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Biocon: Contract research rules - Views on News from Equitymaster
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Biocon: Contract research rules
Oct 18, 2007

Performance summary
  • Revenues for 1HFY08 grow by 19% YoY largely driven by the strong performances of both the biopharmaceuticals and contract research businesses.

  • EBDITA margins expand by 250 basis points (2.5%) on the back of a considerable fall in raw material costs (as percentage of sales).

  • PAT growth at 27% YoY - aided by the strong performance at the operating level and a lower tax outgo.

  • Completes divestment of enzymes business (around 8% of revenues) to Novozymes South Asia Pvt Ltd, a wholly owned subsidiary of Novozymes A/S of Denmark for a gross consideration of Rs 4.6 bn.

Financial performance: A snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 2,490 2,790 12.0% 4,610 5,500 19.3%
Expenditure 1,830 1,980 8.2% 3,410 3,930 15.2%
Operating profit (EBIDTA) 660 810 22.7% 1,200 1,570 30.8%
Operating profit margin (%) 26.5% 29.0%   26.0% 28.5%  
Other income 10 20 100.0% 20 30 50.0%
Depreciation 180 250 38.9% 290 460 58.6%
Interest 20 20 0.0% 40 50 25.0%
Profit before tax 470 560 19.1% 890 1,090 22.5%
Tax 20 40 100.0% 60 50 -16.7%
Minority interest - 20   10 30 200.0%
Profit after tax/ (loss) 450 540 20.0% 840 1,070 27.4%
Net profit margin (%) 18.1% 19.4%   18.2% 19.5%  
No. of shares (m) 100.0 100.0   100.0 101.0  
Diluted earnings per share (Rs)*         22.3  
P/E ratio (x)*         23.7  
(* 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 1HFY08?
Contract research drives topline: Biocon’s topline clocked a 19% YoY growth during 1HFY08, chiefly led by its biopharmaceutical and contract research businesses. The biopharmaceutical business reported a 14.5% YoY growth in sales. While statins continued to remain the mainstay of the biopharma business, growth was also led by the strong performance of insulin (namely ‘Insugen’) and its branded products for nephrology and oncology (‘Biomab EGFR’) in India. Besides this, the company recorded a superlative growth in its technology and licensing income for some of its biopharma products, which was also instrumental in boosting performance of this segment.

The enzymes business reported a 15% YoY decline in revenues for 1HFY08. Biocon completed the divestment of this business (accounting for around 8% of total revenues) to Novozymes for a consideration of Rs 4.6 bn. It must be noted that Biocon had not been investing in the growth of the enzymes business and hence this move to divest is a positive one and will enable the company to focus on its core businesses of biopharmaceuticals and contract research.

The contract research business grew at a scorching pace (81% YoY growth), which could be attributed to revenue generation from new contracts signed by the company during previous quarters. Also, the company has increased the scope of its contract research partnership with BMS, which is also expected to augment the performance of this segment going forward.

Business mix

  2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Biopharmaceutical 1,760 1,800 2.3% 3,370 3,860 14.5%
(% of consolidated revenues) 70.7% 64.5%   73.1% 70.2%  
Enzymes 320 250 -21.9% 540 460 -14.8%
(% of consolidated revenues) 12.9% 9.0%   11.7% 8.4%  
Contract research 410 740 80.5% 700 1,180 68.6%
(% of consolidated revenues) 16.5% 26.5%   15.2% 21.5%  
Total 2,490 2,790 12.0% 4,610 5,500 19.3%

Improvement in operating margins: Biocon’s operating margins witnessed a 250 basis points expansion during 1HFY08. This was largely due to the decline in raw material costs (as percentage of sales). With the manufacturing facilities in Biocon Park (Bangalore) 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. The rise in staff costs could be attributed to the addition of personnel at the research facilities of Syngene. The company was able to expand its operating margins despite the 68% YoY rise in R&D expenditure (from 4.1% of sales in 1HFY07 to 5.8% in 1HFY08), which is commendable. We believe that R&D expenditure will continue to rise going forward, as Biocon invests in its discovery led biotherapeutics programmes.

Cost break-up

(% of sales) 2QFY07 2QFY08 1HFY07 1HFY08
Raw material costs 53.4% 48.4% 54.7% 48.2%
Staff costs 8.8% 10.8% 8.7% 10.9%
Other expenses 11.2% 11.8% 10.6% 12.4%

Flows down to the bottomline: Bottomline grew by 27% YoY during 1HFY08 aided by strong performances both at the topline and the operating level. 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 59% YoY rise in depreciation charges. However, with Biocon Park enjoying SEZ status, tax expenses fell by 17% YoY ensuring that the bottomline growth outpaced the topline growth for half-year period.

Over the last few quarters: Revenue growth in the last five quarters has been commendable, backed by stable statin prices in the European region, statin supplies to the US market and increased contribution from insulin, immunosuppressants and branded formulations. The sharp rise in the rupee, however, has partly exerted pressure on revenues as can be evinced in 2QFY08. While the operating margins have been robust, they are likely to remain under pressure going forward, as the company continues to make investments in R&D.

Quarterly trend

  1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales growth 21.8% 24.5% 22.9% 30.5% 27.8% 12.0%
Operating profit margin 25.5% 26.5% 31.6% 30.6% 28.0% 29.0%
Net profit growth 0.0% 4.7% 27.3% 25.0% 35.9% 20.0%

What to expect?
At the current price of Rs 529, the stock is trading at a price to earnings multiple of 17.4 times our estimated FY10 earnings. Given the fact that statins is a commodity like business facing pricing pressure, 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. While these new segments will take some time to significantly contribute to revenues, products like Insugen and Biomab EGFR are performing strongly, which is a positive sign. Contract research will be a significant revenue driver in the future as is amply demonstrated by the rising contribution of this segment to overall revenues. The company is also gearing up for biosimilar launches in Europe beginning with insulin and is focusing on branding of products and getting closer to the markets. That said, higher depreciation charges and increased R&D spend are expected to pressurise the profitability of the company in the medium term. Overall, we maintain our positive view on the stock.

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