Sun Pharma's Q3FY19 results (Neutral) - Lower costs and forex gains drive EBITDA beat

Q3FY19 result highlights

• Consol revs came at Rs77.4bn – in line; Taro beat est at Rs12.7bn vs est Rs10.3bn; Ex-Taro, revs were below est at Rs63.8bn vs est Rs66.38bn
• Ex-Taro, US revs came at $205m – flattish qoq vs est $220m; Domestic sales grew 7% yoy vs est +13% growth; notably, Sun  had undertaken significant inventory adjustment in Q2; RoW+EM sales at $308m were ahead of est of $295m
• EBITDA beat due to forex gains and lower other expenses. EBITDA came at Rs20.7bn (post Rs2.3bn forex gains) vs est Rs16bn; Q2 was Rs14.4bn; EBITDAM - 27% vs est 20.8%; Adj for forex, EBITDAM – 24%.
• Gross profits were also in line at Rs54.9bn; Staff costs were marginally lower than est at Rs14.9bn (Est Rs15.3bn). However other expenses came sharply lower – Rs19.3bn vs est Rs23bn; Adjusted for Rs2.3bn forex gains, other expenses were flattish qoq. Notably, mgt guidance on meaningful increases in sales and promotion expenses to fund speciality launches hasn’t quite materialized.
• R&D spend at Rs4.65bn (Rs4.45bn in Q2) – 6.1% vs 6.5% in Q2; Initial FY19 guidance of 8-9% spends now lowered to 7-7.5%.
• PAT came at Rs12.4bn vs est Rs10.2bn; EBITDA gains partially neutralized by higher minority interest and lower other income

Key positives: Lower staff costs / other expenses / forex gains

Key negatives: Revenue miss in US / domestic 

Impact on financials: Increase FY19 earnings estimates by 6%; Maintain FY20 / FY21 earnings estimates.

Valuations & view

Significant qoq fluctuations in profitability along with US sales underlines the near-term challenges for Sun’s business as it seeks to undertake a transition to becoming a global speciality player. With launch of 3 potential big ticket speciality products, Sun’s specialty strategy will take significant strides forward from FY19 onwards. While there are multiple and formidable challenge 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 20x FY20e earnings we see limited upsides given the volatility in its base business along with the significant growth uncertainties inherent in any early stage speciality business. Uncertainty on whistle-blower complaint outcome adds to the challenges. Maintain Neutral with TP of Rs504. Pick-up in key speciality assets will be the key monitorable going forward.