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Biocon: A year full of challenges! - Views on News from Equitymaster

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Biocon: A year full of challenges!

Apr 20, 2006

Performance Summary
Biocon has announced mixed results for the fourth quarter and year ended March 2006. While the topline has clocked a double-digit growth during both the periods, led by its biopharmaceuticals and contract research business, operating margins have contracted due to continued pricing pressure in the European statins market. Bottomline for the year has declined on the back of higher depreciation and tax charges and a considerable fall in other income.

Financial performance: A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 1,750 2,140 22.3% 7,130 7,880 10.5%
Expenditure 1,250 1,540 23.2% 4,890 5,590 14.3%
Operating profit (EBIDTA) 500 600 20.0% 2,240 2,290 2.2%
Operating profit margin (%) 28.6% 28.0%   31.4% 29.1%  
Other income 30 10 -66.7% 150 50 -66.7%
Depreciation 70 80 14.3% 220 290 31.8%
Interest - 10   20 20  
Profit before tax 460 520 13.0% 2,150 2,030 -5.6%
Tax 40 50 25.0% 180 310 72.2%
Minority interest - 10   10 20  
Profit after tax/ (loss) 420 480 14.3% 1,980 1,740 -12.1%
Net profit margin (%) 24.0% 22.4%   27.8% 22.1%  
No. of shares (m) 100.0 100.0   100.0 100.0  
Diluted earnings per share (Rs)*         17.5  
P/E ratio (x)*         27.3  
(* 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 13% to the total consolidated revenues of the company (as per FY06 numbers).

What has driven performance in FY06?
Biopharma recovers: FY06 has been a challenging year for Biocon’s biopharmaceuticals business, especially on the statins front (around 74% of biopharma sales) due to intense pricing pressure witnessed in the European market. That said, the pricing pressure reduced in 4QFY06, resulting in a 19% YoY growth in biopharmaceuticals sales and can be construed as an encouraging sign. For the year, this business posted a decent 8% YoY growth. Strong growth in insulin also played its part in contributing to the overall biopharma sales.

The contract research business grew at a scorching pace (52% YoY growth), which could be attributed to revenue generation from new contracts signed by the company during previous quarters. In fact, during FY06, the contribution from the contract research business increased to 13% of revenues as against 9% in FY05.

The enzymes business performed poorly during the year, registering a 6% YoY decline in revenues. This was due to capacity constraints. It must be noted that the enzymes capacity was being utilised for manufacturing biopharmaceuticals, thereby negatively impacting revenue growth. Going forward, with the capacity addition for biopharmaceuticals on stream, the management is optimistic of growing enzymes revenues.

Business mix
  4QFY05 4QFY06 Change FY05 FY06 Change
Biopharmaceutical 1,320 1,570 18.9% 5,570 6,030 8.3%
(% of consolidated revenues) 75.4% 73.4%   78.1% 76.5%  
Enzymes 240 250 4.2% 900 850 -5.6%
(% of consolidated revenues) 13.7% 11.7%   12.6% 10.8%  
Contract research 190 320 68.4% 660 1,000 51.5%
(% of consolidated revenues) 10.9% 15.0%   9.3% 12.7%  
Total 1,750 2,140 22.3% 7,130 7,880 10.5%

Margins under pressure: As far as operating margins are concerned, they fell from 31.4% in FY05 to 29.1% in FY06 due to a rise in raw material and other expenses and also on account of the pricing conditions in the European markets during the first half of the year. Other expenses (as a percentage of sales) increased due to a rise in R&D expenses and costs incurred by the company in acquiring the intellectual property assets of Nobex.

Cost break-up
(% of sales) 4QFY05 4QFY06 FY05 FY06
Raw material costs 57.1% 57.0% 53.7% 55.1%
Staff costs 7.4% 7.0% 8.0% 7.9%
Other expenses 6.9% 7.9% 6.9% 8.0%

Profitability takes a hit: Biocon has been building capacities 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 32% YoY rise in depreciation charges in FY06. Besides this, significant reduction in other income and a higher tax outgo resulted in a 12% YoY decline in the bottomline during the year. The fall in the other income was due to the deployment of the IPO proceeds towards capex.

Over the last few quarters: While revenues have been subdued due to pricing pressure on the statins front (especially in the last three quarters), the strong growth in the fourth quarter is a positive sign. While the company has managed to maintain operating margins at around 28% levels, they are likely to remain under pressure going forward, as the company continues to make investments in R&D.

Quarterly trend
  3QFY05 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06
Net sales growth 28.1% 20.7% 0.0% 8.6% 11.8% 22.3%
Operating profit margin 33.7% 28.0% 28.7% 29.7% 29.6% 28.0%
Net profit growth 45.7% 0.0% -20.4% -22.8% -12.0% 14.3%

What to expect?
At the current price of Rs 456, the stock is trading at a price to earnings multiple of 17.6 times our estimated FY08 earnings. While the current fiscal has been a tough one for Biocon, FY07 and beyond is expected to be relatively better. This is on the back of a strong performance of its statins business with both ‘Simvastatin’ and ‘Pravastatin’ going off patent in the US in FY07. However, it must be noted that while the ‘Simvastatin’ supplies have begun in the fourth quarter (the real opportunity will begin when it goes off patent in June 2006), ‘Pravastatin’ opportunity is expected to begin from October 2006. 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. 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. At current valuations, we believe that growth has been adequately factored into the stock price. We shall soon update our research report on the company.

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