Why you should continue to hold Sun Pharma stock

As investors brace for the third wave of the pandemic, defensive stocks can be in focus again led by pharmaceuticals which provide earnings visibility and Covid-19 therapies. Even as valuations are not cheap across the board, Sun Pharma is poised to offer a structural growth story differentiating itself from other pharma stocks. Sun Pharma’s various initiatives over the last five years are beginning to bear fruit and the valuations have captured the shift. But with different growth levers, the stock is still a good one to hold for the long-term.

Branching into speciality products, Sun Pharma now has achieved a critical mass of 5-6 products in this segment, which may support the division’s growth from hereon. Also, by operating on the lucrative side of the patent regime, speciality products may not face the same pricing challenges as other Indian pharma companies. Sun Pharma’s flagship speciality product, Ilumya is now marketed across US, and also Australia, Europe, Japan, and Canada, leveraging its investment over its geographical base or with partnerships. This, combined with a strengthened India sales team, can sustain the revenue momentum. The company’s EBITDA margin can scale back to 26-28 per cent range achieved earlier, based on revenue growth and good operating leverage.

Key segments

Sun Pharma’s US formulations breached US$ 2 billion in revenues in FY16 and has since been on a gradual decline clocking $1.3 billion in FY21, as price erosion took its toll. But driven by speciality sales, Sun Pharma can be expected to breach that mark again by FY24. Approval for additional indication for Ilumya can be a positive surprise.

Going by H1FY22, Sun Pharma’s US revenue of $740 million is from US generics (29 per cent), Taro (38 per cent) and speciality sales (33 per cent - assuming US accounts for largest portion of global speciality). Contribution from speciality sales improved from 21 per cent two years earlier.

Specility products are those with patent protection, in Sun Pharma’s context. The speciality portfolio consists of Odomzo, Levulan, Absorica, Ilumya, Cequa and Winlevi with the latter three being latest entrants, of which Winlevi was in-licensed in 2021.

The most prominent Ilumya (tildrakizumab), is a biologic in-licensed from Merck in 2014 and approved for moderate to severe plaque psoriasis.

Plaque psoriasis is close to US$ 10 billion crowded market currently accommodating 11 products across old generation biologics and new pathways including Ilumya. Ilumya has beaten Enbrel (old generation) in head-to-head trials.

In its own class, Ilumya may be without a significant edge in efficacy but scores on treatment convenience and longer-term efficacy. Ilumya reported sales of $143 million in FY21 (52 per cent YoY growth). Even after being impacted by pandemic in ramp-up stage, Sun Pharma reported 70 per cent annualized growth in Sep-21.

Sun Pharma’s first experience in competing against Big pharma and their flagship products (JNJ’s Tremfya, Abbvie’s Humira, Novartis’Cosentyx and so on) maybe an uphill battle. But even garnering a mid-single digit market share in a post-biologics, moderate to severe psoriasis market may imply a $750 million market (in US) by 2024,with pricing rebates at 50 per cent.

Sun Pharma’s ramp up in Iiumya post-Covid interruptions , will be a key monitorable in its march towards speciality dominated portfolio. Psoriatic arthritis is another indication Sun Pharma is exploring with Ilumya, the trial of which has been slowed owing to Covid related delays in clinical site on-boarding.

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Cequa also competes with key products of established players - Restasis (Allergan) and Xiidra (Novartis) in a multi-billion market. Cequa’s prospects may face impending generic competition as Restasis looses patent protection, but additional studies in Cequa’s benefit profile may support a stronger launch trajectory. Cequa faced pandemic disruption in even earlier stage of ramp and yet reported 100 per cent annualised growth in Sep-21.

Sun Pharma’s sales portfolio in general dermatology segment carries Levulan, Ilumya, Absorica. It has now added Winlevi for acne.

Launched in US in Q3FY21, the product has high expectations of peak sales ranging north of US$ 150 - 200 million by FY25 as per analysts.

This would be before double-digit royalties on sales and milestone related payouts..

US generics and Taro (acquired in 2010) have faced strong price competition in US, especially Taro. The pandemic imposed further impact on Taro which has a large dermatology product base.

The generics portfolio on the other hand, is expected to be bolstered by a strong suite of pipeline including 13 advanced filings, a recently launched product with a 180-day exclusivity and generic Revlimid with unknown terms of launch but high expectations.

Sun Pharma expects a product wise but consistently high competition in US generics, stressing the importance of its speciality portfolio.

Financials and valuation

India business accounting for 31 per cent of revenues reported Q2FY22 sales growth of 26 per cent with only a 2 per cent contribution from Covid portfolio.

Sun Pharma has refocused on this segment and is reflected in the improving market share of the leader and a 10 per cent increase in field staff.

The higher strength in a market that normally grows at 10 per cent, is expected to translate into even higher growth for Sun Pharma which focusses on product launches (28 launched in Q2FY22 alone) and in-licensing opportunities.

Sun Pharma reported sales growth of 2.5 per cent in FY21 of ₹33,139 crore. In the build-up phase of FY18-20, the margins were impacted by higher R&D expenses, under-leveraged sales force (new additions in India and US), a high direct to consumer (DTC) campaign cost in US (Ilumya and Cequa) apart from higher price erosion in US. The asset base can now generate optimal returns even as R&D and DTC campaigns remain, but lower than earlier peaks. Sun Pharma is reporting an average EBITDA margin of around 25 per cent in the last one year, which is more than the 20 per cent reported in FY18-20.

The stock is trading at 25 times FY23 expected earnings (Bloomberg consensus), which is closer to its historical higher range.. But from owning the stock at such levels, the potential long term rewards can outweigh the risks, in the form of a strong ramp up in the US and India . The pricing power from speciality laden portfolio (within sector) and a possible uptick in Covid portfolio (approved for generic molnupiravir) are factors which may weigh positively in the short-term, as well..

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