Correction offers good value in pharma stocks

Sun, Lupin, Cipla have fallen 9-15% but fundamental prospects remain unchanged as analysts expect 15-25% earnings growth

Shares of pharma majors as Sun Pharma, Lupin and Cipla have corrected meaningfully in the past two months. From its 52-week high in mid-October, Sun is down over 12 per cent, Lupin has corrected by more than nine per cent, while Cipla has fallen by almost 15 per cent from a 52-week high of Rs 450 in September.

The correction is mainly due to investors churning their portfolio in favour of other sectors. Fundamentally, there seems to be no reason for this correction and the strong show posted by these companies during the September quarter stands testimony.

Arvind Bothra at Religare Capital Markets feels it is just a matter of time when stocks like Sun rebound. Though some argue that valuations remain stretched for Sun and Lupin, analysts at JPMorgan observe they like Sun and Lupin’s business models and believe Sun’s premium over peers is justifiable given its growth record.

Same is the case for Lupin and Cipla. While Sun, Lupin and Cipla closed at Rs 578, Rs 852 and Rs 383 levels on Wednesday, the one-year consensus target price of Rs 664, Rs 978 and Rs 459 (according to analysts polled by Bloomberg) indicates an upside of 14-20 per cent.

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Sun Pharma

Sun stands tall with strong growth prospects across all markets. Its US subsidiary, Taro (a fourth of consolidated sales), which felt the heat in June quarter due to increased competition in key dermatology products like Nystatin Triamcinolone (about 12 per cent of Taro’s revenues), rebounded in September quarter.

Hitesh Mahida at Fortune Broking says Taro’s results indicate that it has taken some price hikes in other products. Moving forward, for the week ending November 1 (referring to IMS prescription data) Nomura reports indicate that in Nystatin Triam Cream, Taro’s market share is stabilising at 60 per cent (up 70 basis points week-on-week).

In October, Taro’s NDA launches in the dermatology segment namely, Topicort spray and Calcitreine ointment, have continued to gain share, adds Mahida.

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Taro’s recent share buyback proposal of $200 million should also prove positive for earnings. Analysts at HSBC observe that assuming the offer is fully subscribed at maximum offer price ($97.5 a share), it can push FY14 earnings estimates for Taro by five per cent. HSBC analysts maintain their overweight rating with target price of Rs 725.

After growing 17 per cent year-on-year in September quarter, IMS data show Sun’s domestic business grew 19 per cent year-on-year in October (best in industry).

Sun’s other US arm, URL, is also likely to see continued traction led by supplies of anti-bacterial, Doxycycline.

The launch of anti-diabetic, Prandin (in August 2013), on exclusivity is likely to garner $30 million in revenues and $15 million in profits during first six months of exclusivity. Overall, analysts expect Sun’s EPS to rise by over 35 per cent in FY14 and another 15 per cent in FY15.

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Lupin

The company has seen a strong rebound in the September quarter performance. After a blip in June quarter due to the new drug pricing policy, its domestic business rebounded with nine per cent growth in September quarter. Nilesh Gupta, MD, Lupin, sees the domestic growth rebounding to 18-20 per cent in a few quarters.

The US business contributing 32 per cent to overall revenues continues to grow strongly. Its current portfolio is growing well and further growth is likely to come from the expansion in Oral contraceptives, Lipid control drugs, besides growth in ophthalmology, dermatology and planned asthma range.

Analysts at JP Morgan estimate Lupin’s US generic sales to grow at 23 per cent CAGR over FY14-16.

Lupin’s Japanese revenues, which declined year-on-year by 12 per cent in June quarter and six per cent in September quarter, are also likely to see a turnaround in second half of FY14 as contract manufacturing picks up, besides launch of more products. All these should help Lupin post 19 per cent annual growth in EPS for FY14 and FY15.

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Cipla

While Cipla continues to see good growth in the domestic market, it has changed its strategy for the export markets and is working on its own front-ends.

Analysts at Bank of America Merrill Lynch see Cipla moving away from supply chain model to front-end model, which requires higher front-end investments and low capex.

While this will have impact on margins in near-term, it will lead to strong free cash flow (FCF) generation. They highlight it has generated FCF of Rs 520 crore in FY13 and expect the rate to accelerate as capex and working capital requirements remain stable.

As a matter of fact, Cipla’s cash conversion cycle has improved by 18 days in first half of FY14. Overall, Cipla’s EPS is seen increasing by 20-23 per cent each year in FY14 and FY15, led by expanded reach in global markets.

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