Sun Pharma: Merger queered the pitch

The stock of the country’s largest drug maker, Sun Pharmaceutical, has lost over 10 per cent in the past year. This was on two counts.

First, weak performance beginning March 2015 quarter following consolidation of Ranbaxy’s numbers into that of Sun Pharma came as a disappointment. From about 45 per cent in 2013-14, Sun Pharma’s consolidated operating profit margin fell to 26 per cent in the first six months of the current fiscal. This was because of Ranbaxy’s single-digit margin, which was hit by regulatory issues involving four of its plants.

But drag in operating profit margin post-consolidation with Sun Pharma was very much anticipated. Moreover, though the merger may be margin-dilutive in the short term, synergies from Ranbaxy’s portfolio in the US, India and other emerging markets will help over the next three to five years. Sun Pharma is rationalising Ranbaxy’s portfolio and businesses across markets, the benefit from which should start accruing over the next few quarters.

Sun Pharma recently increased its synergy guidance from the earlier $250 million to about $300 million. Its strong track record of turning around its acquisitions, Taro Pharma being a good example, puts faith in the ability of the company to better the synergy guidance.

Nothing to worry about

Second, Sun Pharma received a warning letter from the US drug regulator Food and Drug Administration (FDA) citing deficiencies in quality control systems at the Halol (Gujarat) facility. This was perceived negatively by the market, given that the plant is critical for the company’s US business — accounting for about 15 per cent of its sales from this geography.

However, this should not be a cause for concern, given that Sun Pharma started remedial measures almost a year back after the US drug regulator raised observations in Form 483 in September 2014. According to the management, the warning letter only details the issues raised in Form 483 in September 2014 and there is nothing incremental.

The management is confident about resolving the issues at the earliest and is working closely with third-party consultants to complete the remediation process.

The company’s track record of resolving regulatory issues involving its manufacturing facilities (Cranbury facility, New Jersey) in the past provides comfort.

Hence, the recent correction in the stock price may be overdone. Investors with a two- to three-year investment horizon can use the weakness to buy the stock.