By Sarabjit Kour Nangra, Sushant Dalmia (Angel Broking)

Performance Highlights

- Net Sales come in higher than our estimate: Sun Pharma reported Net Sales of Rs1,185.2cr (Rs1,177.8cr), which were flat on a yoy basis and were above our estimate of Rs913.0cr, primarily on the back of a one-time receipt from Lexapro settlement of US $20mn from Forest Labs and higher sales of Protonix. As a result, Export Formulation sales de-grew by a mere 5.1% to Rs592.9cr (Rs624.5cr). Sun’s US subsidiary, Caraco, reported Net Sales of US$78.4mn which were up by 63.3% sequentially, driven by Protonix sales. Caraco received a one-time payment of US $20mn from Forest labs on the Lexapro settlement during the quarter. Domestic Formulation sales increased by 5.3% to Rs471.0cr (Rs447.3cr) and continue to be impacted by one-time sales of Rs200cr booked in Q4FY2009. The company expects its Domestic Formulation sales to grow in line with the Industry rate in 2HFY2010. For 1HFY2010, the company reported Net Sales of Rs1,972.8cr (Rs2,219.6cr), down 11.1%.

- OPM expands on a sequential basis: For the quarter, Sun Pharma reported an OPM of 37.7% (45.7%), down by 794bp, mainly on account of higher Para IV sales in 2QFY2009. On a sequential basis, the OPM expanded from 22.1% to 37.7%, mainly driven by one-off, higher Protonix  sales and growth on the Domestic Formulation front. For 1HFY2010, the OPM came in at 29.2% (48.5%), contracting by 19.3% yoy.

- Recurring Net Profit beats expectations: Sun Pharma reported a Net profit of Rs453.8cr (Rs512.8cr), down by 11.5% yoy but higher than our estimate. Even after adjusting Rs130cr for the one-off items, the bottom-line was up by 36.5% from our estimates. For 1HFY2010, the company reported a Net Profit of Rs617.9cr (Rs1,014.1cr), down by 39.2%, albeit on a high base.

Business Performance

Exports surprise on the positive front

For 2QFY2010, Exports de-grew by a mere 2.4% to Rs709.7cr (Rs727.0cr), mainly on account of a lower-than-expected de-growth on the Export Formulations front. Caraco sales came in at US $78.4mn (US $122.2mn), down 35.8% yoy, but higher by 63.3% sequentially, driven by Protonix sales. Moreover, Caraco made an additional provision of US $7.5mn during the quarter for the inventory seized in June 2009, over and above the US $8.4mn provision made in 1QFY2010. In June 2009, Caraco’s inventory worth US $24.0mn was seized by US Marshalls, of which the company has made a provision for US$15.9mn and expects the balance to be realisable. Export Formulation sales, excluding Caraco, grew by 29% yoy, while Export API grew by 15.0% to Rs115.9cr (Rs100.8cr) During the quarter, the company filed for 3 ANDAs; with these, 11 products were filed for 1HFY2010. Further, during the quarter, the company received 6 product approvals from the regulator.

Domestic formulation business clocks growth

The Domestic formulation business of the company grew by 5.3% to Rs471.0cr (447.3cr), which continues to be impacted by one-off sales of Rs200.0cr booked in 4QFY2009. Sun Pharma launched 9 new products in the market and 21 during 1HFY2010. The company indicated that it expect its Domestic Formulation business to grow at the Industry rate during 2HFY2010.

Outlook and Valuation

Sun Pharma’s 2QFY2010 results were above our estimates, even after adjusting for the one-offs, indicating a limited downside on the financial front after the US FDA issue. Moreover, Caraco reducing its workforce, curtailing the R&D expenses and entering into a consent decree with the US FDA entails limited cost-pressure / adverse financial impact  from here on. As a result, we are increasing our Target Multiple for the stock from 16x earlier to 18x now, as concerns on the US FDA front seem to be abating, at least from the financial point of view.

However, on the valuation front, the stock is trading at 22.6x FY2010E and 19.0x FY2011E earnings, factoring in the positive on the earnings front. Hence, we recommend a Neutral on the stock, and expect any upside from here to be driven by the following factors:

- Effexor-XR launch: The launch of Effexor-XR (Sales of US $3.7bn in 2008) during the exclusivity period (prior to July 2010) could be a major catalyst for Sun Pharma. The company has again filed ANDA on the Osmotica product and has not been sued. The company is awaiting the approval of the US FDA, given the pending citizen petition by Osmotica.

- Positive Outcome on Taro: The management has indicated that a decision by the Supreme court of Israel on Taro can be expected in the near-term. Any positive outcome on this front will act as a catalyst for the stock.

- Resolution on US FDA front: Caraco has now entered into a consent decree with the US FDA, which entails the steps that need to be taken by the company to ensure that its Detroit facility becomes operational again. Any early resolution (in the next 6-12 months) could provide an upside to our estimates.

- Acquisitions: Sun Pharma has one of the strongest Balance Sheets in the Pharma sector (Cash of Rs3,500cr). Any further acquisitions by the company, given the strong Balance sheet, could lead to an upward revision of our estimates.