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Good quarter; near-term headwinds limit upside potential

* We maintain Hold rating on the stock as we believe the current valuations limit the upside potential in view of near-term headwinds such as 1) potential increase in R&D expense, 2) reversal of Covid and seasonal product sales in India and 3) increase in S&M costs.

* Q1 revenue/EBITDA/PAT beat our expectations by 3%/11%/33%. The revenue beat was driven by higher revenue in India, EM and the RoW businesses. The EBITDA beat was driven by slightly better gross margins and lower-than-expected other and R&D expenses.

* Global specialty sales of US$157mn included a milestone payment of US$10mn related to two specialty products. Excluding that, specialty sales were flat qoq. QoQ growth in Ilumya and Cequa was offset by Abosrica genericization and supply issues in Levulan.

* The stock is trading at a 1-year forward P/E of ~25x, which is largely in line with the historical average. We value SUNP at a 21x P/E on our Dec’23E EPS to arrive at a core business value of Rs750/share and add NPV/share of Rs25 for SCD-044 and gRevlimid.

All businesses, except API, see yoy growth:

India revenue growth of 26% yoy was driven by good growth in its chronic and sub-chronic therapies due to the longer monsoon season and ~Rs600mn contribution from Covid-related sales. Global specialty sales of US$157mn included a milestone payment of US$10mn related to two specialty products. Excluding that, specialty sales were largely flat qoq. Taro revenue was down 11% qoq. RoW and emerging markets saw a healthy uptick in sales (+10% yoy). API sales saw a decline, mainly due to lower opioid sales.

One-offs and lower R&D aid profitability:

The quarter included a US$10mn milestone payment and Covid sales of ~Rs600mn in the domestic business. Adjusting for these, EBITDA margin would come down to ~27% from the reported EBITDA margin of 28.1%. In addition to topline one-offs, R&D expenses were exceptionally lower at 5.1% of sales (ex-Taro) due to slow patient enrollment in the PsA and SCD-004 trials.

Mixed guidance:

Management sounded confident in ramping up specialty sales. However, the FY23/24 specialty breakeven guidance given in Q1FY22 was withdrawn. On the cost front, management expects R&D expenses to inch up. Moreover, other expenses are expected to inch up due to the launch costs related to Winlevi and the return of medical conferences and international travel. ETR was also guided higher for the ensuing quarters.

Softness in Specialty and near-term headwinds keep us on sidelines:

We raise our FY22E earnings estimates by 8% to reflect the Q2 beat but largely maintain our FY23/24E estimates. Specialty sales growth paused in Q2, a trend we believe could likely continue in Q3 as well, as more Absorica competition has emerged. Despite baking in ample upside for key specialty molecules, such as Ilumya and Cequa, the stock is still trading at a 1-year forward P/E of 25x, in line with its historical average. Upside risks: Higher-than-expected growth in businesses and Halol plant resolution. Downside risks: Lower-than-expected growth in specialty, adverse regulatory actions, and higher price erosion in the US.

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