Sun Pharmaceuticals. CMP: INR554 TP: INR614 Neutral

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1 BSE SENSEX S&P CNX 17,849 5,416 Bloomberg SUNP IN Equity Shares (m) 1, Week Range (INR) 566/404 1,6,12 Rel. Perf. (%) -3/10/31 M.Cap. (INR b) M.Cap. (USD b) February QFY12 Results Update Sector: Healthcare Sun Pharmaceuticals CMP: INR554 TP: INR614 Neutral * Including Para-IV/one-off upsides Results beat estimates: Sun Pharma's (SUNP) 3QFY12 performance was significantly better than our expectations. Net sales grew 34% YoY to INR21.45b partly driven by Taro's strong performance and favorable currency. EBITDA surged 119% YoY to INR9.64b with EBITDA margin at 44.9% compared to 27.5% for 3QFY11. Reported PAT (including one-offs) increased 91% YoY to INR6.68b, higher than our estimate of INR5.1b. US formulations business boosts core topline: Core topline growth was driven mainly by the robust performance in US formulations business (up 63% YoY) led by Taro and favorable currency. Domestic formulation revenues grew 8.6% YoY. Excluding the one-off upsides, core US formulation business is estimated to have grown by a healthy 77.6% YoY. Formulation exports to RoW markets grew 27% YoY. Better operational performance: Core EBITDA (excl. one-offs) is estimated to have grown 137% YoY to INR8.9b (v/s est. of INR5.7b), while core EBITDA margin is estimated at 43.7% (v/s est. of 33.5%). Excluding one-offs, adj. PAT at INR6.1b (up 99% YoY) was higher than estimate of INR4.78b due to better operational performance. Outlook and view: An expanding generic portfolio, coupled with sustained double-digit growth in highmargin life-style segments in India, is likely to translate into long-term benefits for SUNP. Key drivers for future: (1) Ramp-up in US business and resolution of Caraco's cgmp issues; (2) Monetization of the Para-IV pipeline in the US; (3) Launch of controlled substances in the US and (4) Sustaining Taro's high profitability. Valuations: The stock is valued at 24.7x FY12E and 22.6x FY13E core earnings. While we are positive on SUNP's business outlook, stiff valuations have tempered down our bullishness. Maintain Neutral rating with a TP of INR614 (25x FY13E EPS), despite the robust strong 3QFY12 performance. Inorganic initiatives (SUNP has cash of ~USD1b) would be the key risk to our rating. Nimish Desai (NimishDesai@MotilalOswal.com); Tel: Amit Shah (Amit.Shah@MotilalOswal.com); Tel:

2 Performance driven by Taro and favourable currency Net Sales grew by 34%YoY to INR21.45b partly driven by strong performance of Taro and favourable currency. EBITDA increased by 119% YoY to INR9.64b with EBITDA Margins at 44.9% v/s 27.5% for 3QFY11. Reported PAT (incl one-offs) at INR6.68b was up 91% YoY v/s estimate of INR5.1b. Excluding the contribution of one-off revenues, core topline is estimated to have grown by 37% YoY to INR20.36b. Domestic formulation revenues grew 8.6% YoY to INR6.96b (v/s est of Rs7b). The company has stated that, excluding third party business which has been discontinued, underlying growth was at 22% for the quarter. US formulations business grew by 63.1% YoY to INR10.4b led by strong performance at Taro, favorable currency, better than estimated revenues from one-off opportunities and market share gain in few products. Excluding one-off upsides, core US formulation business is estimated to have grown by 77.6% YoY to INR9.3b. Formulation exports to RoW market grew by 27% YoY to INR2.8b. We note that the RoW formulation business this quarter also includes Taro's revenue from outside US. Revenue mix (INR m) 3QFY12 3QFY11 YoY (%) 2QFY11 QoQ (%) Formualtions 20,166 14, , India 6,956 6, , US 10,400 6, , RoW 2,810 2, , API 1,536 1, , Others Net Revenues 21,720 16, , Source: Company/MOSL Core EBITDA above estimates driven by higher margin expansion at Taro Reported EBITDA increased by 118.8% YoY to INR9.64b with EBITDA margins at 44.9% v/s 27.5% for 2QFY11. Core EBITDA (excluding the contribution of one-off opportunities) is estimated to have grown by 137% YoY to INR8.9b (v/s est of 5.7b) while core EBITDA margins are estimated at 43.7% (v/s est. of 33.5%). Trend in EBITDA margins Source: Company/MOSL 15 February

