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Sun Pharma started 2018 with a bang and is ending it on a whimper. What went wrong?

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The year 2018 was expected to be filled with milestones for Sun Pharmaceuticals Industries, India’s biggest drugmaker by market capitalisation.

Sun Pharma started 2018 with a bang and is ending it on a whimper. What went wrong?
The year 2018 was expected to be filled with milestones for Sun Pharmaceuticals Industries, India’s biggest drugmaker by market capitalisation. The shadow of USFDA on its multi-dosage Halol facility — the American drug regulator’s warning on quality control violation at the plant had remained since 2015 — lifted this year.
Though the contribution of the Halol facility to Sun’s total sales has reduced — accounting for around 10 percent of total US sales from the peak 25-30 percent in 2014 — it still remains a vital part of the company’s ambitions in a lucrative market.
Sun’s speciality pipeline got a boost this year. The company got approvals for speciality drugs Yonsa (prostrate cancer), Tildrakizumab, or the Illumya brand (psoriasis), Xelpros (glaucoma) and Cequa (dry eye).
The financial year too started auspiciously, with first quarter sales growing at 16 percent, led by growth in the company’s biggest markets, the US and India. Margins sustained at more than 20 percent. This optimism was reflected in the stock market, with the scrip rallying to more than 650 levels.
What a difference a few months make. The stock is now down to sub 500 levels. Sun has lost over 15 percent of its value in just November.
So why the fall? Here is a list of the important reasons that have resulted in Sun’s series of reversals on the stock market.
Poor Results In The Second Quarter
Sun also reported a shock quarter loss of Rs 212 crore owing to the provision of over Rs 1,200 crore that it estimates will be required to settle a US litigation over its sleep disorder drug Modafinil. The bad news was that even on an adjusted basis, the bottom line missed many analyst estimates.
The numbers disappointed the street. Since the earnings were reported on November 13, the stock has underperformed peers, falling more than 10 percent against the Nifty Pharma Index, which has corrected around 3-4 percent.
While operational performance was in line with expectations, revenues missed targets. Revenue grew 4.3 percent year-on-year compared with estimates of a 17 percent growth.
Sales in the US and India were also down. US revenue fell 10 percent to $342 million quarter on quarter compared with estimates of the company generating $385-390 million of US sales. India, which accounts for around 27 percent of total sales, too fell 16 percent year-on-year due to one-time inventory changes.  Emerging markets were flat year-on-year while sales from the rest of the world declined 2 percent year-on-year.
Brokerages such as Edelweiss revised downward the Sun ratings and the likes of Morgan Stanley retained their underperform call, calling Q2 a miss.
Sun remained optimistic, however. It said the weak second quarter doesn’t reflect the health of underlying business and expected a positive performance in the second half.
Speciality Pipeline 
Initial trends of sales in Sun’s speciality pipeline have given no cause for cheer. For example, one of the reasons the US sales in Q2 were lower was due to slower sales from the prostate cancer drug Yonsa. The drug is a part of the company’s speciality pipeline and was launched in 2018.
Analysts now expect lower sales on Yonsa because it is likely to face competition from the generic versions of Zytiga, another prostate cancer drug, soon hitting the market. The street has lowered its initial expectations of Sun generating $50-100 million in peak sales from Yonsa to $30-40 million (peak sales generally fructify two to three years from launch).
According to analysts, Sun is also facing challenges in ramping up its skin cancer drug Odomzo, which it acquired from Novartis in December 2016 for $175 million. Peak sales from Odomzo was initially expected to be around $150-200 million which is now reduced to $80-$120 million due to lack of scale up in market share.
The other drug the street is tracking and probably most closely is the psoriasis drug Illumya or Tildrakizumab. Sun launched this speciality drug in October 2018.
The expectations are big — $200-500 million in peak sales. Sun has already invested around $350-400 million in the drug itself. Illumya is also being studied for psoriatic arthritis and ankylosing spondylitis.
Further launches the street will watch for in FY19 from the Sun stable will be two drugs for eye conditions — Xelpros for glaucoma and Cequa for dry eyes. Peak sales for Xelpros is estimated at $30-50 million and Cequa is estimated to clock up to $80-100 million. Sun has also guided that spending will be high in the second half FY19 on account off launch costs and higher R&D costs on due to the speciality pipeline
The higher costs were already visible in the second quarter with the increase in costs on account of expanding the field force to launch key speciality drugs. The street will be fine with higher costs as long as sales are robust. Sun’s speciality drugs in the second half will be watched closely.
Controversy Over Corporate Governance Issues 
Soon after the disappointing Q2 numbers, Sun Pharma faced another setback. A sales note by a foreign brokerage and sent to select clients went viral.
The note reminded investors of old incidents that pointed to possible governance lapses in the company. The management of Sun Pharma clarified that the information was available in the public domain and some of it was more than 10-15 years old. The company denied any wrongdoing.
When contacted, Sun Pharma said: “We understand that someone has compiled and circulated this information about Sun Pharma. The information, already available in the public domain, has been portrayed in a way to indicate that something inappropriate has been done by Sun Pharma. Some of the information presented is even more than 10-15 years old. We believe we are in compliance with all the legal/regulatory provisions applicable to us.”
Nonetheless, it pushed investors to take a fresh look at the concerns pointed by analysts in the 2017-18 annual report.
For example, Motilal Oswal in its September 2018 analysis on Sun’s annual report pointed to a rise in related party transactions and loans and advances to non-related parties. According to Motilal Oswal, sales to parties controlled by key managerial personnel increased from Rs 10 crore in FY17 to Rs 7,990 crore in FY18, comprising of  30 percent of consolidated revenue. The report points to a consequent increase in receivables from these entities to Rs 1,230 crore.
The number of related parties in FY18 increased to 12 in FY18 from five in FY17.
Some analysts pointed to Aditya Medisales, Sun’s main distributor of drugs in the domestic market, getting classified as a related party in the FY18 annual report. However, it is important to note that Aditya Medisales has been a distributor for Sun’s domestic drugs since the company’s early days.
Aditya Medisales also shows up as a promoter entity in Sun’s shareholding pattern. As of September 2018, Aditya Medisales held 1.67 percent in Sun Pharma.
The Motilal report also points to loans and advances to non-related parties, which rose 124 percent to Rs 2,330 crore in FY18 compared with Rs 1,040 crore. Though disconcerting, this information is publically available.
A reiteration of these concerns might not impact domestic investors, but it could well taint the view of a foreign institutional investor. (Foreign portfolio investors hold 16.78 percent in Sun Pharma as of the second quarter of FY18).
CNBC-TV18 reached to Sun Pharma on queries specific to the annual report and the article will be updated when it responds.
The Halol Plant
The Halol plant is being reinspected for the third time in 2018 by the USFDA, said people familiar with the matter. The inspection is said to have begun on November 26 and will go on until the first week of December.
The latest inspection is specific to products. While the street seems to be more confident on the facility as USFDA warning has lifted, an inspection always causes some nervousness.
So while the street maybe more confident, it does have a niggling worry of the pace of approvals from the Halol facility. The approvals have been in single digits this year. But the pace of approvals is expected to increase, as indicated by the frequent reinspections by the USFDA.
When contacted, Sun Pharma said:  “As a policy, we don't comment on the schedule of regulatory inspections.”