Biocon - some more wait; initiating coverage; Accumulate

Biocon (BIOS IN, INR 563, Accumulate)

 

Biopharmaceuticals: Margins to remain steady

Biocon generates ~74% of its revenues from biopharmaceuticals, which include statins, insulin, immunosuppresants, and other biopharma products and domestic formulations; statins account for 35% of these revenues. We expect flat revenue growth for the statins over the next few years. Although revenues for the others are estimated to grow significantly over the near term, their margins will be muted on account of high S,G&A expenditure.

 

Contract research services: Appreciating rupee a concern

Contract research services (CRS) is amongst Biocon's most important segments, as it contributed ~13% to the company's total revenues and ~25% to its consolidated profits as of FY07. Further, its contribution to the company's revenues and net profit is likely to increase to ~17% and ~36%, respectively, by FY09E. However, profitability of this segment is directly co-related to the USD/INR movement, and therefore, any adverse currency movement can hurt the company's profitability significantly. Though we remain bullish on Biocon's CRS business, we anticipate the currency movement to keep Syngene's bottomline under pressure. We are expecting EPS CAGR of ~24% for Syngene over FY07-09E.

 

R&D: Significant investments required to payoff after two years

Biocon is currently working on projects of oral insulin and monoclonal antibodies, for which it needs to increase its R&D expenditure significantly over the next two years; we expect the company's R&D to increase at ~43% CAGR over FY07-09E. Biocon could be in a position to enter into an out-licensing deal for some of its R&D initiatives over the next few years. These unforeseen opportunities could trigger a significant upside for the stock, though we have not accounted for such an event in our estimates.   

 

Outlook and valuations: Some more wait; initiating coverage with 'ACCUMULATE'

Biocon is likely to record an EPS CAGR of 15.4% over FY07-09E. The company has sold out its enzymes business for INR 4,700 mn, as a result of which, it would have cash of INR 33 per share. At CMP of INR 563, the stock trades at P/E of 24.0x (adj) and 21.7x for FY08E and FY09E, respectively. With reducing ROEs and ROCEs over FY07-09E and the current run-up in the stock, upsides are limited. Though we like Biocon's business, we believe its valuations are stretched. Hence, we initiate coverage on the stock with an 'ACCUMULATE' rating.