Sun Pharma: buy or sell?

The company's short-term pain justifies the stock price tanking, but markets have always rewarded companies that are upfront about their problems

Is the Ranbaxy jinx rubbing on Sun Pharma? The thought would have crossed the mind of a superstitious investor and nobody would blame him especially after seeing how the earlier buyer of the company, Japan’s Daiichi Sankyo, struggled after the acquisition. Sun Pharma’s Monday evening release of a muted revenue and profit forecast brought back memories of the Daiichi deal.

After the announcement, Sun Pharmaceutical lost Rs 34,000 crore in market capitalisation on Tuesday with its stock tanking 15 per cent. The loss in market value of Sun Pharma is much higher than the deal size of its Ranbaxy acquisition. Meanwhile, the stock is today trading 2% higher at 820 levels. 

 

However this time around, Ranbaxy is not the only factor for the downward revision in guidance. Let’s look at the reasons Sun Pharma has provided for the new estimates and see if the fall in share price is justified or if there is room for the stock to fall further.

As per Sun Pharma's statement, there are multiple reasons for the revision. First, there are supply constraints from its Halol unit, which is a Sun Pharma plant and not Ranbaxy’s. The Halol unit had received warnings from the US FDA on procedural issues in respect of the functioning of the plant.

According to brokerage firm Jefferies, Halol is the only drag in the company’s revenue estimates. This unit accounts for only 10 per cent of the company’s sales and Jefferies believes that a 60 per cent drop in production from this unit will have a maximum nine per cent impact on sales. While analysts did expect disruptions from the Halol unit, the difference of opinion is the timeline for normalcy in the unit. Earlier estimates indicated that the unit will regain normalcy by the third quarter of the current fiscal, but this has now been pushed forward. Jefferies feels that the issues regarding the unit will be resolved by the end of the current fiscal. Others like Nomura feel that revival will take longer.

Abhishek Sharma of IIFL says in his report that clearance for the Halol plant in the current fiscal seems unlikely. The Halol unit will require a re-inspection before it can get a clearance from the US FDA. But what is of more material impact is that the same unit was to be used to produce Gleevec, the next big drug coming out of the company. Sharma feels that Sun Pharma will have to complete a site transfer of generic Gleevec from Halol to another facility. There is an inherent risk in the ability to execute successful site transfers on time, especially from a facility that is under regulatory scrutiny, says Sharma in the report.

The top line guidance issues are clearly on account of Sun Pharma’s Halol unit and have nothing to do with Ranbaxy. But for bottom line guidance, Ranbaxy is the main reason. What Daiichi could not do in seven years, Sun Pharma expected to complete in three years. The integration of Ranbaxy is taking longer and consuming more resources than what Sun Pharma had envisaged earlier.

Jefferies in its report pointed out that most of these costs are one- time in nature and not recurring. Sun Pharma’s management in its call with analysts had indicated that they expect significant integration costs in the current year. Jefferies points out that the charges are due to IT and other system integration and rationalisation of facilities and employees. These costs are expected to end in FY16 and the benefits of some of these, especially the integration costs led by asset rationalization, will flow through from FY17, says Jefferies.

A small impact on revenues is also expected to come from discontinuation of low margin or loss making businesses which had come into the company because of its acquisition of Ranbaxy. This move will have a one-time impact of revenue but will have a marginal positive impact on the bottom line as overall margins will improve. Shutting down these businesses will have a 5-6 per cent impact in revenues as per Jefferies estimates.

Sun Pharma is confident about the benefits of Ranbaxy acquisition. The management has increased its synergy benefit guidance from $250 million in FY18 to $290-300 million in FY18. They also pointed out that unless they severely mismanage the integration, the acquisition would be EPS accretive in FY18. The company is working on asset rationalisation including in manufacturing, which should lower cost in the medium term. 

What comes out clearly is that the Sun Pharma issue is temporary in nature. Analysts have unanimously reduced Sun Pharma’s profit estimate by around 25 per cent for FY16. But FY17 estimates are not likely to be impacted severely according to Jefferies, who feels that profit can drop by only 4 per cent. Other analysts argue that the drop will be around 12 per cent as compared to their current assumptions. Difference in profit assumption in FY17 is largely on account of when the Halol unit will be normalised.

A sharp 15 per cent loss in market value is justified given that the company will be losing around 25 per cent of its profit this year. But in the medium to long term, markets have always rewarded companies that have been upfront about their issues rather than releasing it at the time of their results.