Biocon 1Q: Sluggish Biopharma & Licensing Income Triggers Miss  Citi research

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Biocon (BION.BO)
1Q: Sluggish Biopharma & Licensing Income Triggers Miss

 Big Miss — 1Q net income missed our estimate by c28%, as sluggish biopharma
sales and lower licensing income translated into lower margins. The management
indicated that this is a temporary phase (lower licensing income is merely timingrelated) and the top line should gain momentum over the next few quarters. While
Biocon is India’s leading play on the exciting biosimilars opportunity, we remain
cautious on the regulatory landscape. Our Hold (2M) rating reflects this as well as the
lack of any major catalysts for the base biz in the medium term.
 Biopharma Disappoints — Revenues (+10% YoY) missed our estimate by c12%, on
lower Biopharma sales (Middle East crisis, sluggish API biz) & lower licensing income
(Rs144m v/s Citi est. of Rs250m). Services biz (+21% YoY) has seen a strong growth
over the last two quarters, although the clinical services part still remains challenging.
 Margins Sluggish — The disappointment on top line – especially lower licensing
income – translated into sluggishness at  the EBIDTA level as well, with margin
declining c9bps YoY. Staff cost went up c25% YoY & offset the improving trend in other
(RM, R&D) expense ratios. Recurring PAT grew at a sluggish 7%.
 Some Momentum in Later Quarters  — We expect earnings to pick up in the
forthcoming quarters, as licensing income (primarily from the Pfizer deal for insulins)
picks up and offtake from the Middle East gets back to normal – translating into higher
EBIDTA margin and flowing down to the bottom line.
 Key earnings call takeaways  — a) Fidaxomicin supplies have commenced in
1QFY12 – should ramp up in coming quarters; b) On the lookout for partners for Oral
Insulin & Anti-CD6 molecules; c) R&D cost to be in the 8-10% (of sales) range; d) To
add 1,000 people in FY12; d) Pfizer to launch Insulin & Glargine in India during
2QFY12; e) FY12 capex: Rs1.5 to 2bn.



Biocon
Company description
Biocon is an integrated biotech company that encompasses all three critical stages
of drug development - drug discovery, development, and manufacturing and
commercialization of biopharmaceuticals. It is also engaged in contract research
services. With more than 25 years of expertise in fermentation technology, the
company has built strong capabilities in high-growth segments like statins,
immunosuppressants and anti-diabetes. While statins form the major part of its
current business, Biocon is aggressively pursuing the biosimilars opportunity in
regulated markets and is also making investments in drug discovery research to
build a future pipeline.
Investment strategy
We have a Hold/Medium Risk (2M) rating on Biocon. We believe that Biocon’s
partnerships with Pfizer (insulins) & Mylan (mainly MABs) validate its capabilities &
establish it as a leading play on biosimilars in developed markets. While many are
targeting this space, Biocon has tied up funding & front end support for a large part
of its pipeline. We expect these factors to reflect favorably on valuations. Thus,
while its base business continues to face challenges in the form of limited new
launches (in APIs) & competition (in research services), it has ensured that it is in a
position to aggressively pursue its biosimilars plans without putting undue pressure
on its profitability or balance sheet.
Valuation
We have a target price of Rs480 for Biocon, based on an SOTP valuation. We value
Biocon’s base business at Rs360/share – based on 18x March ‘12E EPS (v/s 17x
Sept ‘11E earlier), at a 10% discount to our target range for leading generic pharma
companies in our coverage universe, such as Dr.Reddy's & Lupin. We believe the
discount is warranted given Biocon's relatively narrow product basket in APIs &
lower growth. Since pharma is a growth sector, we prefer to use P/E v/s EPS CAGR
as our primary valuation methodology for the base business of pharma companies.
We also ascribe a value of Rs120/share to the insulins deal with Pfizer – based on
an NPV of expected cash flows (upfront & milestone payments, capex &
development cost as well as payments linked to Pfizer’s sales). We build in explicit
forecasts till FY20, following which we use a terminal growth rate of -2%. We
assume gradual increase in market share for Pfizer and that Biocon makes c15%
on Pfizer’s sales. Given the back-ended nature of cash inflows and uncertainty over
timelines & assumptions, we use a relatively higher discounting rate (15%) in our
analysis.
Risks
Our risk rating for Biocon is Medium Risk as against the Low Risk rating suggested
by our quant based rating system, given the risk from rupee appreciation and scope
for delays / execution issues. The main downside risks include: 1) slower-thanexpected ramp-up in the insulins deal with Pfizer; 2) Setback on the oral insulin
project could hurt sentiment; 3) Sustained appreciation in the rupee could hurt
revenues & profitability, especially in the research services biz. Key upside risks
include: 1) licensing deals for oral insulin or T1h molecules; 2) faster- than-expected
progress in biosimilars efforts in the US & / or EU; 3) Swift turnaround in the
research services biz.