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Strong speciality and domestic growth drive Q2

Sun Pharmaceutical’s (Sun) Q2FY22 performance was above our estimates mainly on profitability largely led by strong margins. Consolidated revenue grew 11.7% YoY to Rs95.5bn (I-Sec: Rs92.9bn) and adj. PAT was up 24.5% to Rs19.8bn. EBITDA margin improved 120bps YoY to 26.8% (I-sec: 24.5%) with scale-up in specialty, strong India growth and lower R&D spend. Specialty portfolio grew 6.1% QoQ to US$157mn including the milestone income of US$10mn as well as ramp-up in Ilumya and Cequa. We remain positive on long-term outlook considering strong India business, scale-up in specialty sales and focus on margin expansion through superior revenue mix and operational efficiency. Maintained BUY with a revised target price of Rs959/share.

* Business review: US revenues declined 5.0% QoQ to US$361mn led by sharp decline in the Taro’s revenues (impacted by COVID-19). Global specialty revenue stood at US$157mn in Q2FY22, a growth of 6.1% including US$10mn of milestone income for two products as well as ramp-up in Ilumya and Cequa which we expect to continue. We expect overall US revenues to grow at a CAGR at 8.5% over the next two years to US$1.6bn despite decline in Absorica revenue. India business grew robust 25.9% YoY led by recovery in industry growth, seasonality benefit and upside from COVID-19 related portfolio. We expect the company to continue outperform industry growth supported by strong chronic portfolio. ROW and EMs YoY grew 4.2% and 15.5% respectively. While, API sales decline 14.6% YoY due to lower opioid sales. EBITDA margin up 120bps to 26.8% with lower staff and R&D spend. We expect EBITDA margins to improve 250bps over FY21-FY23E to 27.8% led by operational efficiency and improving revenue mix.

* Key Concall Highlights: 1) Ilumya and Cequa grew 70% and 100% YoY respectively on MAT basis 2) Levulan declined in Q2 due to supply constraints 3) Unlikely to see any material increase in cost due to Winlevi launch, DTC promotion cannot be don’t in the first six months of launch 4) Launched 6 new products in US in Q2FY22 while 13 505(b)2 products are pending for approvals 5) Taro’s gross margins declined in Q2 due to one-time impact and is expected to recover in the coming quarters 6) No clarity on Halol inspection by USFDA.

* Outlook: We expect 11.4% revenue and 17.7% adj. PAT CAGRs over FY21- FY23E on high PAT base of FY21. Focus on cost control and free cash flow generation has augured well. We expect specialty portfolio to grow at 19.7% CAGR to US$677mn in FY23E which would help improve profitability.

* Valuations and risks: We marginally tweak our estimates due to factor in the current quarter’s performance. Retain BUY with a revised target of Rs959/share based on 28xFY23E EPS (earlier: Rs900/share). Key downside risks: Higher than expected pricing pressures in the US, and regulatory hurdles.

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