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Five reasons why Morgan Stanley has turned bullish on Sun Pharma

Sun Pharma rose 4 per cent to Rs 424.50 in Monday's early trade after Morgan Stanley upgraded the stock to 'overweight' and raised its target to Rs 505 per share from Rs 470 per share.

The brokerage firm said Sun Pharma was its top pick in its Indian healthcare coverage and sees 27 per cent upside in the stock. The brokerage firm also listed possible risks to the stock achieving the price target, which includes cost escalation in FY21, a lack of niche US launch, a material slowdown in India/Emerging Market (EM) businesses, a lack of take-up of Ilumya, a worsening of corporate governance issues, and adverse foreign exchange movements.

Following are the five reasons for Morgan Stanley's upgrade:

Earnings revival driven by operating leverage in FY21: Morgan Stanley expects an earnings revival for Sun Pharma from FY21 onwards, driven by steady growth in the base business coupled with plateauing of the current elevated cost structure, leading to positive operating leverage. 

"Over the next two years (F20-F21), we expect CAGRs of 14.1 per cent in sales and 20.3 per cent in EPS, driven by steady growth in the US, India, and ROW along with margin expansion due to operating leverage," the report said. 

The stock has been a significant underperformer: The stock has corrected 41 per cent and 56 per cent over the last two and four years, respectively. In comparison, the Sensex has risen 31 per cent and 40 per cent over these periods.

Reasonable valuation: As a result of the correction, valuation has become reasonable. In terms of Price-to-Earnigns (P/E), the stock trades at 22.3 times FY20e and 15.8 FY21e EPS (1.1 PEG) and 2.8 times and 2.5 times FY20e and FY21e EV/Sales, which is one standard deviaion below its five-year average valuations, the report said.

US specialty business has potential:  Ilumya should benefit from a multi-year trend of psoriasis patient conversion to biologics, a relatively low frequency of dosing, and its niche medical benefit positioning, as per the report. "Phase II clinical data for psoriatic arthritis appear encouraging. We estimate $30mn and $110mn in revenue for FY20 and FY21," the report siad.

Ilumya injection is a prescription medicine used to treat moderate to severe psoriasis in adults who may benefit from receiving injections, pills, or treatment using ultraviolet or UV light phototherapy).

Potential resolution of regulatory issues: Closure of ongoing litigations in the US with regard to price collusion (DOJ investigation and 44 State Coalition), plus, SEBI investigation in response to the whistleblower complaint will also help the stock, as per the report.

Morgan Stanley said various catalysts like ramp-up of Ilumya (tildrakizumab) in the US, faster approvals from Halol, domestic market growth accelerates, and value-accretive mergers and acquisitions may help Sun Pharma. Globally, aging population, pressure to contain costs, significant patent expiries, and new markets (such as Japan) define opportunities for the company.

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