No depression, just growth

Dilip Shanghvi IS NOT easy to rattle. The US Food & Drug Administration had just issued a warning to his US subsidiary Caraco and investors took it as a cue to push down his company's stock by five per cent. But the Chairman & Managing Director of Sun Pharmaceutical Industries, the domestic leader in psychiatry, neurology, cardiology therapies, was his usual calm self as he spoke to Business Today on the evening of November 4, the day the markets hammered the stock.

What helped sun outperform
1 Comparatively less dependence on the US and Europe
2 Virtually no debt on balance sheet
3 The high-risk research business has been hived off
4 Generics of pantoprazole and amifostine doing well in US, with very little competition

"This warning allows us to improve our focus on quality. We expect to be back in compliance soon. The regulators have visited four of our factories in the last one year with very limited issues. But we are concerned," Shanghvi says over the phone as he shuttles between meetings in Mumbai.

Following the FDA caution and the 5 per cent fall in the stock price, brokerage house Angel Broking changed its outlook for the stock from buy to neutral. But the next day, when the BSE Sensex went down by 4.82 per cent, the Sun Pharma scrip recovered 10 per cent.

No one will deny Shanghvi his right to exude confidence-it has been a great 12 months for Sun and an even better first half for 2008-09. The company has reported a 76 per cent year-on-year growth in sales and a 134 per cent growth in net profits for the quarter ended on September 30, 2008, following up on a 133 per cent sales growth and 241 per cent profit growth for the quarter ended June 30, 2008.

And Sun did this when other pharma majors were struggling. As Ranjit Kapadia, Research Head at Prabhudas Lilladher, points out, the earnings before interest, depreciation, tax and amortisation (EBITDA) margin of 45 per cent reported by Sun is way ahead of the 35-36 per cent achieved by Glaxo, the next best in the industry.The strategy has been-in the words of Shanghvi- "Creating stable businesses and creating strong cash flows."

First to file opportunities
Angel Broking changed its outlook on the stock on November 4 after assigning a buy and a target price of Rs 1,600 on October 24. Sarabjit Kaur Nangra, Research Head at Angel, says: "The growth has been fuelled by exports to US and that is based on the success of its two generics- pantoprazole and amifostine. The company may sustain this kind of growth for another quarter."Both these products were launched as a part of patent challenges that Sun had filed on established products in the US-Protonix and Ethyol. Being the first to file the challenge, Sun gets a 180-day exclusive period to market its product after it is approved by the FDA. Sun Pharma seems to be making the most of this period now, and Shanghvi says that between Sun and Caraco there are quite a few other first-to-file opportunities waiting to be exploited.

"We have abbreviated new drug applications (ANDA) for 61 products approved in the US. ANDAs for another 96 products await approval of the USFDA, which include some Para IV challenges (patent challenges) and within these a few first-to-file (FTF)." Shanghvi asserts: "Even if we take away the US exports story, the underlying business remains strong." The Research Head of Anagram Stockbroking, V.K. Sharma, corroborates Shanghvi, and says Sun's revenues are not too dependent on the US and Europe and that it is precisely this factor that has helped Sun perform better than the pack. But that might change soon. Total exports accounted for a little over half of sales in the quarter to September 30. While exports grew by 173 per cent, domestic sales grew by a little more than 22 per cent.

Exports and beyond
The FDA warning to Caraco is worrying, say analysts. Himanshu Varia, Head of Institutional Sales of Brokerage House Asit C Mehta, says: "In the context of what happened with Ranbaxy, this is a case for substantial worry." In February 2007, the FDA had shut the US headquarters of Ranbaxy Laboratories, in New Jersey, following a search by "criminal investigators". It later banned 30 generic products of the company, which affected Ranbaxy's US sales.

Kapadia of Prabhudas Lilladher sees no immediate concern. "The company has said that the Caraco warning will not immediately affect the sales and no products are being withdrawn. Many products that Caraco sells in the US are manufactured in India and even now Caraco's products are not being withdrawn."

Shanghvi himself is looking for growth on all fronts. "If you look at all the product areas that we are in, you will see we are at the top in six of the therapy areas while we are at No. 2, 3, 4 and 5 in the other areas. Sun's aim, he says, is to be within the top three in all the areas that it operates in.

But Hitesh Sharma, National Leader of Healthcare Practice at Ernst & Young, cautions that the first-to-file opportunities might just become a little less lucrative in the near future. "Over the last three to four years, this FTF opportunity has become a little diluted as the original patent holder has started authorising generics that compete in the same space. So, we see this as just one more enabler of, and, not just a single growth driver for Indian pharma industry," says Sharma.

Pharmaceuticals is also considered a defensive sector from the investor's perspective-an industry where demand is not so elastic as people continue to buy medicines even if there is an economic downturn. And Shanghvi points out: "While pharma sector doesn't perform as well as some of the other industries at the time of a boom, the effect of an economic downturn is also reduced." The downturn is of concern, but he is betting on consistency and profitability to cushion the impact.

Kapadia of Prabhudas Lilladher points out that between now and 2010, a lot of pharma multinationals will be shutting down their manufacturing facilities in Europe and US and a lot of this manufacturing will shift to Asia through outsourcing.

"The competition will be between India and China and India will get preference because the quality of scientists here is much better," Kapadia claims.

The FDA's aarning To Caraco Sun's US subsidiary Caraco Pharmaceutical Laboratories received a warning from the US Food and Drug Administration about its Detroit manufacturing unit. Caraco said in a press release: The observations set forth in the warning letter include, among other things, the inadequate and untimely investigation by the qualitycontrol unit of certain incidents at the facility contrary to the company's standard operating procedures. Caraco added: Caraco intends to respond promptly and timely to the FDA within 15 business days. The company is committed to working cooperatively and expeditiously with the FDA to resolve the matters indicated in its letter. Sun Pharma Chairman and Managing Director Dilip Shanghvi said: "We are concerned. This helps us improve our focus on quality issues. The idea is to strengthen Caraco and meet the norms."

Taro & acquisitions
There is also the unfinished business of Taro. Shanghvi says Sun remains committed to the acquisition of the Israeli company and the tender offer for its shares (Taro gets 90 per cent of its sales from North America) as well as the litigation in the courts against the Taro management.

But in the current financial market turmoil, Sun is taking a closer look at the debt that Taro will bring with it if Sun manages to bag it. Before the global credit crisis erupted last month, such debt would not have been a bother. Taro had a net debt of $224 million (Rs 918 crore) when the two announced the deal in May 2007.

"We are now additionally concerned about the debt that Taro holds. Taro has acknowledged in the past that it has defaulted on the debt covenants. Such a default can potentially trigger either a recall of debt or an increase in borrowings cost or both, which in turn can reduce the attractiveness of the Taro business," says Shanghvi.

Anagram's Sharma says Sun's virtual debt-free status is another reason its stock has done better.

As Shanghvi says, Sun is generating a lot of cash so it has no worries on the liquidity front. For the future, he says, Sun is not looking at acquisitions in Europe. "We are focussed on the US market for the time being," says Shanghvi.