Sun's 3Q interims (excluding the Taro contribution) disappointed us primarily due to weak Caraco revenues (-22% yoy) and weaker EBITDA margin. In the absence of one-offs, overheads at Caraco and Taro's consolidation, EBITDA margin has declined by c860bp yoy to 27.5%. Maintain Sell on rich valuations.

Caraco's performance: key reason for revenue disappointment
􀀟 Sun Pharma reported 3QFY11 revenues of Rs16.0bn (+57% yoy) vs. our estimate of Rs18.2bn. The key reason for the revenue disappointment was lower than expected Caraco (Sun Pharma's US subsidiary) revenues which came in at US$40m (-22% yoy) as against our expectation of US$88m.

􀀟 Excluding Taro's contribution (US$102m) and our estimate of one-off sales of gExelon (US$9m), we believe adjusted revenues were Rs10.9bn (+7% yoy).

􀀟 Taro reported revenues of US$102m (+23% yoy, flat qoq) which were in line with our estimate. We highlight that the complete impact of Taro's consolidation was visible for the first time during this quarter.

􀀟 Domestic formulation business revenues at Rs6.4bn (+20% yoy) were in line with our expectations. Bulk business - both domestic (revenues of Rs274m, -5% yoy) and export (Rs887m, -22% yoy) was weak.

􀀟 We highlight that Sun Pharma had built up a provision of cUS$15m in 1HFY11 for potential sales return in the books of Caraco. We believe that the company has now reversed that provision which leads us to believe that the remaining export formulation business (ex-Caraco and Taro) reported revenues of Rs1.5bn (+19% yoy).

EBITDA margin disappoints due to absence of one-offs and Taro consolidation
􀀟 Sun Pharma reported EBITDA margin of 27.5% as against our estimate of 33.5%. We highlight that EBITDA margin in the past has been boosted by contribution from one-offs - FY10 EBITDA margin was 31.8% while it was 39.1% in 1HFY11. The decline in EBITDA margins is due to an increase in operating overheads (staff expense increase of 137% yoy, SGA expense increase of 81% yoy) largely due to: (a) consolidation of Taro; (b) fixed and operating overheads at Caraco where manufacturing operations have not yet commenced; and (c) absence of any significant one-offs (gProtonix, gEloxatin, etc - as seen in the past).

􀀟 The tax rate came in higher at 13% vs 7.1% in 3QFY10. We believe this is due to a higher tax rate in Taro this quarter to make up for the lower tax provisions during the earlier part of this year.

􀀟 The company reported PAT of Rs3.5bn (+3% yoy) vs. our estimate of Rs5.9bn and consensus of Rs4.5bn translating into an EPS of Rs3.4/sh.

􀀟 Excluding contribution of Taro and gExelon, we estimate adjusted earnings of Rs2.1bn (-38%yoy).

We maintain our forecasts and Sell rating
􀀟 9MFY11 has met 69% and 68% of our FY11 revenue and earnings estimates, respectively. We expect 4Q to be strong benefiting from the re-launch of gProtonix (has a head start in the market compared to most competitors) as well as potential improvement in Taro and therefore maintain our estimates.

􀀟 We have a Sell rating on the stock with a TP of Rs380/share. It currently trades at 25.4x and 24.9x our FY11 and FY12 core earnings forecasts, respectively.

Update on Caraco, Taro & R&D pipeline
􀀟 Caraco continues to work with cGMP consultants towards resolution of its US FDA woes but maintains that it will not be able to resume manufacture of products before the end of FY11. The company has transferred a few products to Sun's manufacturing facilities and is exploring more such transfers.

􀀟 During 1HCY11, Caraco and Sun will discuss a plan to transition the marketing of products covered by the two distribution agreements between the two companies that expires on 28 January 2012.

􀀟 Taro has filed its audited 2008 results and is in the process of auditing its CY09 results. We note that audited net profit now stands at US$30.6m which is 31% lower compared to earlier published provisional estimate. This is largely attributable to lower net sales of US$7.7m and higher expense of US$6.2m.

􀀟 During the quarter, Sun filed five ANDAs (excluding the two filed by Taro) and received approval for two products (excluding approval for the one received by Taro). Cumulative ANDA filings across Sun Pharma, Caraco and Taro stand at 369 of which 149 await US FDA approval (including 20 tentative approvals).