Fastest Growing Companies 2015

Growth eclipse

After a dream run, Sun Pharma is grappling with growth and regulatory issues. Can the country’s biggest drug maker rediscover its mojo?

Form 483 has been a source of chronic pain for Indian pharma companies that have a major presence in the US. Issued by the US food and drug administration (USFDA), the form notifies a company of objectionable conditions found at its drug units. At the conclusion of an inspection, companies have to respond to the US regulator about their corrective action plan and then implement these plans expeditiously.

While most well-known Indian drug majors have found themselves in the middle of an FDA tangle, Sun Pharmaceuticals, owned by reticent billionaire Dilip Shanghvi, has never found infamy in this department. That is, until now. Following a 15-month-long inspection of Sun’s largest manufacturing plant at Halol in Gujarat, the US regulator had issued a Form 483 to the company, detailing deficiencies in the processes at the facilities or controls used for manufacturing, processing and packing, which did not conform to good manufacturing practices.

A warning letter from the USFDA followed late last month — even though corrective plans were already underway — meaning that additional efforts were required. “The management expects a resolution to happen less than 12-15 months from now,” says a report by Motilal Oswal Securities.

Although the drug maker, a big supplier of generics to the US, can continue to supply customers from the facility, it cannot launch any new products from the site. Till corrective action is taken and the facility gets reinspected, earnings could be under pressure. Analysts at Kotak don’t foresee the FDA reinspecting the site before the second quarter of FY17, while Morgan Stanley has lowered its earnings estimates for both FY17 and FY18. The sudden turn of events has been rather dramatic for the first-generation company, which has had a stellar record so far: from a turnover of under Rs.700 crore in 2002, revenue has grown manifold to almost Rs.28,000 crore in FY15.

The company has almost made a habit out of acquiring distressed companies and turning them around. For instance, Sun Pharma bought over Israeli drug firm Taro, which had a significant presence in cardiovascular neuropsychiatric diseases and skin treatment products in the US, after a three-year-long battle with its shareholders. Taro’s revenue grew by 14% to $863 million, while profit increased by 39% to $482 million in FY15. Sun had almost elevated the acquisition process to an art form; prominent buyouts include Caraco in 1997, followed by Able Labs’ formulation plants and Chattem Chemicals and URL’s generic businesses. In 2015, Sun acquired GSK’s opiate business in addition to InSite Vision. However, it was not until March 2015 — the merger with Ranbaxy — that Sun brought into its fold a company that large.

In fact, the past five years saw Sun Pharma’s turnover jump five-fold to Rs.27,433 crore, while profit, too, nearly trebled to Rs.5,500 crore, translating into a margin that was never below 20%. “Over the five-year period between 2011 and 2015, all our business segments have grown. This has partly been on account of bringing more products to the market, especially through acquisitions. Growth has been a consequence of organic and inorganic play,” points out Uday Baldota, CFO, Sun Pharma. The company is today the fifth-largest generics player in the US — with sales of over Rs.13,700 crore (including the Ranbaxy acquisition) and one of the largest product portfolios — and has 440 approved products and 154 ANDAs awaiting approval.

The ANDA business, which contributes about half of Sun’s revenue, has grown over 47% on average over the past decade and has been one of its main growth engines. In the Indian market, the Sun-Ranbaxy combine is the market leader with an 8.9% share and its revenue grew 27% over the past decade.

It was almost as if Sun Pharma could do no wrong. In fact, the stock touched a 52-week high of Rs.1,200 in April 2015 despite the warnings issued by the USFDA about two of its plants. Things started to unravel when the company reported its March 2015 quarter earnings, which was the first indication of slowing growth. 

Fall from grace

Despite revenue being up 52% at Rs.6,157 crore, net profit fell sharply to Rs.888 crore from Rs.1,587 crore, a 44% drop. This was attributed to various one-time charges largely on account of the Ranbaxy merger, as well as price erosion for some of Sun’s products in the all-important US market. And when Sun announced its profit warning in July 2015, the stock saw its biggest fall, losing 16% in a single trading day.

In an indication that things will take time to clear out, founder Shanghvi said that consolidated profit in FY16 would be adversely impacted due to lower revenue and certain expenses/charges arising out of the integration with Ranbaxy as well as remedial actions. Already in the first two quarters of FY16, growth in the US was down 14% and 28%, respectively. The eternally composed Shanghvi, also the company’s MD, spoke of supply constraints and volatile currency movements at the earnings conference call post the Q2 result. He said that significant costs relating to integration had been incurred but that their benefits would be visible, going forward.

And if that was not enough, the company’s announcement that its subsidiary Taro will be investing $225 million in the wind energy business spooked investors further. While Sun was quick to withdraw its plan, the growing uncertainty over its core business and the FDA warning saw the stock come off 40% from its 52-week high price of Rs.1,200. 

The Halol plant alone is estimated to contribute 15% of the company’s US sales and a quarter of its profit. “There is no doubt that Halol is the single-largest challenge for Sun today. It has not just impacted supplies in the US but has affected the process of getting new approvals for the facility as well,” says Hemant Bakhru, CLSA’s pharma analyst.

This has had a serious impact on the company’s sales in the US, a market that brings in as much as 50% of its revenue. Kewal Handa, promoter-director, Salus Lifecare, and former MD, Pfizer India, refers to the change in the USFDA Act in 2012, which resulted in plants outside the US needing to undergo a yearly audit. “It was sporadic earlier and Indian companies now are playing catch-up. That is why these issues are coming up so frequently now,” he says. According to Bakhru, the FDA has gotten a lot stricter with Indian companies.