3 3QFY12 EBITDA Margins are above estimates due to Price increases for some of Taro's products - which have resulted in very high profitability for Taro (50.3% EBITDA margins vs 44.8% sequentially). We believe that Taro has been able to undertake price increases mainly due to exit of certain competitors due to supply chain and US FDA related issues. This implies that the higher product prices will be sustainable only till these competitors remain absent from the market. We believe that Taro will be able to sustain these higher margins for another 2-3 quarters by which time the competitive intensity is likely to increase. Depreciation of the INR vs the USD seems to have positively impacted the RM inventory valuations thus boosting gross margins and EBITDA margins on a consolidated basis. In the past SUN has reported such high profitability (overall 44.9% EBITDA margins) when there was significant contribution from one-offs in the US. However, for 3QFY12, SUN has reported similar profitability without any large one-offs, which although is a positive but may not be sustainable. Taro - Strong performance Taro has reported very strong 4QCY11 performance with topline growth of 44%, EBITDA growth of 245%, EBITDA Margins at 50.3% and PAT growth of 454%. Sequentially, it has reported 7% topline growth, 20.2% EBITDA growth and 6.5% PAT growth. The significant improvement in EBITDA margins was led by price increases, lower SG&A expenses and flat R&D expenses. PAT growth was aided by improvement in operational performance as well as significant reduction in effective tax rate at 6.8% vs 32.5% YoY and 23.8% sequentially. Taro management has indicated that a significant portion of the growth in net sales and profits was derived from price increases on select products in the US market and may not be sustainable. We believe that Taro has been able to take price increases in certain key products in the US market due to absence of competition from the market. These competitors may come back to the market after resolving their supply issues and hence the high profitability at Taro may not be sustainable. During the quarter, Taro filed an one ANDA with the USFDA taking the total filings to 3 for CY11. It has also received approvals for 7 products during the year. It currently has a pipeline of 23 products (including four tentative approvals) and one New Drug Application awaiting final USFDA approval. As of 31-Dec-2011, Taro had cash of USD242m (excluding restricted bank deposits) and debt of USD44.7m. Upgrades FY12 guidance Management has upgraded its topline growth guidance for FY12 from 28-30% to 32-34% given the strong 3QFY12 performance. The strong growth will be partly driven by full-year consolidation of Taro financials as compared to a little over two quarters for FY11. Management has indicated that the high EBITDA margins recorded in 3QFY12 are not likely to sustain in the long-term. R&D expenses will be at ~6% of sales. Capex is estimated at INR b while the company has guided for increasing tax rate (not quantified) going forward. 15 February

4 Caraco US FDA resolution is likely to be long-drawn While there is no fresh update on the US FDA resolution at Caraco, the company has, in the past, indicated that the process will be very gradual. We are estimating partrecovery in Caraco's core US revenues from FY13 onwards based on the assumption that the US FDA issues will get resolved over the next few quarters. The on-going US FDA issues have adversely impacted Caraco's core revenues (excluding distributed products revenues) for the past two years. Caraco revenue trend (USD M) Source: Company/MOSL Domestic formulations to sustain 15-20% growth; Emerging markets portfolio to grow at 20-30% CAGR Given its strong positioning in the lifestyle segment, we expect Sun to sustain its growth momentum in the domestic formulations business. It is among the top players in the CNS, CVS, Gastro, Ophthalmology and Orthopedics segments. This business has grown at 17-18% CAGR for FY08-11 and we expect the company to sustain this growth rate till FY13E. Absence of contract manufacturing revenues (which contributed INR630m to sales in FY11) will partly temper down domestic formulations growth for FY12. We also believe that SUNP's emerging markets revenues are likely to grow at 20-30% CAGR over next two years given its plans to increase its penetration in key markets. Sun - Emerging Mkt Sales to grow at 20% CAGR (INR m) Sun: Domestic Formulations - sustained momentum (INR m) Source: Company/MOSL 15 February

