>SUN PHARMACEUTICAL INDUSTRIES (ICICI SECURITIES)

FDA strictures nettle goliath

Sun Pharmaceutical Industries’ (SPIL) US subsidiary Caraco Pharma’s (Caraco) continued non-compliance with US FDA standards has aggravated, with the recent seizure of drugs, which was unexpected. Despite strong support from SPIL that boasts of best-in-class management, Caraco has failed to adhere to US FDA’s cGMP standards for over a year. While financial impact may be limited (Caraco contributed 8% of SPIL’s consolidated PAT in FY09), the FDA issue is a substantial risk to SPIL’s repute. SPIL management has retracted its 13-15% YoY FY10 revenue growth guidance, which it will revisit. Hence, we cut our EPS 11% for FY11E but raise it 9% for FY10E, with SPIL continuing to sell generic Protonix at risk. We trim fair value to Rs1,216/share and, for the first time, downgrade the stock to HOLD from Buy. The stock trades at FY10E EPS of 16x, excluding upside from para IV products.

■ Seizure of Caraco’s drugs by US FDA. Despite ‘improving compliance with the US FDA’ having been Caraco’s priority for the past five years as well as full parent support with excellent management, violation of manufacturing standards for over a year is alarming. The recent seizure of Caraco’s drugs (including ingredients) at its three Michigan-based facilities surprised us. SPIL believes that Caraco is likely to enter into a consent decree with the FDA to ensure complete compliance with cGMP requirements. Resolution of the issue is likely take at least 9-12 months.

■ Generic EffexorXR and base business – Key positives. SPIL expects US FDA approval for generic tablet version of EffexorXR capsules in FY10, which could potentially generate additional EPS of Rs11-14 if launched in December ’09. SPIL’s track record of sales and PAT growth of 2x and 3x respectively on a rolling four-year basis is exemplary. Notwithstanding current US FDA issue with Caraco as well as the Taro Pharma acquisition, we have confidence about SPIL’s robust business model and expect healthy performance in the medium-to-long term.

■ Downgrade to HOLD for first time. Given uncertainty on course of action (which could potentially worsen before getting fully resolved), timeline for the resolution, inadequate data for calculating precise negative impact on earnings, we downgrade the stock to HOLD from Buy. This coupled with a subdued H1FY10E and absence of major positive stock catalysts (except approval for generic EffexorXR), we expect the stock to underperform peers and Sensex over the next 2-3 quarters.

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