Sun Pharma's Q3FY20 results (Neutral) - Good quarter despite Taro miss

Q3FY20 result highlights

• Consol revs came at Rs81.5bn vs est of Rs82.7bn. Taro sharply below est at Rs10.5bn vs est of Rs12.6bn; Ex-Taro, revs came at Rs69.9bn - inline. Other operating income stood at Rs1.1bn above est of Rs1bn
• Ex-Taro, US revs grew 11% qoq to ~$220m (Q2 - $197m) vs est $210m. Although mgt noted that there was a nominal degrowth in the base business, 3 new product launches in the qtr, along with specialty drove revs
• Domestic sales grew 13% yoy vs est of 11%, faster than IPM growth.  This is one of Sun’s best showing in domestic market in last several quarters. RoW+EM sales at $350m (incl. Pola acquisition)
• EBITDA stood at Rs16.4bn vs est of Rs18.1bn; Miss due to lower GP (Rs58.4bn vs est Rs58.8bn) and higher other exp (Rs26.5bn vs est Rs24.5bn). EBITDAM at 20.4% vs est 22.2%; Q2 – 20.3%.
• R&D stood at Rs5.2bn (6.4% of sales) vs Rs4.9bn (6.1% of sales) in Q2.  Mgt guided to increase in R&D costs going forward.
• Interest exp came at Rs818m vs est of Rs800m which was offset by forex gain of Rs630m. PAT came at Rs9.1bn vs est Rs11.7bn partly due to higher tax rate (24.2% vs est 16%).
• Global specialty business sales of $118m in Q3; 30% qoq – partially driven by seasonality effect; Specialty accounted for 24% of consolidated R&D spends in Q3- $17.5m / 1.5% of consol revenues; Much lower than our expectations
• Net debt reduced by ~$500m through 9mFY20.

Impact on financials: Reduce FY20/21 earnings by 4%/3% to account for lower margins. We introduce FY22 estimates

Valuations & view

Despite the Taro disappointment, overall Q3 has been operationally one of the better quarters for Sun in a while with strong 13% growth in domestic sales and speciality segment driven $20m qoq increase in US sales. Guidance of enhancing domestic FF underlines mgt focus on this key segment. Given the seasonality impact in this quarter, next few quarters will be critical to gauge the underlying trend in US business which has been fairly volatile in recent quarters.  With launch of Illumya and Cequa, Sun’s global specialty strategy has taken significant strides forward. While there are multiple challenges in making this transition, it is a strategic imperative for larger Indian players to go down this path. Sun is potentially best placed amongst large domestic peers to make this transition. While Sun’s medium term growth story is interesting, at current levels, we see limited upsides given the growth uncertainties inherent in any early stage speciality business. Maintain Neutral with TP of Rs494 (19x FY22E EPS). Speciality pickup remains key monitorable.