Sun Pharmaceutical Industries - Surprise Audit Of Halol Unit By USFDA - Outcome Is Key - Nirmal Bang

As per a report in the Business Standard newspaper dated 11 September 2014, the US Food and Drug Administration (USFDA) has undertaken a surprise audit of Sun Pharmaceutical Industries' (SPIL) Halol facility in Gujarat. While it will take a few days to know the outcome of the inspection, we believe it will remain a near-term overhang on SPIL after the recent import alert on its Karkhadi (Gujarat) facility over data integrity issues. Based on our interactions with SPIL's management, we believe the Halol facility is the largest, which supplies products to the US excluding Taro (as per our assessment, the facility contributed around 22%-25% to FY14 EBITDA) and, therefore, any negative outcome will significantly impact earnings. If the inspection is cleared successfully, then we believe it will significantly boost investors' confidence in SPIL's manufacturing capability. Since the inspection of Karkhadi unit, there have been three inspections by the USFDA, out of which SPIL has been given 483 on one audit (as per http://fdazilla.com, a website tracking USFDA regulatory actions). In our earlier interactions, SPIL's management had stated that an internal review of all facilities was undertaken after the Karkhadi import alert and that the focus was on strengthening the manufacturing practices across plants. We prefer a wait-and-watch strategy pending clarity on Halol unit inspection and have retained Accumulate rating on SPIL with a target price of Rs872, valuing the stock at 25xFY16E EPS of Rs34.9 (unchanged).

USFDA's uninformed audit comes as a surprise, but not a bolt from the blue: While the sudden and uninformed USFDA audit is surprising, it is not a bolt from the blue as after the Karkhadi import alert – because of data integrity issue – it was widely expected that SPIL's other facilities will also be subject to strict scrutiny by the USFDA. It may be recalled that in the warning letter issued for the Karkhadi unit, the USFDA had raised the issue of integrity of all data generated by the company. While the Karkhadi import alert had a negligible impact (<1% of sales), Halol is the largest facility supplying products to the US (excluding Taro) and had accounted for 22%-25% of FY14 EBITDA, as per our estimate. An adverse outcome can significantly impact earnings as well as SPIL's premium valuation. If SPIL clears the inspection successfully, then we believe it will significantly boost investors' confidence in SPIL's manufacturing capability. As per http://fdazilla.com, there have been three inspections by the USFDA since the Karkhadi inspection, out of which SPIL has been given 483 on one audit (the inspection was immediately after the Karkhadi audit). In our earlier interactions with the management, SPIL had stated that an internal review of all facilities was undertaken after the Karkhadi import alert and that the focus was on strengthening the manufacturing practices across its plants.

Surprise USFDA audits may happen across the pharmaceuticals sector: While the remaining facilities of companies which had experienced GMP (Good Manufacturing Practices) non-compliance problems are likely to be under the highrisk category, we believe the scope of USFDA surprise checks is likely to expand. In the past, companies were informed at least one-two months prior by the USFDA about its inspection, which gave them ample time to set things right. However, with the USFDA setting up an office in India, the frequency of its inspections has increased (often, without any notice), while the lead time has declined significantly, resulting in an increase in the number of GMP non-compliance cases.

Shares of SUN PHARMACEUTICAL INDUSTRIES LTD. was last trading in BSE at Rs.805.9 as compared to the previous close of Rs. 822.8. The total number of shares traded during the day was 788449 in over 33432 trades.

The stock hit an intraday high of Rs. 819.25 and intraday low of 789. The net turnover during the day was Rs. 635465989.

Source : Equity Bulls

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