The stock of Sun Pharmaceutical Industries has lost nearly 30 per cent in the last eight months. This was on two counts.
First, weak performance following consolidation of Ranbaxy’s numbers caused jitters among investors. This was unwarranted given that Ranbaxy’s weak operating performance and the resultant drag in operating profit margin after consolidation with Sun Pharma was a given.
Second, Sun Pharma received a warning letter from the US drug regulator Food and Drug Administration (FDA), citing deficiencies at the Halol (Gujarat) facility with respect to quality control systems, among others.
This was perceived negatively by the market given that the plant is critical for the company’s US business — it accounts for about 15 per cent of the geography’s sales.
However, the steep fall in the stock price seems to have more than factored in the impact from the warning letter.
The stock now trades about 23 times its estimated 2016-17 earnings, compared with its historical range of 22-25 times. Sun Pharma has a track record of resolving regulatory issues within a reasonable timeframe.
Good growth prospects Also, the company’s growth prospects remain strong, driven largely by the synergy from its Ranbaxy acquisition and healthy product pipeline in the US. Investors with a three-to-five-year horizon can buy the stock.
Sun Pharma consolidated Ranbaxy’s financials in March 2015. The former’s operating profit margin prior to the merger was at about 45 per cent levels in 2013-14. In contrast, Ranbaxy’s operating profit margin was in high single-digit, due to the regulatory issues involving four of its plants.
After the merger of Ranbaxy with itself, Sun Pharma’s consolidated operating profit margin fell to 26 per cent in the first six months of the current fiscal, largely on expected lines.
While the merger may be margin-dilutive in the short term, synergies from Ranbaxy’s portfolio in the US, India and other emerging markets should come to the fore in the medium to long term. Sun Pharma is in the process of rationalising Ranbaxy’s portfolio and businesses across markets and the benefit from the exercise should start flowing over the next few quarters.
Sun Pharma recently increased its synergy guidance from the earlier $250 million over two years to about $300 million. Given its strong track record of turning around its acquisitions, Taro Pharma being a good example, chances are high that the value from the merger may be more than what the management has guided.
The warning letter by the US FDA pertaining to the Halol plant may be a sentiment dampener, but not a big cause for concern.
First, Sun Pharma commenced remedial measures almost a year back after the US FDA expressed concerns (observations in Form 483) over the company’s quality control systems following an inspection in September 2014.
According to the management, the warning letter issued in December 2015 details the issues raised in Form 483 in September 2014 and there is nothing additional.
Comforting factor With the Halol plant key to the company’s US business, the delay in the re-approval by a few more months due to the warning letter has been a concern. But the management is confident of resolving the issues soon and is working with third-party consultants to complete the remediation process.
According to the management, its other plants that cater to the US market have been inspected by the US FDA without any major observations.
Also, the company’s track record of resolving regulatory issues involving its manufacturing facilities (Cranbury facility, New Jersey) provides comfort. Exclusive opportunities, such as the generic version of cancer pill Gleevec, can add more than $400 million to Sun’s revenues over the next two years, beginning February 2016. These can more than compensate for the delay in the Halol plant re-approval.
For the six months ended September 2015, Sun Pharma’s revenue declined 7 per cent, compared with the same period last year. This was largely due to rationalisation of Ranbaxy’s businesses. Operating profit margin stood at 26 per cent, higher than the 14 per cent reported in the March 2015 quarter, the first quarter after the consolidation of Ranbaxy.
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