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Biocon: Europe hurts! - Views on News from Equitymaster
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Biocon: Europe hurts!
Jan 18, 2006

Performance Summary
Biocon has reported mixed results for the third quarter and nine months ended December 2005. While the topline has clocked a double-digit growth during the quarter led by contract research business and a revival in the biopharmaceutical sales, operating margins were due to continued pricing pressure in the European statins market. This, coupled with a rise in depreciation charges and interest costs, has percolated down to the bottomline (down 12% YoY). For 9mFY06, while the topline has grown by 7% YoY, bottomline has fallen by 19% YoY.

Financial performance: A snapshot
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 1,780 1,990 11.8% 5,380 5,740 6.7%
Expenditure 1,180 1,400 18.6% 3,630 4,050 11.6%
Operating profit (EBIDTA) 600 590 -1.7% 1,750 1,690 -3.4%
Operating profit margin (%) 33.7% 29.6%   32.5% 29.4%  
Other income 50 20 -60.0% 120 40 -66.7%
Depreciation 60 70 16.7% 160 220 37.5%
Interest 10 10 0.0% 20 10  
Profit before tax 580 530 -8.6% 1,690 1,500 -11.2%
Tax 80 90 12.5% 150 250 66.7%
Minority interest - -   10 10  
Profit after tax/ (loss) 500 440 -12.0% 1,550 1,260 -18.7%
Net profit margin (%) 28.1% 22.1%   28.8% 22.0%  
No. of shares (m) 100.0 100.0   100.0 100.0  
Diluted earnings per share (Rs)*         17.1  
P/E ratio (x)*         27.9  
(* on a trailing twelve months basis)            

What is the company’s business?
Biocon is India's largest biotechnology company with presence in biopharmaceuticals, enzymes, custom research and clinical research. It 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 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. These subsidiaries contribute over 12% to the total consolidated revenues of the company (as per 9mFY06 numbers).

What has driven performance in 3QFY06?
Biopharma weathers the storm: Biocon’s biopharmaceutical business clocked a 12% YoY growth in 3QFY06, which is decent considering the fact that the company was bogged down by difficult pricing conditions in the European statins market. However, from here on, the management stated that they do not foresee any significant price erosion, which can be construed as an encouraging sign. Strong growth in insulin also played a role in contributing to the overall biopharma revenues. The contract research business witnessed a significant traction (up 50% YoY), which could be attributed to revenue generation from new contracts signed by the company during the previous quarters. In fact, during 9mFY06, the contribution from the contract research business increased to 12% of revenues as against 8.7% in 9mFY05.

The enzymes business proved to be a dampener, as can be evinced by the 18% YoY decline in revenues. This was due to capacity problems faced by the company. While Biocon did not invest in increasing capacities for this business, the existing capacities were used for the manufacture of other biopharma products, thereby contributing to the decline.

On the research front, Biocon is looking to market ‘Biomab’, an antibody for the treatment of head and neck cancers in the domestic markets in FY07. Also, the company is extensively filing for registration of insulin in the Middle East, Latin America and South East Asia.

Business mix
  3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Biopharmaceutical 1,380 1,540 11.6% 4,250 4,450 4.7%
(% of consolidated revenues) 77.5% 77.4%   79.0% 77.5%  
Enzymes 220 180 -18.2% 660 600 -9.1%
(% of consolidated revenues) 12.4% 9.0%   12.3% 10.5%  
Contract research 180 270 50.0% 470 690 46.8%
(% of consolidated revenues) 10.1% 13.6%   8.7% 12.0%  
Total 1,780 1,990 11.8% 5,380 5,740 6.7%

Profitability still a concern: As far as operating margins are concerned, they fell from 33.7% in 3QFY05 to 29.6% in 3QFY06 due to a rise in raw material and staff costs and also on account of the pricing conditions in the European markets. Staff costs witnessed a rise on the back of an increase in headcount at its subsidiary, Syngene. Also, Biocon has been undertaking several expansion initiatives to gear up for the statins potential when two major statins, ‘Simvastatin’ and ‘Pravastatin’ go off patent in 2006 in the US markets. This resulted in a 17% YoY rise in depreciation charges in 3QFY06. This factor, along with a significant reduction in other income and higher tax outgo resulted in a 12% YoY decline in the bottomline during the quarter. The fall in the other income was due to the deployment of the IPO proceeds towards capex.

Over the last few quarters: Revenues have been subdued due to pricing pressure on the statins front, the effect of which has been more pronounced in the last 4 quarters. Operating margins have however, ranged between 28% and 33%, which is an encouraging sign.

Quarterly trend
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06
Net sales growth 62.2% 24.0% 28.1% 20.7% 0.0% 8.6% 11.8%
Operating profit margin 30.8% 33.3% 33.7% 28.0% 28.7% 29.7% 29.6%
Net profit growth 112.2% 54.1% 45.7% 0.0% -20.4% -22.8% -12.0%

What to expect?
At the current price of Rs 477, the stock is trading at a price to earnings multiple of 18.4 times our estimated FY08 earnings, which is at the higher end of our valuation spectrum. While the current fiscal has been a tough one for Biocon, as pricing pressure in the European statins showed no signs of abating, FY07 is expected to be a relatively better year. This is because both ‘Simvastatin’ and ‘Pravastatin’ will go off-patent enabling Biocon to capitalise on the same. However, it must be noted that while the ‘Simvastatin’ supplies are expected to begin in the fourth quarter, ‘Pravastatin’ supplies will begin from October 2006, as Teva Pharma has been granted 180-exclusivity period for the same. Also, we expect the contract research business to grow at a healthy pace going forward.

Having said that, post FY07, both ‘Simvastatin’ and ‘Pravastatin’ will most likely face competition and price erosion in the US markets as well. Also, though the company has been focusing on other biopharma products such as insulin and immunosuppressants, it will be a while before they start making any significant contribution to overall revenues. We have factored in the upside from these statins in the US markets in our numbers, which we believe has been adequately factored into the current stock price as well. We had recommended a SELL on the stock in December 2005. We maintain our view.

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