Sun Pharma stares at sharp earnings downgrades

A muted revenue outlook and higher costs will keep margins and earnings under pressure in FY18

A weak revenue outlook for FY18,  pricing pressure in the US, a high cost base, and investments in building a speciality drug pipeline will continue to put pressure on Sun Pharma’s margins for the next few quarters.
 
Given the near-term outlook, especially related to the US business and the weak June quarter results announced on Friday, analysts have cut their consolidated earnings estimates for FY18 and FY19. Centrum Broking’s Ranjit Kapadia believes net profit estimates for 2017-18 and 2018-19 could be revised downwards by a further 10-15 per cent. The earnings downgrades by Emkay Global’s Jatin Kotian and Vishal Advani have been sharper –32 per cent lower for FY18 and 13 per cent for FY19, post the investor call. Given the downgrades, the stock could face selling pressure on Monday.
 
From a revenue standpoint, the key pressure area remains the US business. Taro, which accounts for 45 per cent of Sun’s US top line, saw its revenues shrink 33 per cent over a year ago. The Taro management, after the June quarter results, had indicated that pricing pressure had intensified due to distributor consolidation, a faster pace of the US Food and Drug Administration (FDA) approvals, and increasing competition from generic players. Analysts believe pricing pressure, given Teva’s (the world's largest generic drug maker) recent commentary, will continue for at least two more quarters. Taro, the most profitable part of Sun Pharma, saw its margins shrink 750 basis points over a year to 50.5 per cent in the June quarter. This, coupled with a higher base, has reflected in the consolidated margins of Sun Pharma, which halved to 17.6 per cent. This is despite the company’s June 2016 quarter benefiting from the six-month exclusivity sales for cancer drug Imatinib.
 

Source: Analyst reports

In addition to intensifying price erosion, what is hampering Sun’s US revenue growth is the lack of product approvals from the Halol plant. Though the company is looking at mitigating this risk by transferring product approvals to alternative sites, given the process takes time, an early resolution will remain a key trigger. The company has completed the remedial procedures and is awaiting a fresh US FDA inspection of the plant.
 

Data complied by BS Research Bureau

Despite the overall weakness on revenue and no major product launch to cushion the pricing pressure, Sun’s management maintained the single-digit revenue fall guidance for FY18. Given the prevailing conditions, Emkay’s analysts believe even the modest guidance, both on revenue and margins, is a stretch. The company says it will achieve 20-22 per cent operating profit margins for the second half of FY18. Analysts say the margin guidance for the second half of the year is nothing to write home about and reflects the high cost base and falling revenue. The company’s management highlighted this in an investor call, when it said its execution has not been the way it would have liked it to be. This, coupled with continuing investments in building a speciality drug business and structural weakness in pricing, is hampering the margin expansion.
 
Analysts say Sun is banking on emerging markets, rest of the world, and sales from active pharmaceutical ingredients to overcome the weakness in the US. The three segments, however, put together account for only a third of sales. For the near term, what could relieve some of the pressure is a rebound in India sales. Revenue from this geography, which accounts for 29 per cent of sales, fell 5 per cent over a year to Rs 1,761 crore, due to the introduction of the goods and services tax. Analysts expect the company to see a gradual improvement in India growth, both on revenue and margin.
 
Overall, for now, analysts don’t have too much confidence about the company’s prospects in FY18 but believe growth in FY19 could come, as the specialty business it is investing heavily in will start delivering.