We stay negative on the US generic market outlook and expect price erosion to accelerate further. But on a relative basis, we are positive on Sun Pharma, with its (i) increasing contribution from specialty products and (ii) lower price erosion risk, given its high price erosion phase (the last three quarters) is over and concentration has reduced now. Sun Pharma’s near-term key event is Halol inspection. Halol reinspection in Q4FY18 could unlock several key filings. We increase target price of Sun to Rs 640 (from Rs 595) as we roll forward to FY20, with EPS unchanged. Price erosion for sector should accelerate as (i) approvals increase by 50% over next two years, (ii) buyer consolidation continues in CY18, and (iii) late entrants get >30% of system approvals. Hence, we expect the US market and profit pool to decline by 5/8-9% CAGR over CY17-20.
Specialty success could help Sun revert to 20% growth trajectory
Sun Pharma started investing in specialty products three years back and has already invested >$600 mn in dermatology, ophthalmology, CNS and oncology. Two drugs are already in the market, and the lead derma drug, MK-3222, should be approved in Q1FY19. Currently, the annual spend on specialty is $150 mn, which is suppressing base profits by 15%. With the ramp-up of MK-3222 and oncology drug Odomzo, specialty should break even by FY20.
The overall specialty contribution should swing from a loss of 15% currently to a profit of 15% over next four years. Increasing contribution of specialty should address growth concerns in generics (10-12% profit CAGR) and help Sun Pharma revert to the 20% profit growth trajectory overall. Strong FCF (>$500 mn) should help Sun Pharma to acquire more assets and deepen its presence in its chosen specialties.
The key event for Sun Pharma in the near term is Halol inspection: Halol re-inspection in Q4FY18 could unlock several key filings (Ganirelix, Lupron, Vagifem, Protonix IV, Invega, Makena). But any delay or adverse observations at Halol could delay upside for the company.