report on Sun Pharma by Motilal oswal

SUN PHARMA: Caraco provides update on resolution of US FDA issues; Indicates slow progress

Caraco, Sun Pharma’s (SUNP IN, Mkt Cap US$9.7b, CMP Rs2,075, Buy) US subsidiary, has provided an update on the ongoing process of resolution of US FDA issues at Caraco’s US facilities. Key highlights:

-          Under the terms of the Consent Decree (signed by Caraco in Sep-2009), before resuming the manufacture of any product, certifications and approvals from both outside experts and the US FDA are to be obtained.

-          Caraco has made significant progress toward completion of this process for its first set of two products, and expects to commence manufacture of these first two products by the end of FY11.

-          A second set of 2-3 products is planned for manufacture during 3QFY12. Hence, by the end of FY12, Caraco expects to be manufacturing and distributing 4-5 products.

-          All of Caraco’s prior approved products, together with the new products pending approval from the US FDA, will be subject to the same processes, certification and approvals as set forth in the Consent Decree.

-          Caraco has indicated that it will take significant time before it reaches its previous levels of manufacturing in its Detroit facility.

Implications – Slower progress in resolving US FDA issues

-          We believe that the pace of progress in resolving US FDA issues is very slow. This is despite signing of the Consent Decree, implying that the US FDA is very stringent regarding cGMP compliance.

-          This is in-line with our expectations of a gradual recovery in Caraco’s core performance. We currently model a part-recovery in Caraco’s manufacturing operations beginning FY12E onwards.

Valuation and view

-          An expanding generic portfolio coupled with change in product mix in favor of high-margin exports is likely to bring in long-term benefits for Sun Pharma. Its ability to sustain superior margins even on a high base is a clear positive.

-          Key drivers for future include:

1. Ramp-up in US business and resolution of US FDA issues at Caraco & Cranbury facilities.

2. Monetization of the Para-IV pipeline in the US

3. Launch of controlled substances in the US

4. Sun’s ability to improve Taro’s profitability (currently lower than Sun)

-          We expect core FY11 EPS at Rs61.8 (up 34.7%) and FY12 EPS at Rs74.7 (up 20.9%) resulting in 28% core earnings CAGR for FY10-12 albeit on a low base. Including Para-IV upsides, we expect FY11 EPS of Rs79.3 (up 21.6%).

-          The stock is currently valued at 33.6x FY11E and 27.8x FY12E core earnings. Including upsides from Taro acquisition, the stock is valued at 25.5x FY12E core earnings. Earnings growth is likely to improve post the resolution of Caraco’s US FDA problems.

-          With the Taro acquisition going through recently, we believe the next catalyst to the stock’s performance will be resolution of Caraco’s US FDA issues.