“The FDA has been saying for a while now that data recording has been improper and that there is a lack of access controls. Maybe Indian companies have been slow to adapt, which is really quite hard to understand, as they should have done all this earlier,” he says.

The warning letter comes on the back of other large pharma companies in India such as Lupin and Dr Reddy’s Laboratories also coming under the FDA scanner. Lupin received six regulatory observations for its Pithampur plant in Madhya Pradesh in early 2015. Dr Reddy’s received a warning letter as well in November for three of its manufacturing facilities in Andhra Pradesh and Telangana. At the earnings conference call, Shanghvi said current good manufacturing practices remediation efforts for Halol were on and any deviations pointed out would be addressed.

For Sun Pharma, getting the growth story back on track is heavily dependent on getting it right in the US. “The slowdown is on account of issues relating to Halol, the end of 2014’s exclusivity (the 180-day exclusivity on Valsartan tablets, which bolstered Sun’s revenue from the US in Q2FY15) and the price increases that Taro has taken,” says Manish Jain, founding partner, SageOne Investment Advisors.

Further, the US market itself is going through a significant transformation. Handa points out that the primary objective there is to bring down the prices of generic drugs. “There is a consolidation of stockists in the US and margins, as a result, have dropped for most players,” he says. This is a far cry from the past, when huge margins and high market shares were the norm. “There has been an increase in approved ANDAs and many players have entered the US market. From three players for each molecule, there are 10-20 present now,” adds Handa. The disappointment of the first two quarters of the current fiscal is expected to persist till end-FY16, according to the management. Bakhru isn’t surprised at the company’s performance and insists that the third quarter will be weak as well. 

Saving face

Thankfully for Sun Pharma, most of the observations in the warning letter are similar to those raised earlier in the Form 483. In other words, there are no fresh observations cited in the warning letter. Besides, the points raised in the Form 483 are only procedural in nature and do not relate to data integrity, which is a big positive, point out analysts. And there is a silver lining on the horizon.

What could change the fortune of the company in FY17 is the launch of the generic version of the cancer drug Gleevec. Sun recently announced that it finally has the USFDA’s nod to launch the drug on February 1, 2016; it settled its patent dispute with Novartis, which holds the patent for the drug, in May 2014. IMS data puts Gleevec’s revenue at $2.5 billion and analysts expect the six-month exclusivity to give Sun revenue to the tune of $300 million-450 million. The company even shifted the production of the drug from the mired-in-controversy Halol site to another facility in order to get the approval. The launch of Gleevec will help Sun Pharma tide over the bumps till the regulatory hurdles surrounding Halol clear up and the integration with Ranbaxy is complete. 

Handa believes that the current period of turmoil will continue as long as synergies between Sun and Ranbaxy aren’t cashed in. “Sun is dealing with issues such as attrition and restructuring, which has taken a toll on domestic sales in particular,” he says. Handa adds that there is a fundamental difference in the way business is conducted between Ranbaxy and Sun. “If Ranbaxy pushes sales through bonuses to the trade, Sun does it taking the prescription route. It calls for a huge change in mindsets and till the time everyone in the organisation agrees on this, pressure on sales will continue,” he says.

For Shanghvi, the story has been about scale and getting the most from the global market. To date, the US has been Sun’s largest and most important market, although the merger with Ranbaxy throws open other markets as well. Ranbaxy has existing distribution networks in Europe, Japan, Australia, New Zealand and some emerging markets. “It is a dominant player in branded markets such as Russia, Ukraine, Romania, Malaysia and Myanmar, where gross margins are high,” adds Jain of SageOne Investment. While pointing out that Ranbaxy is present in 40 of Africa’s 54 countries, Jain believes Sun would have required multiple acquisitions to create this kind of a presence in the continent.

Ranbaxy’s presence in the OTC business, where Sun is not a large player, also works to its advantage. “Products such as Revital and Volini have significant growth potential across both emerging and regulated markets. These two alone can grow at a CAGR of 25% over the next decade,” he adds. According to Jain, Sun will be able to get higher sales for its innovative products such as Leuprolide, PICN and Doxil (all anti-cancer drugs) on the back of Ranbaxy’s presence in non-US markets.

“Sun can recover its investment in Ranbaxy by launching 15 such innovative products in non-US markets where it is currently not present,” says Jain. In an indication that the management does not expect further challenges from the Ranbaxy integration, during the earnings call post the second quarter results, Shanghvi mentioned that the process was on track. “We are going to implement synergies ahead of time and realise its full value by FY18,” stated Shanghvi. 

As part of the restructuring process, some of the company’s non-strategic assets are being sold off. In September 2015, Sun Pharma inked an agreement with Strides Arcolab to sell its central nervous system portfolio for Rs.165 crore. Two marketing divisions, Solus and Solus Care, which had combined sales of around Rs.90 crore, were transferred to the buyer as a part of this agreement.

This was preceded by an announcement from Sun that it had put Ranbaxy’s Ireland plant on the block. This facility manufactures Atorvastatin, a cholesterol drug that is sold in the EU. Barring the Gleevec launch, there still is no definite timeline for the FDA’s next inspection, which is critical for Sun’s growth. Even as analysts believe the negatives are priced in from a valuation perspective, given that the stock trades at 24.4x estimated FY17 earnings, what matters for Shanghvi and team is how soon Sun Pharma’s growth story gets back on track.