Sun's margins may reduce to 30-32% post merger: Surajit Pal

Meanwhile, the plunge in Russian rouble may impact companies such as DRL and Glenmark from the pharmaceutical space.

Below is the verbatim transcript of the interview:

Q: The CCI has given its go ahead to the the Sun-Ranbaxy integration, contingent on the divestment of those certain products plus the US FTC approval is expected to be around the corner as well. In your sense given all things are positive for Sun-Ranbaxy in terms of the approvals what will the integration process look like for the two companies?

A: I think internally if you look at that, first of all what they have to do is that rationalisation of workforce; that is one. Given the kind of manufacturing activity in the company I think they need to rationalise that. Second is that there might be some overlaps in domestic market sales force because in lifestyle therapy, Sun Pharma is better placed than Ranbaxy whereas Sun Pharma will have a better foothold in acute therapy through Ranbaxy. So, that will be the benefit or synergy for them.

As far as export market is concerned, I think they will get direct access to Ranbaxy’s quite strong sales force as well as product profile in US. So, what they have to do is that or which is the ongoing process in Ranbaxy about the rationalisation of their presence in rest-of-the-world (RoW) market which could be beneficial for Sun Pharma. That is where they also need to see the commercial ability vis-à-vis the investment already Ranbaxy has made. There is a lot of scope in terms of rationalising their product force as well as sales force in those risk areas like Latin or Russia.

Q: The biggest performer in this year has been Lupin from the pharma space, up almost about 60 percent. There are many reports doing the rounds about various acquisitions that Lupin is looking at to bolster its presence in the global market. Would you still buy the stock at these elevated levels or would you recommend buying the stock now?

A: If you keep that question of acquisition out, I think definitely company has prospect in FY16. However, the question is that whether they will have a similar 60 percent run up or not. I believe that FY16 second half will be bit tough for almost all the companies given the kind of product which is about to be off patent and the size of the product.

So, I think for last three or four months when number of approvals has been slower, that might help first half of FY16 and Q4 of FY15. However, second half onwards we could start feeling the pinch. Number of patent will come down slowly so big product opportunity will be limited. So, we could see some bit of rationalising the growth both in topline as well as margin.

Q: One of the key issues about the integration is that Sun’s elevated margins that they enjoy right now could come down simply because Ranbaxy has single digit margins. On a consolidated basis where do you expect Sun Pharma’s margins to come in and by when, will it be in the second half of the fiscal that we will see Sun Pharma reduce its margins?

A: If I assume that their integration will start from Q1 beginning of FY16 then definitely it will directly impact Sun Pharma’s quite an attractive margin which is already 40 percent plus.

Q: What will it come down to according to you by and to how much?

A: Initially it could be around say 32-35 percent level because I think Diovan will give them quite a good opportunity initially and after that when Diovan opportunity will be gone then the reality of 10-12 percent would be coming into picture. However, it all again depends on how far Sun Pharma could rationalise their cost in terms of Ranbaxy’s plant level or operation level as well as introducing some of the products.

Q: What are your top picks for 2015 in the pharmaceutical space and what kind of target prices do you have?

A: In largecap, Dr. Reddy and Cipla; we maintain our top picks. In midcap, Aurobindo Pharma and Glenmark.

Q: What is the trigger for Cipla, that stock has not performed much compared to the rest of the pack but in 2015 what could the trigger be and what is the target price that you have ascribed?

A: I think what management indicated in Q1, FY15 is that they are waiting for quite a good number of approvals particularly one product approval in Europe which could be one of the trigger in near to medium-term. I think going forward slowly and gradually when they are getting more and more approval in Seretide generics or other inhaler generics into those markets, I think that will be the trigger point. When we will see exactly in terms of number reflecting both in topline growth and the margin growth because what I understood is that the Seretide is not directly substituted. So, what it means is that they have to go for promoting their drug both in formularies as well as medical practitioners as well as the end users; that will take some time.

Q: One, what is the impact that we could see from the Russian rouble as well as problems from the Venezuela currency which could impact companies for example Dr. Reddy and the others which would be the companies in focus on account of that and do you think Glenmark will be in focus on account of a possible out-licensing deal in 2015?

A: I think Russian rouble will impact three main companies – Dr. Reddy, Ranbaxy and Glenmark. Dr. Reddy and Ranbaxy will be in the range of 5.2-5.3 percent of our EPS estimation. Glenmark could be around 8 percent for FY15 EPS estimation.

As far as Glenmark’s out-licence opportunity, management last time when they said that they will be ready with a lot of clinical trials numbers which will be base for making any kind of out-licensing deal on profitable terms. So, FY16 could be at least one if not two out-licence deal possible for the company.