Introduction to results

Biocon, a leading biopharmaceutical company, has declared its 2QFY05 results, reporting strong topline and bottomline growth. The topline of the company grew by 24%, while net profit witnessed a growth of 54%. However, the operating margins of the company saw a 70 basis points decline.

Leading bio-pharmaceutical company
Biocon started as an enzymes (organic chemicals used in fermentation process) manufacturer and leveraged its expertise in fermentation to evolve into an integrated bio-pharmaceutical company with expertise across the value chain, with strengths in microbial techniques, manufacturing and marketing. The company has two subsidiaries: Syngene and Clinigene, which are involved in custom research and clinical research respectively. Syngene contributes about 8% to the total consolidated revenues of the company, while its bottomline contribution stands higher at 12% (FY04).

What has driven performance?

Sales: The sales growth in 2QFY05 continues to be robust at 24%. However, it is more supported by custom research and enzymes business, rather than bio-pharmaceutical business. The bio-pharmaceutical business grew by 19%, which now stands at Rs 1,470 m and contributes about 80% to the consolidated revenues of the company in the first half of FY05. One of the major reasons for the slowdown in the growth rate of biopharma business is higher base. The September quarter last year saw a scorching growth rate for the statins business. Also, capacity constraints have marred the growth of the company in the quarter. The new capacities for pharma products are likely to come up only in the last quarter of this fiscal. The revenues from the custom research business saw a jump of 58% on account of new contract that company has entered into. Biocon has increased its employee strength and increased the capacity of Syngene (its custom research subsidiary). The company will soon start its new facility for custom research.

Margins not sustainable: The company saw a decline in operating margins during the quarter. Biocon's margins have been high owing to very high capacity utilization and lower competition in the biopharmaceutical space. However, with new capacity coming up and competition in statins space heating up, we believe that the past margin profile is unsustainable. A glimpse of this is being witnessed in the quarter. The decline in the margins would have been even more prominent, but for the strong growth in custom research. This business grew by a strong 58% YoY, stemming the margin slide. The margins in custom research business are very high and the operating margins for 2QFY05 stood at 46%.

Tax benefit: The net profit margin of the company has however increased basically on back of lower taxation and interest charges, and higher other income. The new capacities of the company, which came up last year are EOU's (Export oriented units) and thus get tax holiday, reducing outgo for the company. Also, the proceeds from the IPO are still in the treasury of the company, and has thus given a fillip to other incomey.

What to expect?

At Rs 532 the stock is trading 25.1x its annualized 1HFY05 earnings. The growth in the topline of the company will continue to be robust. Revenues will be driven by statins in the short term. Statins opportunity in the form of Pravastatin (came off patent in Europe in FY05) and Simvastatin and Pravastain (both will come off-patent in FY06 in US) will help the company drive its revenues. With the company investing in creating capacity for the same, we believe Biocon will be the biggest beneficiary of this opportunity. Apart from that, the company's successes in R&D such as human insulin and monoclonal anti bodies and other biological products will help it to grow in long term. However, competition is likely to increase significantly in the future and the ability of the company to sustain margins at the current level is suspect.