>SUN PHARMA (CLSA)

Considering increasing growth momentum going into FY11/12, positive indications from Taro acquisition battle and visible upgrade potential from a couple of limited competition opportunities, we are upgrading Sun Pharma and adding it to our Conviction BUY list. We arrive a target price of Rs1,780 /share ascribing 22x multiple to core earnings, add present value of one-time opportunities and assign 50% probability adjusted value to Taro. We expect superior stock performance with strong core earnings growth and potential upgrade opportunities.

GATHERING MOMENTUM

■ Strong growth in Sun’s US generics business
Sun Pharma management remains determined to scale up in the US generics segment with accelerating ANDA filings and exponential growth in controlled substances. With close to 85 ANDAs pending approval, Sun Pharma has one of the largest ANDA pipelines that are likely to provide small but regular upgrade opportunities over the coming years. A few of these, Taxotere and Gleevec could provide substantial one-time cash flows though are a couple of years away.

■ Scale benefits from potential Taro integration
Taro acquisition could provide a strong base for Sun Pharma in the US generics segment. US market contributes to more than 80% of Taro’s total revenues. It has around 26 pending ANDAs and a strong dermatology franchise. Sun’s management could potentially drive manufacturing and other operational efficiencies resulting in improvement in Taro’s profitability from current c.10% net margins. With US$600m+ of idle cash lying with Sun Pharma, completion of acquisition will help improvement of return ratios. We incorporate a 50% probability of acquisition and assign Taro a value of Rs71.5/share based on 12x one-year forward earnings.

■ Earnings growth resumes in FY11, potential for further rerating
Sun Pharma returns to reported profit growth in FY11 along with a better core earnings growth profile over the coming years as Caraco losses get into the base. We value Sun Pharma at Rs1,780 per share adding up value of core business and one-time earnings and a probability based value of Taro. We ascribe 22x multiple to Sun Pharma one-year forward core earnings and add present value of cash flows from know exclusivities. We upgrade the stock to a BUY see reducing risks to our positive call. Continued uncertainty related to Taro acquisition, potential increase in tax rate (direct tax code), and appreciation of rupee could pose risk to earnings growth.

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