The Hindu Business Line : Biocon: Sell

INVESTORS can consider reducing exposure to the Biocon stock. Our latest call represents a continuation of the stance we held on the stock since May last year. Though the stock has appreciated by about 15 per cent since our previous call, it has under-performed the broad indices.

In the period since then, the Sensex has returned close to 60 per cent and the Nifty Junior — of which Biocon is a part — has appreciated by about 50 per cent.

Though our current view is more of an outlook for the near term — driven primarily by our expectation of escalating price competition in the Biocon's key statins division — we continue to be confident about Biocon's research initiatives and believe that a gradual reduction in its dependence on statins will bolster its prospects.

A 10-15 per cent decline in the stock's price from the current levels may be a good entry point for investors with a long-term investment horizon.

The numbers

For the September quarter, Biocon reported a revenue growth of 12 per cent, with the biopharmaceuticals segment (75 per cent of sales) registering a 11 per cent growth. Growth in the contract research/clinical services segment has been strong at 50 per cent, albeit on a low base.

Since the beginning of this fiscal, there has been a significant pricing pressure in Biocon's key statins segment. As a result, margins for this financial year have been in 29-29.5 per cent range, compared to 33 per cent in the year-ago period.

That margins have been confined to a band this fiscal probably indicates a stabilising pricing environment for statins in the European market.

Margins should be sustained at this level in the ensuing quarter as well. Incidence of taxation for this fiscal has been high, suggesting a higher proportion of domestic sales; this should moderate as Biocon commences production from its new facility, which will enjoy a tax holiday.

Overall, we expect Biocon to end the year with earnings that would be 12-15 per cent lower than what was reported in FY-05.

The road ahead

The key event to watch out for in the coming fiscal would be the launch of pravastatin and simvastatin in the US market, both of which are going off patent in April and June respectively. The opportunity it throws up for Biocon will be significant, but so will it be for competitors too.

Further, with some substitution therapy (patients being moved from a branded molecule to a similar, but lower-priced, generic) likely to take place, demand volume could be high.

However, given the attractiveness of the opportunity, participants could, in our view, resort to aggressive pricing tactics to gain a foothold in the marketplace.

However, there are two key events that compel us to adopt a cautious view. The first pertains to the six-month exclusivity on prava for Teva, which would ensure that the molecule is out of bounds for generic competition till October 2006. This would extend the supply timeline further for all players, including Biocon.

Additionally, the possibility of exclusivity to the Ivax/Teva combine may render the US statins market inaccessible for best part of the current calendar.

Even if exclusivity does not come through, we expect quite a few players to be present on the date of the generic launch, and even though pricing may be at a premium initially, it will be no surprise if the sharply declining trends evident in Europe play itself out all over again in the US.

Research initiatives

We continue to be sanguine on the investments and the progress Biocon is making in the insulin and the monoclonal antibody (MaB) space (for the treatment of head and neck cancer). The next important trigger would be the launch of follow-on biologics in Europe, now that regulatory guidelines for four such products have been enunciated and, subsequently, in the US. We expect revenues from such launches to kick in over a longer time horizon.

Another key milestone would be the launch of the MaB (expected in the latter part of FY-07) and its expansion into geographies for which Biocon has commercial rights. Such initiatives should considerably insulate Biocon from the pricing vagaries in the statins space.

Valuation and view

Assuming a strong FY07 when we expect earnings to rebound by about 30-35 per cent, the stock is available at about 20 times its expected per share earnings for that fiscal, which, in our view, is demanding in the context of the extant business environment.

We would prefer to enter the stock at lower levels, at which downside risks might be mitigated. The principal risk to our recommendation would be the prevalence of a better-than-anticipated pricing environment for statins in the American market.

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