The seizure of Caraco’s drugs by the FDA could have an adverse impact on Sun Pharmaceutical in the near term.
The Sun Pharma stock lost 12 per cent on June 26 to Rs 1,140, a day after US authorities seized drugs at its 76 per cent-owned subsidiary, Caraco Pharmaceuticals’ Michigan-based facilities for violations of good manufacturing practices. This move by USFDA means that Caraco Pharmaceuticals will not be able to market drugs it manufactures at its three facilities in Michigan. Though the company also imports and markets Sun Pharmaceuticals’ products, the USFDA action will not affect the sale of its parent’s US drug basket. The closure of Michigan facilities and the company planning to layoff a part of its 350 employees, will have an adverse impact on Caraco’s 2009-10 revenues. For 2008-09, manufactured products contributed $112 million or a third of the total revenues of $227 million. On a consolidated basis, about 10 per cent of Sun Pharmaceutical’s revenues could be affected.
Intensifying troubles
Problems for Caraco began in June 2008 when the FDA issued a 483 and followed it up with a Warning Letter in October, 2008. While a 483 records observations of non-compliance with current good manufacturing practices (cGMP) by investigators and does not need an official response from the investigated party, a Warning Letter indicates that the FDA is not happy with the quality of drugs manufactured and the company in question must address the situation quickly if it is to avoid further action. Since January 2009, Caraco had initiated voluntary recalls of drug products due to manufacturing defects, including oversized tablets.
In May 2009, the FDA issued a fresh 483 listing 18 observations which indicated non-compliance. Though Caraco states that it took steps to improve cGMP compliance and quality systems, the FDA thought otherwise and seized drugs at Caraco’s three Michigan facilities on June 25. The inventory seized is to the tune of $15-$20 million. Caraco is meeting its expenses from its cash balance of $64 million and by selling Sun Pharma’s products and those manufactured by third parties in the US.
The next step
Since the current seizure has been carried out under a court order, Sun Pharma management believes that Caraco will interact with the FDA and work out a consent decree. The step means that the FDA through the court will impose its own controls and restrictions on manufacturing operations of Caraco. The consent decrees can be removed if the FDA is convinced that the firm has achieved compliance in line with regulations. It is unclear how long the process will take, but analysts believe that it will be at least 3-4 quarters before the issue is resolved which will mean higher fixed cost, no revenue from manufactured costs and likelihood of expensive changes to Caraco’s manufacturing processes.
| CARACO:PRODUCTION PAIN | |||
| in $ million | FY08 | FY09 | % change |
| Net sales | 350.0 | 337.0 | -3.7 |
| Manufactured products | 125.0 | 112.0 | -10.4 |
| Distributed products | 225.0 | 225.0 | 0.0 |
| Gross profit | 85.0 | 68.0 | -20.0 |
| Manufactured products | 61.0 | 48.0 | -21.3 |
| Distributed products | 23.0 | 20.0 | -13.0 |
| Net income | 35.0 | 21.0 | -40.0 |
| ANDAs pending approval (Nos) | 27.0 | 29.0 | - |
| Source: Caraco, analyst reports E:Estimates In FY10, sales is estimated at $230 million or 32% lower than FY09 | |||
Impact
Caraco, which has been struggling to maintain its sales in FY09, (sales down by 4 per cent y-o-y) due to price erosion and product recall, is likely to see a major part of the $110 million revenues from manufacturing operations affected in FY10.
| HOLDING STEADY | ||||
| in Rs crore |
FY09 | % chg | FY10E | FY11E |
| Net sales | 4272.0 | 27.3 | 4122.0 | 4,489 |
| One-off para IV sales* | 974.0 | 25.2 | 659.0 | 289 |
| Operating profit | 1864.0 | 20.2 | 1524.0 | 1,632 |
| Net profit | 1817.0 | 22.2 | 1542.0 | 1,666 |
| P/E (x) | 13.1 | 15.1 | 14.0 | |
| Source: Sun Pharma, analyst reports E: Estimates Consolidated financials * Edelweiss estimate | ||||
This means revenues for 2009-10 are estimated to could come down to about $230 million which is 32 per cent lower y-o-y. As far as Sun Pharmaceutical is concerned, the company has withdrawn its 13-15 per cent revenue growth guidance for 2009-10. Though the Caraco events could impact its revenues, the bigger issue could be a hit to its credibility as far as sales in the US is concerned. While none of its own facilities have any serious quality concerns, analysts believe there will be a short term impact on Sun’s products marketed by Caraco. The Sun Pharma management has indicated that its first priority would be to resolve the FDA issue before looking at either transfer of products manufactured at Caraco to third parties or to its plants in India.
Outlook
On the back of superlative margins and niche product focus, Sun Pharma’s revenue and net profit have grown at a fast clip; in the last five years, these have risen at a CAGR of 32 per and 42 per cent, respectively. However, in 2009-10, the high base and one-off sales in 2008-09 and Caraco issue means that sales are likely to remain flat. The flat sales would get support from the strong domestic business, which account for about half of sales and is expected to grow by 18-20 per cent led by a favourable product mix. Here, nearly three quarters of sales accrue from products in the chronic segment, which is growing in doubling digits, say analysts.
One factor that could also help provide a fillip to Sun’s sales is EffexorXR. In the current fiscal, Sun Pharma will bank on USFDA approval for EffexorXR (used in treating depression and anxiety disorders) with an estimated innovator sales of $2 billion to improve incremental revenues. The approval, if it comes towards the end of the calendar year, could boost sales upwards of $75 million (Rs 375 crore) for 2009-10. One-off sales can substantially improve revenues as was seen in the case of generic Protonix (used for treating acid reflux disease), which was launched by Sun in the US in January 2008 and has so far grossed around $280 million (Rs 1,400 crore). The downside for this drug, however, is that if the company loses the patent case against Wyeth, it will have to pay stiff damages.
At Rs 1,120.90, the stock is trading at about 15 times its 2009-10 diluted estimated EPS of Rs 74. Given the uncertainty over Caraco and continuing legal battle for Taro both of which are likely to take a year to resolve, the short term is unlikely to have any upsides.
