Sun Pharma tells investors headwinds are getting stronger
Even a sharp cut in Sun Pharmaceutical Industries Ltd’s valuation in the run-up to its results may not prevent a further cut this week. The company’s consolidated sales and profitability took a hard knock in the March quarter but what’s worse is the management guidance of a single-digit sales decline in FY18. Combine that with higher research and development (R&D) spending at 9-10% of revenue, compared with 7.6% in FY17, and margins are likely to get squeezed.
The company management has said it will cut costs further during the year, which may soften the blow. The problem is not one of cost containment but of driving sales growth. One part of this problem is internal. Sun Pharma’s Halol facility is on the US Food and Drug Administration’s (FDA’s) radar, which has affected approvals of drugs produced at this facility. Sun Pharma said it’s implementing a remediation plan and waiting to hear from the regulator.
This exercise may take time. Until the issue is resolved, no new approvals will be given to products made at this facility. That is affecting sales growth as the rest of the portfolio is facing pricing pressure, an external problem. Sun Pharma’s US market sales (in dollar terms) declined 34% from a year ago and by 24% sequentially. While year-ago comparisons are affected by sales of a product during its exclusivity period, the sequential decline indicates pricing pressure.
This is getting worse as consolidation among the buyers is giving them more bargaining power. This phenomenon is not new but has gotten worse each year. It has come to a stage where the company said even drugs with exclusivity, when no generic competition exists, may see prices decline. New products are a solution to beat a decline in the base business but the Halol situation has reduced that possibility. Sun Pharma’s management said it may move some key products to other sites to get over this problem.
In India, sales grew by 10% from a year ago, an improvement over the 5% growth in the previous quarter, when demonetization disrupted business. While this is better than the US market, there are risks from the Indian government’s move to make medicines affordable. While price control is an ever present danger, the move to ask doctors to prescribe generic medicines is a significant risk.
The outlook for FY18 looks clouded but Sun Pharma also has to press ahead with its R&D investments to launch speciality products in the coming years. One of them, a drug to treat psoriasis, is now with the US FDA and can turn things around if it eventually gets clearance. Till new launches are able to contribute enough to offset price erosion in its base business and the Halol facility gets a green signal, the pressure from price erosion in the US market will weigh heavily on its performance.
Sun Pharma’s consolidated sales declined by 8% from a year ago and by 11.2% sequentially, while its earnings before interest, taxes, depreciation and amortization (Ebitda) margin fell by 8 percentage points and 9.3 percentage points. Some of this margin decline is due to one-off events such as inventory write-offs. Net profit declined by 19.5% and 22.2%. Its share price has declined by 27% from a year ago. The March quarter results and the glum outlook for FY18 are likely to continue to weigh on valuations.