Specialty scale-up, product mix: Sun's medicine cabinet piques brokerages

In the near term, higher R&D costs and a recent acquisition to weigh on earnings growth

India’s largest listed pharmaceutical (pharma) company — Sun Pharmaceutical Industries (Sun Pharma) — is expected to maintain its outperformance vis-à-vis the sector’s, as its multiple bets on specialty products, improving product mix, recent acquisitions, and branded business are finding favour with brokerages.

While it has gained 7 per cent over the past year, the Nifty Pharma Index is down 13.6 per cent. Its outperformance over two years has been fairly evident, with the market leader gaining 66 per cent to Nifty Pharma’s minus 1.4 per cent.

Although analysts have reduced their near-term earnings estimates, given the ongoing investments, higher research and development (R&D) expenses, and amortisation costs, they believe it is one of the strong investment candidates among large-cap pharma companies in the medium to long term.

Pharma analyst Tarun Shetty of Haitong Securities expects the company’s R&D to rise sharply in 2023-24 (FY24) and 2024-25 (FY25) due to expedited Phase 3 studies for Ilumya’s psoriatic arthritis indication and residual spending from the acquisition of US-based Concert Pharmaceuticals, Inc. (Concert) — a late-stage biopharm firm pioneering the use of deuterium in medicinal chemistry.

This, in tandem with a decline in other income and an increase in amortisation (both as a result of Concert acquisition), will result in lower earnings growth (12-13 per cent annually over 2021-22, or FY22, through FY25), compared to historical levels (23 per cent annually over 2017-18 through FY22). However, these investments will help Sun Pharma build a formidable specialty franchise for the long term, observes Shetty.

Among recent triggers has been its purchase of Concert for $576 million, which was announced in January and completed earlier this month. This takeover gives it global rights for Deuruxolitinib — the lead candidate being developed for the treatment of alopecia areata, which is an autoimmune dermatological disease.

Health care research analysts Alok Dalal and Dhawal Khut of Jefferies Research say that the buy adds a complementary derma product to its specialty portfolio.

“An unmet medical need, strong efficacy, as compared to competing drugs, and leveraging existing infrastructure should result in peak global sales of $850 million by 2031, translating into the pre-tax net present value of Rs 64 per share,” they add.

While Sun Pharma’s specialty segment sales were up 39 per cent in FY22, the growth momentum is expected to continue in the current year, on the back of key products, such as Ilumya (plaque psoriasis), Cequa (eye drops), and Winlevi (acne vulgaris). 

While regulatory issues at the Halol plant impacted US generic sales in the October-December quarter (third quarter, or Q3) of 2022-23 (FY23), JM Financial Research believes that the scale-up of recently launched ‘orphan drug’ for neonatal/preterm infant seizures — Sezaby (as also cancer drug Revlimid to treat multiple myeloma), along with higher specialty sales and new launches of generics — will mitigate price erosion and Halol worries. 

Given strong growth, the share of the specialty segment to overall revenue has risen from 13 per cent last year to 15 per cent this year. This trend is expected to sustain in the future.

In the home-grown market, weak performance in Q3FY23 was an exception due to the reduction in prices of two in-licensed brands and muted showing by the gastrointestinal segment.

Brokerages expect the company, whose February sales were in line with the market’s, to outperform the domestic sector, on the coat-tails of launches and improved productivity of its salesforce.

For IIFL Research, robust execution in the specialty/India business and low dependence on US generics (only 12-14 per cent of overall operating profit) make Sun Pharma its top pick in the large-cap pharma space. The company can post good growth rates, even as peers struggle with high price erosion for their basket of generics assortment.

Jefferies Research also believes that in an uncertain global environment, Sun Pharma offers the best medium- to long-term earnings growth visibility among pharma stocks.

Global specialty scale-up, along with consistent performance in India and the emerging markets, provides a superior earnings outlook for Sun Pharma, vis-à-vis peers.

Further, the brokerage points out that Sun Pharma trades at an attractive price-to-earnings (P/E) valuation of 24x and 20x its respective FY24 and FY25 earnings estimates, which are in line with core P/E valuations of Cipla’s and Dr Reddy’s Laboratories’, but its earnings outlook has higher predictability, compared to peers.

As regards margins, a higher share of the specialty segment, improved product mix, and price hikes in the domestic segment are expected to help the company offset the pressures on account of higher R&D expenses.

Brokerages expect margins, which came in at 26.5 per cent in FY22, to be maintained at 25-27 per cent levels.