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Biocon: Mixed signals - Views on News from Equitymaster

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Biocon: Mixed signals

Oct 18, 2006

Performance summary
Biocon has announced mixed results for the second quarter and half year ended September 2006. Topline during both the periods has grown at a healthy double-digit pace led by its biopharmaceuticals and contract research businesses. However, the operating margins have contracted sharply due to a considerable rise in raw material costs and R&D expenditure. Despite a lower tax outgo, the rise in depreciation charges and interest costs has resulted in the bottomline for both the periods growing at much slower pace than the topline. We have also included the excerpts from the conference call in our analysis.

Financial performance: A snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 2,000 2,490 24.5% 3,740 4,610 23.3%
Expenditure 1,410 1,830 29.8% 2,650 3,410 28.7%
Operating profit (EBIDTA) 590 660 11.9% 1,090 1,200 10.1%
Operating profit margin (%) 29.5% 26.5%   29.1% 26.0%  
Other income 10 10 0.0% 30 20 -33.3%
Depreciation 80 180 125.0% 150 290 93.3%
Interest - 20   - 40  
Profit before tax 520 470 -9.6% 970 890 -8.2%
Tax 90 20 -77.8% 160 60 -62.5%
Minority interest - -   10 10 0.0%
Profit after tax/ (loss) 430 450 4.7% 820 840 2.4%
Net profit margin (%) 21.5% 18.1%   21.9% 18.2%  
No. of shares (m) 100.0 100.0   100.0 100.0  
Diluted earnings per share (Rs)*         17.6  
P/E ratio (x)*         21.8  
(* 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 15% to the total consolidated revenues of the company (as per 1HFY07 numbers).

What has driven performance in 1HFY07?
Strong topline growth: Biocon reported an impressive 23% YoY growth in topline during 1HFY07 driven by strong performances by both its biopharmaceutical and contract research businesses. Biopharmaceuticals grew by 19% YoY during the quarter led by its global statins sales (excluding the US) and insulin and immunosuppressants (used in organ transplant). Revenues from statins rose by 20% YoY, while volumes grew by around 35% YoY. No pricing pressure was witnessed and prices have stabilised in the last 3 to 4 months. Statins opportunity in the US is set to commence from 3QFY07 onwards beginning with ‘Pravastatin’, as the 180-day exclusivity granted to Teva will expire in October. Revenues from ‘Simvastatin’ will start filtering in from 4QFY07. The company already has contracts with 4 suppliers each for ‘Pravastatin’ and ‘Simvastatin’ and is looking to attain above 20% market share.

As far as product launches are concerned, the company launched its monoclonal antibody called ‘BIOMAb EGFR’ in the Indian market in 2QFY07 and the company is aiming to make this product a Rs 1 bn brand in the next three to five years. Other biosimilars products such as ‘EPO’, ‘GCSF’ and ‘Streptokinase’ will be launched in the Indian market in the next 6 to 8 months depending upon approval received in the country. As regards insulin, the company has started exporting insulin formulations to 2 countries (looking to target 10 countries by FY08) and insulin bulk to 10 countries. In the European market, Biocon is focusing on registering insulin as per the EMEA guidelines. If all goes well, this product is likely to receive market authorization by the end of CY08. Other players in the insulin space include Novo Nordisk, Eli Lilly, a Chinese company, a Polish company and Wockhardt.

The contract research business grew at a scorching pace (64% YoY growth), which could be attributed to revenue generation from new contracts signed by the company during previous quarters. Enzymes segment also registered a decent 14% YoY growth during 1HFY07, which could be attributed to the easing of the capacity constraints that this segment faced in FY06.

Business mix
  2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Biopharmaceutical 1,550 1,830 18.1% 2,900 3,440 18.6%
(% of consolidated revenues) 77.5% 73.5%   77.5% 74.6%  
Enzymes 220 260 18.2% 420 480 14.3%
(% of consolidated revenues) 11.0% 10.4%   11.2% 10.4%  
Contract research 230 400 73.9% 420 690 64.3%
(% of consolidated revenues) 11.5% 16.1%   11.2% 15.0%  
Total 2,000 2,490 24.5% 3,740 4,610 23.3%

Margins under pressure: Operating margins fell sharply from 29.1% in 1HFY06 to 26% in 1HFY07. This was largely due to a 100% YoY rise in R&D expenditure. Biocon’s R&D expenditure has risen due to the fact that the company is scaling up its discovery led programmes in biotherapeutics.

Cost break-up
(% of sales) 2QFY06 2QFY07 1HFY06 1HFY07
Raw material costs 55.5% 53.4% 55.6% 54.7%
Staff costs 8.0% 9.2% 8.3% 8.9%
Other expenses 7.0% 10.8% 7.0% 10.4%

Staid bottomline growth: Biocon’s growth at the bottomline level (up 2% YoY) has been subdued largely due to the operating margins shrinkage and a considerable rise in depreciation charges. The company had undertaken a major capex programme and the new facilities have begun to come on stream, leading to the sharp 93% YoY rise in depreciation charges.

Over the last few quarters: Revenues in the last three quarters have been commendable, as statin prices seem to have stabilised in the European region and also due to 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
  1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net sales growth 0.0% 8.6% 11.8% 22.3% 21.8% 24.5%
Operating profit margin 28.7% 29.7% 29.6% 28.0% 25.5% 26.5%
Net profit growth -20.4% -22.8% -12.0% 14.3% 0.0% 4.7%

What to expect?
At the current price of Rs 384, the stock is trading at a price to earnings multiple of 16.4 times our estimated FY09 earnings. Statin supplies to the US markets are expected to commence from 3QFY07, which will drive the topline going forward. That said, just as in the European markets, we expect price erosion 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 stand it in good stead in the future. That said, 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. Based on the company’s strong performance in 1HFY07 at the topline level, we shall have to upgrade out topline estimates for the year. However, higher depreciation charges and increased R&D spend are expected to impact the profitability of the company in the medium term.

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