Sun Pharma rating: Buy — Strong performance in operational terms

Gross margin improvement of 330bps was driven by better revenue mix and focus on operational efficiency in manufacturing, partially sustainable in our view.

Sun Pharmaceutical Industries’ (Sun’s) reported operational performance in Q1FY21 beat our estimate of gross and Ebitda margin by 250bps and 450bps respectively. However, revenue growth was below estimate largely due to weak performance in Taro. Consolidated revenue declined 9.4% y-o-y to Rs 75.9 bn and adj. PAT dropped 17.4% to Rs 11.5 bn. Gross margin improvement of 330bps was driven by better revenue mix and focus on operational efficiency in manufacturing, partially sustainable in our view.

Drop in global specialty sales is temporary due to lockdown and would recover in coming quarters. We remain positive on long-term outlook considering strong India business, scale-up of specialty sales and focus on margin expansion through superior revenue mix and operational efficiency. Reiterate Sun Pharma as top pick.

India growth surprises positively, US impacted by COVID-19
India business growth stood at 3.2% y-o-y vs estimated flat sales and industry decline of ~5%. The outperformance was led by strong chronic portfolio which grew ~10% and we expect trend of higher than industry growth to continue. US revenues declined 24.8% q-o-q to $282 mn due to weak sales in Taro and specialty products.

However, we believe sales would improve in coming quarters. Specialty revenue stood at $78 mn, a drop of 38.1% q-o-q. We expect US revenues to remain flattish over FY20-22e with decline in Absorica sales in H2FY21 and generic price erosion. API sales grew strong by 20.1% driven by strong demand for API products.

Margin beat partially sustainable
Ebitda margin at 24.3% was 450bps higher than our estimate led by improved gross margin, lower S,G&A amid lockdowns and reduced R&D spend. We believe margin expansion caused by operational efficiency, revenue mix and cost control is sustainable. We raise our Ebitda margin estimates by ~100bps to 23.1% in FY21e and 24.4% in FY22e.

Outlook
We expect India business growth to remain strong and other markets growth to revert to positive trajectory in coming quarters. Overall, we expect 7.9% revenue and 24.6% adjusted PAT CAGRs over FY20-FY22e with Ebitda margin expansion of 320bps. Recent settlement by Taro for DoJ investigations for $419 mn removes key overhang from the stock.

Valuations and risks
We raise EPS estimates by 3-5% to factor in better margins and remain positive on long term outlook. Reiterate Buy with a revised TP of Rs 612/share based on 24xFY22e EPS (earlier: Rs 585/share). Key downside risks are: higher than expected pricing pressures in the US, and regulatory hurdles.