Sun Pharma up 4%, drops wind energy plan; Barclays upgrades

Taro Pharmaceuticals, on November 17, had proposed a USD 275 million investment in the construction of & acquisition of a wind-powered electric energy project jointly with affiliates of company's controlling shareholder, Sun Pharma in US. It was with equity investment of USD 100 million (Sun Pharma and Taro to invest in a ratio of 2:1), with the balance being funded through debt.

Reason behind Sun and Taro's investment in wind energy was to reduce tax liability as renewable energy projects in the US are eligible for tax breaks under Federal Production Tax Credit (PTC) as well as achieve accelerated tax depreciation.

Credit Suisse (in its note on November 19) had said total cost of the project for Sun Pharma was expected to be USD 250 million and tax savings from this deal was expected to be USD 25 million annually. Additionally, the company was expected to receive lifetime tax benefits of USD 175 million.

The stock has corrected more than 6 percent in last four consecutive sessions and fell more than 20 percent in November due to regulatory concerns at Halol, potential non-strategic investment in wind power project and lack of disclosure around the USD 400 million deal with a third party.

Analysts, which were worried due to company's investment in unrelated business and raised questions over capital allocation decision, feels the company's current decision not to proceed with wind power project in the US is a positive development and valuations are attractive.

According to Bank of America Merrill Lynch (which has maintained buy rating on the stock and target price of Rs 1,070), the street is factoring in worst outcome at Halol plant (import alert), which is reflected in current valuations (trading 20 percent below long-term average). It believes risk-reward is favourable and current valuations present a particularly attractive buying opportunity.

Conceptually, the brokerage continues to like Sun Pharma's best-in-class franchise, strong execution track record, evolving specialty business and ability to generate free cash flow.

It feels Gleevec launch is the next key catalyst for stock.

Sun Pharma recently highlighted that as part of its risk-mitigation strategy, it has filed Gleevec (used to treat blood, bone and skin cancer) from an alternative site and is confident of monetizing this opportunity.

Sun has already settled with an innovator for a February 2016 launch (subject to FDA approval) and this is likely to remain a limited-competition opportunity after the 180-day exclusivity, says Bank of America Merrill Lynch, which is expecting USD 400 million revenue in FY17.

Barclays has upgraded Sun Pharma to overweight from equalweight, given the favorable risk-reward following the 40 percent share price decline from its peak in April 2015.

At these levels, the brokerage believes multiple negatives (including greater probability of regulatory risk heightening at Halol & prolonged operational challenges) are priced in.

The brokerage says its scenario analysis with key variables of Halol, generic Gleevec and Ranbaxy’s synergies suggests that the risk-reward on the stock is improving. "Our bear-case scenario (a very low-probability event) implies 18 percent downside potential from current levels. In base case, on which our price target is based, suggests 27 percnet upside potential. A blue-sky scenario (resolution for the Halol plant, synergies from Ranbaxy) suggests 52 percent upside potential," it explains.

With upgrading stock to buy and revising price target to Rs 815, JM Financial believes that current stock price largely factors in negatives like Halol warning letter.

Barring an import alert, the brokerage says it sees little scope for earnings cut considering that Sun Pharma has managed to de-risk gGleevec and with domestic business strong & one-off costs already incurred, there is scope for margin surprises in the coming quarters. It sees limited possibility of further de-rating given that Sun is already trading near historical lows against peers.

At 09:27 hours IST, the scrip of Sun Pharmaceutical Industries was quoting at Rs 723, up Rs 15.10, or 2.13 percent on the BSE.Posted by Sunil Shankar Matkar