We downgrade Sun Pharma to Neutral from Buy given our view that the stocks current valuations are demanding and leave limited upside potential in the near term. Also, it should be noted that there has been a 40% rise in share price after the Ranbaxy acquisition (7 April 2014).
We raise our PO (price objective) to R850, driven by a 3% increase in FY16e EPS and valuations roll over to FY16 (in line with peers), giving a potential upside of 6%. We highlight that the current valuations are 2SD (standard deviation) above mean and are unlikely to re-rate further, in our view. However, we remain positive on Sun Pharmas long-term outlook.
Ranbaxy deal: Potential acquisition benefits in FY18 priced in Sun Pharmas market cap on the fully diluted equity (2,410m shares post-merger) has gone up from $19.8 bn to $32 bn as on date. Part of the improvement is driven by base business improvement while rest of the addition is driven by potential value accretion/synergy post-Ranbaxy deal. In our view, while the market has already factored the full synergies benefit from the deal till FY18, successful turnaround of Ranbaxy remains a challenge given the size and complexity of Ranbaxys operation.
Taro: Sustainability of price hikes is key. Taro has recently effected significant price hikes in the US, which could lead to an incremental $300m sales and OP (operating profit) to Taro. However, sustainability of the same (ie, price hikes) is the key. Though it is difficult to ascertain with confidence, we have factored in 70% of the price hikes as sustainable in our FY15/16 estimates.
Demanding valuations; we prefer Lupin instead: While Sun Pharmas best-in-class franchise, strong execution skills, healthy B/S (balance sheet) and return profile do justify a premium (20%), its current valuations (23x FY16e) leave limited room for upside. We prefer Lupin over Sun Pharma. We are of the view that in the near term, Sun Pharmas focus would be to integrate Ranbaxy successfully, rather than acquiring new assets. We have not factored in upsides from M&A.
Positive long-term outlook, strong execution record, history of positive surprises and potential M&A limit the downside risks, supporting our Neutral rating.