5 56.6 0.0 2015E 23.6 28.5 104.2 3.5 15.6 23.9 19.7 5.4 6.0 14.5 0.6 25.3 38.3 0.7 87.6 88.6 48.4 0.0

Cash flow statement

Y/E March OP/(Loss) before Tax Interest Direct Taxes Paid (Inc)/Dec in Wkg Cap CF from Op. Activity (Inc)/Dec in FA & CWIP (Pur)/Sale of Invt CF from Inv. Activity Inc/(Dec) in Net Worth Inc / (Dec) in Debt Interest Paid Divd Paid (incl Tax) CF from Fin. Activity Inc/(Dec) in Cash Add: Opening Balance Closing Balance 2010 13,633 2,048 -890 -4,659 10,133 -2,920 -13,069 -15,988 -3,746 -77 0 -1,923 -5,746 -11,601 16,690 5,089 2011 19,534 3,611 -4,048 -286 18,811 -16,500 9,367 -7,134 6,413 2,006 -739 -2,400 5,280 16,957 5,089 22,046 2012 31,933 4,856 -5,373 -8,319 23,096 -10,585 169 -10,416 5,321 -978 -282 -5,115 -1,055 11,626 22,046 33,672 2013 42,451 4,491 -10,379 -2,336 34,227 -22,501 -1,987 -24,488 4,334 -668 -432 -6,058 -2,824 6,915 33,672 40,587

(INR Million)
2014E 41,549 4,512 -9,933 -12,320 23,809 -5,500 -2,000 -7,500 1,036 -729 -876 -7,270 -7,839 8,470 40,587 49,057 2015E 72,796 5,872 -13,210 -16,319 49,139 -5,500 -2,000 -7,500 0 0 -876 -8,481 -9,357 32,282 49,056 81,338

E: MOSL Estimates

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Sun Pharma: Right chemistry in place; good growth visibility Detailed Report
Sun Pha rma

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