5 Proposes to acquire all Taro outstanding shares; Potential cash outflow of USD368m; No major financial impact SUNP has proposed to buy out all outstanding shares of Taro at a price of USD24.5/. This offer is subject to the approval of Taro Board of Directors, shareholder approval and other regulatory approvals. SUNP currently holds 66% stake in Taro. A buy out of all outstanding shares (~15m shares) for USD24.5/share is likely to result in an outflow of USD368m for SUNP. SUNP's consolidated financials already include 100% consolidation for Taro along with minority interest for the 34% public holding. Acquisition of all outstanding Taro shares will make it a 100% subsidiary of SUNP and hence will result in reduction in the minority interest currently being charged to the P&L. SUNP's interest income will also reduce to the extent of utilization of cash of USD368m for this acquisition. Taking in account both these factors, we expect a negligible impact in our FY13 EPS estimates if SUNP is successful in acquiring 100% stake in Taro. SUNP has invested USD252m till date for acquiring the 66% stake in Taro. If SUNP buys out minority shareholders in Taro for USD368m, the total cost for acquiring 100% stake in Taro will be ~USD620m. This will imply a valuation of 1.23x EV/Sales and 3x EV/ EBITDA on Taro's CY11 reported financials. Based on our CY12 estimates for Taro, the acquisition valuation will be 1.19x EV/Sales and 3.3x EV/EBITDA which we believe, is attractive compared to some of the expensive acquisitions made by its peers in the past. However, this may prompt the minority shareholders of Taro to reject SUNP's offer as being too low and they may ask for a higher valuation. We await further clarity on the same. Raising earnings estimates Post the 3QFY12 results and concall, we have raised our FY12E EPS by 14.7% and FY13E EPS by 8.5%. We note that the upgrade in FY12 numbers are higher compared to FY13 numbers due to 1) We believe that the profitability of Taro are unlikely to sustain at current levels anticipating increased competition 2-3 quarters down the line. 2) The currency depreciation benefit in the raw material cost during the quarter will not be recurring unless INR depreciates further from current levels We expect core EPS of INR22.4 for FY12E (up 65.3%) mainly led by Taro and INR24.5 for FY13E (up 9.3%). Excluding one-off upsides, EPS growth for FY13 will be 12% (tempered down by our expectation of normalization of Taro's profitability to lower levels). Revised Forecast (INR m) FY12E FY13E Rev Old Chg (%) Rev Old Chg (%) Net Sales 73,257 68, ,028 78, Net Profit 23,217 20, ,375 23, EPS (INR) Source: MOSL 15 February

6 Valuation and view An expanding generic portfolio coupled with sustained double-digit growth in highmargin life-style segments in India is likely to bring in long-term benefits for SUNP. Its ability to sustain superior margins even on a high base is a clear positive. Key drivers for future include: 1. Ramp-up in US business and resolution of Caraco's cgmp issues 2. Monetization of the Para-IV pipeline in the US 3. Launch of controlled substances in the US. 4. Sustaining Taro's high profitability The stock is valued at 24.7x FY12E and 22.6x FY13E core earnings. While we are positive on SUNP's business outlook, rich valuations have tempered down our bullishness. Price increases for certain products by Taro (due to absence of competition), positive impact of a favourable currency and translation benefits in RM costs were the key reasons for the significant increase in growth and profitability for SUNP in 3QFY12. Of these, the currency has commenced a reversal and we also believe that the significant jump in profitability at Taro is not sustainable in the long-term and that it is likely to reverse post 2HFY13. Our estimates take in to account this potential reversal. Given these potential downsides, we maintain Neutral with TP of INR614 (25x FY13 EPS) despite a strong 3QFY12 performance. Inorganic initiatives (SUNP has cash of ~USD1b) is the key risk to our rating. 15 February

7 Sun Pharmaceuticals: an investment profile Company description Sun Pharma is among the largest players in the domestic formulations market and the most profitable one. It makes and markets specialty medicines and APIs for chronic therapy areas such as cardiology, psychiatry, neurology, etc. Sun has forayed into regulated markets by acquiring majority stake in Caraco Pharma and has strengthened its presence in US by acquisition of Taro. Capability to scale up exports, particularly to unregulated markets, is yet to be fully demonstrated. Recent developments Proposed acquisition of all outstanding shares of Taro Launch of generic Taxotere and Gemzar in US Key investment arguments Ability to identify niches in long term therapy areas with high entry barriers and build strong franchise to ensure sustainable growth and high margins. Sustaining superior profitability on higher base is a strong positive. One of the strongest ANDA pipelines from India with 148 ANDAs pending approval. The pipeline includes a combination of low-competition, patent challenge and normal product opportunities. Key investment risks Unresolved USFDA issues related to Caraco's manufacturing facilities will continue to impact sales in the US and pending ANDA approvals from that facility. Valuation and view The stock is valued at 24.7x FY12E and 22.6x FY13E core earnings. Earnings growth is likely to improve post the resolution of Caraco's problems. Maintain Neutral. Sector view Emerging markets and USA would remain the key sales and profit drivers in the medium term. Japan is expected to emerge as the next growth driver for generics in the long-term. We are overweight on companies that are towards the end of the investment phase, with benefits expected to start coming in from the next fiscal. Comparative valuations Sun Pharma Ranbaxy DRL P/E (x) FY12E FY13E P/BV (x) FY12E FY13E EV/Sales (x) FY12E FY13E EV/EBITDA (x) FY12E FY13E EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) Neutral Stock performance (1 year) Shareholding pattern (%) Dec-11 Sep-11 Dec-10 Promoter Domestic Inst Foreign Others Sun Pharma Sensex - Rebased Feb-11 May-11 Aug-11 Nov-11 Feb February

8 Financials and Valuation 15 February

9 N O T E S 15 February

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