Sun Pharma – BUY -- Defining the Earnings Arc -IIFL

Multiple swing factors, big enough to make material swings in
FY14 and FY15 growth and profitability, make Sun Pharma
earnings projection difficult. Despite that, we believe that the
recent stock price correction and the earnings upside from
weakened INR make Sun’s valuation attractive. In the median
case, we expect 21% core earnings growth in FY14 and 14% in
FY15. If all factors play out favourably, FY14 earnings growth
could be as high as 44%; on the downside, earnings could
remain flat for the year. We raise our FY14, FY15 core earnings
estimates by ~8% to factor in the weaker INR; raise our target
price to Rs1,114. Maintain BUY.

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Multiple moving parts make earnings projection difficult: Taro
Ebitda margin is up from 26% in CY10 to 52% in FY13; sustaining that
depends on entry of competition and their market strategy. Extent of
competition to generic Doxil from innovator and new entrants,
competition to generic Stalevo and Comtan, traction in newly acquired
DUSA and URL and new large launches are other important factors in
the US market. Reported growth in RoW markets could also vary
widely across years.
Core FY14 EPS could grow as much as 44% or as low as 2%:
Our scenario analysis suggests that the best case topline growth could
be 34% in FY14 versus the company guidance of 18-20%. The median
case would be 26% and the pessimistic case 18%. In the best case,
FY14 core EPS could be Rs45.5 (up 43.6% YoY); worst case could see
flat FY14 core earnings.
Stock price correction, weak INR make valuation reasonable:
Sun Pharma shares trade at 23.9x FY14 and 21.1x FY15 core EPS (in
the median case). In the optimistic and pessimistic cases, FY14
multiples are 20.1x and 28.1x respectively. If the best case plays out,
the stock could have >40% upside; the median case represents our
current target price of Rs1,114 – 25x FY15 core EPS. If the pessimistic
case plays out, there could be a 10% downside to the stock.

Other factors complicate projection of future margins as well:
• The large fluctuation in currency rates make analysis of historic
margins as well as projection difficult
• The lack of information about potential competition to limited
competition products
• The lack of information on the margins of the recently acquired
businesses (DUSA and URL)
• The lack of information on new limited competition products that
could get launched
Looking ahead to various possibilities
Given the wide fluctuations that could happen across the various
factors, we have tried to construct three different scenarios. We feel
that this gives a much better grip on the potential upside to stock
price, given the difficulty that even the company management has in
predicting the sustainability of current buoyancy. Of the three
scenarios,

• The optimistic case assumes the current buoyancy being fully
sustained and the newly acquired businesses growing quickly with
expanding margins
• The median case assumes the current buoyancy toning down to
quite an extent and only limited growth and margin expansion in the
newly acquired businesses
• The pessimistic case assumes significant tone down in margins from
current buoyancy and no quick growth or margin expansion in the
newly acquired businesses.
Currency exchange rates form a very significant variable; but we
have not included that in our analysis as it would cloud the impact of
other factors that we analyze here. We have assumed constant
USD/INR rate of 57 in all three scenarios.
FY14 Revenue growth – 34% at best; could be as low as 18%
Our scenario analysis suggests that the best case topline growth
could be as high as 34% in FY14 and 20% in FY15, versus the
company guidance of 18-20% in FY14. The median case would be
26% and 14% and the pessimistic case would be 18% and 8%, in
FY14 and FY15 respectively. Key assumptions for the different
scenarios are:
Median case:
• 17-18% like-to-like domestic formulations growth
• Flat Taro revenues in both FY14 and FY15
• 30% and 23% growth in US base business, in FY14 and FY15
respectively
• USD83m each in FY14 and FY15 from generic Doxil
• DUSA growing 10% and URL 18% (annualized) in FY14 over FY13
• Prandin exclusivity in the US contributing $23m, only in FY15
• RoW and API businesses cumulatively growing 16-17%
Optimistic case:
• 19-20% like-to-like domestic formulations growth
• 10% growth in Taro revenues in both FY14 and FY15
• 35% growth in US base business, in FY14 and FY15
• USD98m each in FY14 and FY15 from generic Doxil
• DUSA and URL growing 20% (annualized) in FY14 over FY13
• Prandin exclusivity in the US contributing $23m in FY14; $23m in
FY15 as well due to full year benefit despite more competition.
• RoW and API businesses cumulatively growing 22%
Pessimistic case:
• 17% like-to-like domestic formulations growth
• 10% decline in Taro revenues in both FY14 and FY15
• 20% and 16% growth in US base business, in FY14 and FY15
respectively
• USD62-69m each in FY14 and FY15 from generic Doxil
• DUSA and URL flat (annualized) in FY14 over FY13
• Prandin exclusivity not materializing even in FY15
• RoW and API businesses cumulatively growing 15%

Margin – up to 600bp swing at Ebitda level
Our scenario analysis suggests that the best case Ebitda margin
could be as high as 45.3% and 44.6% in FY14 and FY15, versus
43.7% in FY13. The improvement on FY13 margins is driven only by
depreciation of INR as the best case assumes similar constant
currency margin profile as FY13. The median case would be 41.7%
and 40.9% and the pessimistic case would be 38.9% and 36.8%, in
FY14 and FY15 respectively. Key assumptions for the different
scenarios are:
Median case –
• Domestic formulations margin at 37%
• Taro margin down to 51% in FY14 and 49% in FY15 from adjusted
~56% in FY13
• 38-39% Ebitda margin in US base business
• 80% gross margin in generic Doxil
• 20-22% Ebitda margin in DUSA and URL
• 80% gross margin in Prandin
• 39% Ebitda in RoW and API businesses
Optimistic case –
• Domestic formulations margin at 37%
• Taro margin sustaining at 55-56%
• 40% Ebitda margin in US base business
• 90% gross margin in generic Doxil
• 24-25% Ebitda margin in DUSA and URL
• 90% gross margin in Prandin
• 45% Ebitda in RoW and API businesses
Pessimistic case –
• Domestic formulations margin at 37%
• Taro margin down to 48% in FY14 and 44% in FY15 from adjusted
~56% in FY13
• 34-36% Ebitda margin in US base business
• 70% gross margin in generic Doxil
• 16-18% Ebitda margin in DUSA and URL
• 75% gross margin in Prandin
• 35% Ebitda in RoW and API businesses

Valuing Taro separately
Taro, Sun’s large US subsidiary is listed on NYSE. If Taro is stripped
out of Sun Pharma consolidated numbers and valued separately at
its current market price, the multiples on core Sun Pharma FY14 and
FY15 EPS are 27.0x and 22.7x respectively. In the optimistic case,
the corresponding multiples are 22.6x and 18.5x whereas in the
pessimistic case the multiples are 31.5x and 28.2x.

Upside to stock price
If the best case starts playing out as quarterly results come in, the
stock could have more than 40% upside from current levels (25x
FY15 optimistic core EPS estimate). The median case represents our
current target price of Rs1,114 – 25x FY15 median case core EPS
estimate plus cash (adjusted for generic Protonix liability) and other
value per share. If the pessimistic case plays out, there could be a
10% downside to the stock despite the benefits of depreciated INR.