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Biocon: US drives growth - Views on News from Equitymaster
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Biocon: US drives growth
Apr 19, 2007

Performance summary
Biocon has announced strong results for the fourth quarter and year ended March 2007. Topline during both the periods under review has grown at a healthy double-digit pace led by its biopharmaceuticals and contract research businesses. While operating margins have improved during the fourth quarter, the same have come under pressure for FY07. Bottomline growth (up 15% YoY) for the year has been relatively slower due to the rise in depreciation charges and interest costs.

Financial performance: A snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 2,130 2,780 30.5% 7,880 9,860 25.1%
Expenditure 1,540 1,930 25.3% 5,590 7,030 25.8%
Operating profit (EBIDTA) 590 850 44.1% 2,290 2,830 23.6%
Operating profit margin (%) 27.7% 30.6%   29.1% 28.7%  
Other income 20 20   50 40 -20.0%
Depreciation 70 200 185.7% 290 670 131.0%
Interest 10 30   20 90 350.0%
Profit before tax 530 640 20.8% 2,030 2,110 3.9%
Tax 60 70 16.7% 310 170 -45.2%
Minority interest 10 30   20 60 200.0%
Profit after tax/ (loss) 480 600 25.0% 1,740 2,000 14.9%
Net profit margin (%) 22.5% 21.6%   22.1% 20.3%  
No. of shares (m) 100.0 100.0   100.0 100.0  
Diluted earnings per share (Rs)*         20.0  
P/E ratio (x)*         25.5  
(* on a trailing 12-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 16.5% to the total consolidated revenues of the company (as per FY07 numbers).

What has driven performance in FY07?
Biopharma, research boosts topline: Biocon’s topline clocked an impressive 25% YoY growth during the year chiefly led by its biopharmaceutical and contract research businesses. The biopharmaceutical business reported a strong 21% YoY growth in sales. It must be noted that while revenues from this business were relatively subdued during the first half of the year, sales picked up in the second half due to the commencement of ‘Pravastatin’ and ‘Simvastatin’ supplies to the US. The company’s product ‘BIOMAb EGFR’ for the treatment of head and neck cancers, which was launched in the domestic market in 2QFY07 and its insulin brand ‘Insugen’ were the other contributors to the overall growth in the biopharmaceutical business.

As far as alliances are concerned, during the year Biocon granted an exclusive license to Ferozsons Laboratories for marketing ‘BIOMAb EGFR’ in Pakistan. Besides this, the company has also signed a MoU to establish a JV with Neopharma, Abu Dhabi for the purpose of marketing a range of biopharmaceuticals in the Gulf region.

The contract research business grew at a scorching pace (63% YoY growth), which could be attributed to revenue generation from new contracts signed by the company during previous quarters. During the fourth quarter, Biocon’s subsidiary Syngene entered into a research partnership with the innovator company Bristol Myers Squibb (BMS) with the new research facility being under development. This is expected to further increase the scope of BMS’s existing relationship with Syngene. The latter will provide research and development services for discovery and early drug development. Enzymes segment also registered a decent 12% YoY growth during FY07, which has been attributed to the easing of the capacity constraints that this segment faced in FY06.

Business mix
  4QFY06 4QFY07 Change FY06 FY07 Change
Biopharmaceutical 1,580 2,040 29.1% 6,030 7,280 20.7%
(% of consolidated revenues) 74.2% 73.4%   76.5% 73.8%  
Enzymes 250 270 8.0% 850 950 11.8%
(% of consolidated revenues) 11.7% 9.7%   10.8% 9.6%  
Contract research 300 470 56.7% 1,000 1,630 63.0%
(% of consolidated revenues) 14.1% 16.9%   12.7% 16.5%  
Total 2,130 2,780 30.5% 7,880 9,860 25.1%

Operating margin picture: While Biocon’s operating margins during the quarter witnessed a 290 basis points expansion, they were under pressure for the full year. Operating margins expanded during the quarter largely due to a decline in raw material costs (as percentage of sales). With the manufacturing facilities in Biocon Park turning operational, the company was able to conduct the entire manufacturing process on its own without having to import intermediates from other parties. This translated into cost savings for the company. Staff costs and other expenditure witnessed a significant rise during both the periods under review. While the details of the R&D expenditure are not available at present, we believe that the same has increased and is also expected to rise going forward, as Biocon continues to invest in its discovery led biotherapeutics programmes.

Cost break-up
(% of sales) 4QFY06 4QFY07 FY06 FY07
Raw material costs 57.7% 50.4% 55.1% 52.0%
Staff costs 7.0% 9.7% 7.9% 9.4%
Other expenses 7.5% 9.4% 8.0% 9.8%

Bottomline growth slower: While Biocon’s growth at the bottomline level (up 15% YoY) has been decent, it has nevertheless been slower than the growth witnessed at the topline and operating profit level. This has been largely due to the rise in depreciation charges and interest costs. It must be noted that the company had undertaken a major capex programme and the new facilities have begun to come on stream, leading to the sharp 131% YoY rise in depreciation charges.

Over the last few quarters: Revenues in the last five quarters have been commendable, backed by stable statin prices in the European region, commencement of statin supplies to the US market from 3QFY07 and increased contribution from insulin, immunosuppressants and branded formulations. That said, margins are likely to remain under pressure going forward, as the company continues to make investments in R&D.

Quarterly trend
  3QFY06 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07
Net sales growth 11.8% 22.3% 21.8% 24.5% 22.9% 30.5%
Operating profit margin 29.6% 28.0% 25.5% 26.5% 31.6% 30.6%
Net profit growth -12.0% 14.3% 0.0% 4.7% 27.3% 25.0%

What to expect?
At the current price of Rs 511, the stock is trading at a price to earnings multiple of 21.5 times our estimated FY09 earnings. While ‘Pravastatin’ and ‘Simvastatin’ supplies have commenced to the US markets and have contributed to revenues during FY07, we believe that just as in the European markets, price erosion is likely to be severe in the US markets as well from FY08 onwards. In this context, Biocon’s strategy to increasingly focus on insulin, immunosuppressants, branded formulations and monoclonal antibodies in a bid to reduce its dependence on statins will be critical to drive growth in the future. However, it must be noted that these new segments will take some time to significantly scale up. Also, we expect the contract research business to grow at a healthy pace going forward. While the biopharma and contract research businesses will be the key revenue drivers in the future, higher depreciation charges and increased R&D spend are expected to pressurise the profitability of the company in the medium term. We shall soon update our research report on the company.

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