USFDA has classified Sun Pharma’s (Sun’s) formulations manufacturing facility at Halol as an OAI (official action indicated). This facility was inspected in Dec’19 resulting in eight 483 observations. The observations highlighted out of specification failure, potential for alterations in sample data, etc. This plant is crucial as it contributes ~10-15% to US sales. We don’t expect any impact on the existing supplies; however, future approvals would get delayed until resolution, which may take 12-18 months, and there would be remediation costs.
We believe gradual ramp-up in specialty portfolio and strong performance in India would be key for revenue growth. Cost control steps, rationalisation of R&D spend and increasing proportion of India augur well for long term earnings stability and margin expansion. Maintain Buy.
OAI status for Halol facility: Halol plant has been classified as an OAI which signifies company’s response to be unsatisfactory, creating a high probability of a warning letter being issued.
India business strong: Sun Pharma’s domestic business remains strong with 11.9% growth in 9MFY20 (200bps higher than industry). We expect this business segment to continue its outperformance vs the industry driven by strong chronic portfolio, high brand recall and ~10% increase in MR strength in near term. Consolidated Ebitda margin has been stable at 22-23% in past three quarters and we expect it to improve gradually to 23.3% by FY22.
Key concerns largely priced in: The major concerns are slow ramp-up in its specialty portfolio and a contingent liability towards the US generic drug pricing case. We have already factored in muted traction in specialty portfolio with its contribution to total US sales to be ~25%. Sandoz’s recent settlement of price fixing case with US DOJ sets a precedence and we also expect Sun to settle the case removing another overhang from valuation.
Valuations and risks: We cut EPS estimates by 2-4% to factor in lower generic revenue and remediation costs. Maintain Buy with a revised target of Rs458/share based on 20xFY22e earnings (earlier Rs 478). Key downside risks: regulatory hurdles and delay in turnaround of specialty business.