After factoring in 550bp Ebitda margin improvement over FY18-20F, EPS for FY18/19F cut 65/32%.
The correction in the US generics business has been much stronger than our expectations. Taro revenues declined 18% q-o-q in Q1FY18F and sales from the Halol site declined 50% over the past 12 months as per IMS data. We expect revival in Halol revenues in the near term and expect approval momentum to pick up post resolution of the Halol warning letter by end FY18F. However, there is limited visibility on potential “high value” generic launches. Also, the outlook for Taro remains challenging with increasing competition, particularly in the derma space. We like the company’s attempt to build the specialty pipeline and expect specialty revenues to increase from $310m in FY17 to ~ $700m in FY20F.
The ramp-up in specialty revenues should help absorb overhead costs and drive up Ebitda margin from the lows of FY18F. After factoring in 550bp Ebitda margin improvement over FY18-20F, we cut our EPS for FY18F and FY19F by 65% and 32%, respectively. Lower US revenues, erosion at Taro, rupee appreciation, one-time litigation settlement in FY18F and higher investment in specialty lead to our earnings cut. We continue to value SUNP at 20x one-year-forward earnings, in line with its large-cap peers. Our target price of `479/sh is based on 20x FY19-20F average EPS of Rs 23.9/sh. The TP implies 3% downside, and we remain Neutral. We prefer Lupin (LPC IN, Buy) among large-cap pharma stocks.
Valuation: Trading at 20-30% premium on FY19F EPS
SUNP stock has not corrected post the Q1FY18 results (stock up 10% vs Nifty up 2% since 13 Aug). Sun Pharma is trading at 51x (36.2x Adj EPS) and 24.0x on our FY18F and FY19F EPS estimates, respectively. The stock is trading at 20-30% premium on FY19F estimates. We think revival in earnings is in the price.
Taro: Outlook remains challenging
Taro revenues in Q1FY18 declined $35m q-o-q. The Q1FY18 annualised revenue run rate for the US market is at ~$560m, materially lower compared to $785m recorded in FY17. The rate of new product approvals at Taro has increased over the past 18 months. But new launches had very limited impact and the erosion in the base business due to competition is a far more dominating factor.