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Biocon: Under pressure! - Views on News from Equitymaster
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Biocon: Under pressure!
Jul 21, 2005

Performance summary
Biocon announced subdued results for the first quarter ended June 2005. Price erosion in the European markets has hurt the company’s statins business, consequently leading to a flat topline for the quarter. This coupled with lower other income, higher tax outgo and depreciation charges have added to the bottomline woes.

Financial performance: A snapshot
(Rs m) 1QFY05 1QFY06 Change
Net sales 1,740 1,740 0.0%
Expenditure 1,210 1,240 2.5%
Operating profit (EBIDTA) 530 500 -5.7%
Operating profit margin (%) 30.5% 28.7%  
Other income 40 20 -50.0%
Depreciation 50 70 40.0%
Profit before tax 520 450 -13.5%
Tax 30 70 133.3%
Minority interest - 10  
Profit after tax/ (loss) 490 390 -20.4%
Net profit margin (%) 28.2% 22.4%  
No. of shares (m) 100.0 100.0  
Diluted earnings per share (Rs)* 19.6 15.6  
P/E ratio (x)   28.0  
(* annualised)      

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 11% to the total consolidated revenues of the company (as per 1QFY06 numbers).

What has driven performance in 1QFY06?
Topline blues:  Biocon’s biopharmaceuticals business proved to be a dampener in the quarter, registering a 3% YoY decline in revenues. This was on the back of poor performance of the statins business, which witnessed increased competition and price erosion to the tune of 30% to 40% in the European markets. Also, flat revenue growth from the enzymes business provided no respite to the company. The only silver lining was the robust 36% YoY growth from its contract research services from Syngene and Clinigene.

In biopharmaceuticals, the company’s proprietary human insulin product ‘Insugen’, which was launched in November 2004 is under registration in over 20 countries in Europe, Latin America, Middle East and Asia. ‘Biomab’, an anti EGFR antibody (for the treatment of head and neck cancers) is in the final stages of Phase 2b clinical trials and the company expects to file for fast track approval in India by the end of this year.

On the custom research side, new contracts signed by Syngene in this quarter and Clinigene’s strategic partnership with SCIREX, a US-based contract research organisation is expected to provide a fillip to growth in the forthcoming quarters.

Business mix
  1QFY05 1QFY06 Change
Biopharmaceutical 1,400 1,350 -3.6%
(% of consolidated revenues) 80.5% 77.6%  
Enzymes 200 200 0.0%
(% of consolidated revenues) 11.5% 11.5%  
Custom research 140 190 35.7%
(% of consolidated revenues) 8.0% 10.9%  
Total 1,740 1,740  

Profitability under a cloud:  Biocon has been undertaking several expansion initiatives to gear up for the statins potential when 2 major statins, ‘Simvastatin’ and ‘Pravastatin’ go off patent in 2006. This has resulted in a 40% YoY rise in depreciation charges. Treasury income has also reduced, corresponding with the deployment of IPO proceeds to fund the expansion programme. All these factors along with a flat topline and higher tax outgo have resulted in a 20% YoY decline in the bottomline.

Over the last few quarters:  Revenues have been subdued with 1QFY06 witnessing a declining trend. This has been due to pricing pressure on the statins front, the effect of which has been more pronounced in the last 2 quarters. Operating margins have, however, ranged between 28% and 33%, which is a positive sign.

What to expect?
At the current price of Rs 437, the stock is trading at a price to earnings multiple of 28.0 times its annualised 1QFY06 earnings. With ‘Simvastatin’ and ‘Pravastatin’ going off patent in the US markets in 2006, the statins markets provide tremendous potential and Biocon intends to capitalize on the same. However, considering the fact that statins have been witnessing pricing pressure and severe competition, the company is planning to reduce its dependence on statins by focusing on human insulin, immunosuppressants and branded formulations, which are expected to be the new growth drivers. The company’s clear strategy of using statins and other generic products as short term cash-flow generator and investment in proprietary technology augurs well for investors who can remain invested for the long-term.

Having said that, though the management had stated that it will be able to maintain margins in FY06, ramping up of capacities to cater to the statins markets is likely to lead to higher depreciation charges. Moreover, Biocon plans to significantly increase R&D investments to support a discovery led research strategy, which is expected to reap benefits in the next 2 to 3 years. As a result, profit growth in FY06 will not grow as fast as sales. Therefore, despite initial concerns, we remain positive on the company from a long-term standpoint.

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