Buy : Biocon Limited CMP Rs 482 Target Rs 542

(BSE: 532523 | NSE: BIOCON | ISIN: INE376G01013)

Strong operational performance : Biocon’s Q1FY08 results were in line with expectations. Sales growth was driven by a strong performance in the biopharma segment, which benefited from a license fee of Rs 150mn-160mn on G-CSF, and increasing traction in the services business. The company has licensed G-CSF to global biopharma company Abraxis Biosciences for the US and EU markets, rendering it eligible to receive an upfront licensing fee and royalties from sale. Aided by licensing income the EBITDA margin expanded 270bps YoY to 28.2% and a 36% net profit growth to Rs 528mn. In a major announcement, Biocon divested its enzymes business to Novozymes for US$ 115mn, valuing the business at over 4x sales. Enzymes had been a drag on Biocon’s profitability and the hive-off will enable the company to focus on its core biopharma business. Biocon has also entered into an exclusive agreement with Invitrogen to market insulin for the global cell culture market. We have revised our estimates by 6.6% and 6.2% for FY08 and FY09 respectively to factor in the enzyme business divestment. At Rs 482, the stock is trading at 21.3x FY08E EPS of Rs 22.6 and 17x FY09E EPS of Rs 28.4. We believe the company deserves a higher valuation considering the divestment of a low-margin, non-core business. We thus maintain Buy with a target price of Rs 542, based on 19x FY09E earnings.

Biopharma and services divisions lead growth in Q1FY08 Led by the biopharma and services business segments, Biocon reported a 28% YoY growth in sales to Rs 2.7bn for Q1FY08. Biopharma which comprises statins, immunosuppressants and insulin recorded a growth of 28% to Rs 2bn. This includes a licensing fee of Rs 150mn-160mn as compared to Rs 20mn in Q1FY07. The licensing income is from insulin and G-CSF (granulocyte-colony stimulating factor).

Key components of revenue growth

G-CSF licensed to Abraxis Bioscience: Biocon licensed G-CSF to Abraxis Bioscience for the development and marketing of a bio-similar version of the product in North America and the EU. A per the agreement, Biocon has received an upfront licensing fee and will receive royalties from sales following approval in the licensed territories. The company will supply the product, but will not have a share in profits. If things progress smoothly, the product would hit both markets simultaneously over the next 18-24 months. In addition, Biocon would be launching the drug in the domestic market soon.

Statin prices stabilise in the US : The management has indicated that statin prices have stabilised in the US market and are likely to remain steady with a positive bias over the next few months. While Chinese companies enjoy a 10% market share in Europe , they have a minimal presence in the US . Export incentives on Chinese companies have been lowered by the Chinese government and tightening product approval laws are likely to discourage their entry and keep prices steady.

Branded products record strong growth: Biocon’s branded products for nephrology, oncology and cardio-diabetes performed strongly. According to the management, BioMab, growing at 15-20% QoQ has become the leading brand in its space and is on track to record sales of Rs 1bn over the next three years. The company will launch Streptokinase in the domestic market this year. The management expects strong sales to come from these products from non- regulated markets over the next few years.

Contract research records 52% YoY growth: The contract research business comprising subsidiaries Syngene and Clinigene maintained its growth momentum, increasing 52% YoY to Rs 440mn. Syngene commenced construction of the dedicated facility for BMS during the quarter. The company has earmarked Rs 1.25bn for the expansion. The two subsidiaries together have a headcount of 800 employees which is likely to touch 1,000 by end-FY08.

Enzymes sales decline; business divested to Novozymes: Biocon uses the same facility for manufacturing both enzymes and bio-pharma. This quarter, the facility was used for a greater proportion of bio-pharma products rather than enzymes, which led to a 4.5% YoY decline in enzyme sales to Rs 210mn. The enzymes business has been divested to Novozymes AG for US$ 115mn and the deal is likely to conclude by September 2007

EBITDA margin expansion of 270bps propelled by licensing income : Biocon was able to report an EBITDA margin expansion of 270bps YoY to 28.2% propelled by licensing income as well as commissioning of Biocon Park which was in the development phase in the same year-ago period. Biocon reported a Rs 20mn treasury loss due to the rising rupee. R&D spending for the quarter was also higher, at Rs 100mn as against Rs 60mn for Q1FY07.

Strong operational performance and lower tax outgo boost PAT Q1 FY08 Recurring income from licensing fees, increasing traction in contract research and lower tax outgo on account of SEZ benefits resulted in 36% YoY PAT growth to Rs 528mn. Tax outgo for the quarter was 2.8% as against 10% in Q1FY07. The company reported an EPS of Rs 5.3 for the quarter as against Rs 3.9 in Q1FY07.

Other highlights

Exclusive agreement with Invitrogen to market insulin for cell culture Biocon has signed an exclusive agreement with Invitrogen Corp, a provider of essential life science technologies for disease research and drug discovery, to market pharmaceutical-grade insulin to the global cell culture market. The cell culture market is a large opportunity for Biocon’s insulin.

Biocon to conduct phase-I clinical trials in Europe for IN105 Biocon has filed an Investigational Medical Product Dossier (IMPD) for IN105 to conduct a phase-I clinical trial in Sweden . The trial will be conducted at Karolinska University Hospital , Stockholm . This marks the first step in the international development plan for IN105.

Divestment to Novozyme The company would receive 85% of US$ 115mn upfront from Novozymes. It would receive another 7% over the next two years and another 7% over the next 10 years from the company. Biocon would lease its facilities to Novozymes for a period of 10 years. The biopharma manufacturing has been completely shifted to Biocon Park .

Strong growth in license income expected Although lumpy in nature, license income would be a recurring income for the company and the management expects strong growth from this segment annually. R&D spending is likely to increase as the pipeline shows progress from one phase to another. Higher R&D spending would be offset by licensing income.

Insulin product registrations Biocon registered its insulin products in three markets in Central America . The company has registrations in over nine countries now.

Capex of Rs 3bn-3.5bn over next two years Biocon has earmarked a capex of Rs 3bn-3.5bn over the next two years to be funded from internal accruals and debt. The company will use the proceeds of the enzymes divestment to fund acquisitions and not for capex.

Valuation :

Positive news flow to keep coming, maintain Buy With a strong R&D pipeline which could unlock value, recurring licensing income from key products and increasing traction in the contract services business, we expect Biocon to record a 23% revenue CAGR over FY07-FY09. The launch of bio-similar products in the regulated markets is a long-term growth driver for the company. We have revised our estimates by 6.6% and 6.2% for FY08 and FY09 respectively to factor in the divestment of the enzymes business. At Rs 482, the stock is trading at 21.3x FY08E EPS of Rs 22.6 and 17x FY09E EPS of Rs 28.4. We believe the company deserves a higher valuation considering the divestment of a low-margin, non-core business. We thus maintain Buy with a target price of Rs 542 based on 19x FY09 earnings.

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