US news flow remains positive on balance: Over the past two years, the key stock drivers for Sun Pharma have been (i) launch of generic Doxil in US, (ii) price increases in Taro and (iii) shortage/price increase in Doxycycline in US. The shortage in Doxycycline is expected to moderate through FY14. There has been increasing competition in key products for Taro while pipeline efforts are going on. In the case of Doxil, the recent J&J supply issues will result in significant earnings upside for Sun Pharma in the near term (3-4% EPS upside for every quarter of delay in J&J re-launch)resolution time lines for J&J remains difficult to predict.
Stock discounting blue-sky scenario
*Given the string of positive developments for Sun Pharma, the stock price is building a case for perpetual price increase and no competitiona scenario we do not quite agree with. For instance, the near-term growth in Taro is entirely banking on price increases to continue despite visible competition in key products. In addition, there is a mismatch between the high P/E (price-to-earnings) multiple (of 23.5x FY2015 EPS; reflecting structural growth) and a price increase/shortages led earnings stream.
*Our SOTP (sum-of-the-parts) analysis provides further evidence of the stock discounting blue-sky scenario(i) 20x multiple to generic Doxil profits reflects a patent protected earnings stream, (ii) limited distinction between Doxil and Doxycycline shortage and (3) the core business (excludes Doxil/Doxy and Taro) at multiples closer to pure play consumer stocks (28.5x on FY2015 EPS).
*We also note that there is excessive optimism on acquisition to resolve any potential challenges to growth on account of the current high-margin base. While Sun Pharma has delivered significant value on previous acquisitions (Taro), we stay cautious of extrapolating this trend.