Sun Pharma's Q1FY20 results (Neutral) - Steady quarter; Lower R&D aidsprofits

Q1FY20 result highlights

• Consol revs came at Rs83.7bn vs est of Rs81.7bn. Taro largely inline at Rs11.2bn; Ex-Taro, revs came at Rs71.4bn vs est Rs69.4bn.
• Ex-Taro, US revs came at ~$282m (Q4 - $282m) vs est $285m; We estimate $40-45m sales against generic supply contract during the quarter; this contract will be discontinued from Q2 onwards. Mgt noted that there has been no broad-based improvement in generics business.
• Domestic sales grew 8% yoy vs est +10% growth. Mgt indicated that underlying growth is 12% adj. for impact due to change in distribution channels. RoW+EM sales at $341m (incl. Pola acquisition) were above  est of $310m – key positive surprise on revenues.
• Reported EBITDA stood at Rs18.8bn vs est of Rs17.2bn; Beat primarily due to lower other exp (Rs23.8bn vs est Rs25bn) driven by lower R&D. forex gains (Rs673m) and likely seasonally lower Ilumya DTC spends
• R&D declined sharply qoq from Rs5.35bn (7.6% of sales) to Rs4bn (4.9% of sales). Mgt guided to increase in R&D costs going forward. GMs of 70.2% were weak vs est of      72% - due to product mix
• Interest exp came at Rs1bn vs est of Rs1.5bn. PAT came at Rs13.9bn vs est Rs10.8bn further aided by lower tax rate (10% vs est 15%).
• Global specialty business sales of $94m in Q1; Specialty accounted for 15% of consolidated R&D spends in Q1
• FY20 Guidance – Low-mid teens rev growth; R&D at 7-8% of sales; $200m capex; Significant DTC spends on Ilumya to continue through FY20. Cequa launch in Q3FY20 – Field force costs already baked in

Impact on financials: Maintain earnings estimates

Valuations & view

Q1 was a steady quarter for Sun albeit aided by lower R&D spends, one-off generic sales and potentially lower DTC spends on Ilumya etc. Some of these tailwinds will likely ease off from Q2 onwards. Overall, while generics continue to account for majority of current business, specialty business will increasingly be the prime driver of Sun’s future growth trajectory. With launch of 3 potential big ticket speciality products, Sun’s specialty strategy has taken significant strides forward. While there are multiple challenges in making this transition and it will take time to yield results, it is a strategic imperative for larger Indian players to go down this path. Sun is clearly best placed amongst large domestic peers to make this transition. While Sun’s medium term growth story is exciting, at current levels, we see limited upsides given the volatility in its base business along with the significant growth uncertainties inherent in any early stage speciality business. Maintain Neutral with TP of Rs475. Pick-up in Ilumya remains key near term monitorable.