The Hindu Business Line : Biocon: Hold

The performance of Syngene is crucial to Biocon’s overall profitability but that might take time as capacities are built and contracts get executed on time.

Ms Kiran Mazumdar Shaw, Chairperson.

Kumar Shankar Roy

Lack of near-term catalysts, staid growth in biopharmaceuticals (over 80 per cent of sales) and sluggish performance in contract research services have dulled the earnings picture for biotechnology company, Biocon. Investors should refrain from taking fresh exposure in Biocon. While costs have surged, thereby putting pressure on margins, the revenues have remained flat in the absence of event-driven licensing income.

The low-margin enzyme business has already been sold off and it is unlikely that this revenue gap will be plugged soon. Second, the focus for the company has currently shifted to its subsidiary, contract research services provider — Syngene — where the growth is sedate. Third, Biocon largely remains a bulk drug supplier and insulin player. Formulations, which generally enjoy better margins, account for about 10 per cent only; biopharmaceuticals will continue to be under pressure till scaling up happens. The stock has corrected over 35 per cent in 2008, under-performing the broader indices and now trades at Rs 390 (17 times its 2008-09 earnings per share), which is not cheap.

Triggers

Over the next 12-15 months, Biocon earnings may benefit from the US launch of an immunosuppressive drug and strong contribution from contract research owing to a large MNC contract, progress on the biosimilars and out-licensing opportunities for at least two molecules. If these materialise, they may provide the much-needed earnings cushion to the company. The listing of Syngene, if market conditions turn conducive, may also provide a trigger to the stock.

While biopharmaceuticals (medical drugs produced using biotechnology) still contribute a lion’s share of Biocon revenues and profitability, Syngene is pegged as the key growth driver for the future. Syngene has entered into effort-based contracts, as against commodity-based projects (low profitability) taken on previously. These new contracts (unlikely to be billed on quarterly basis) will aid Syngene’s margins and may contribute to revenues towards the end of the year. However, for this, Biocon’s dedicated facility for a large MNC company (expected to ring in one-third of Syngene sales) and supplies have to start first. In the last quarter, Biocon has added clients at a healthy pace, but lack of capacity has deterred it from taking on new contracts.

Syngene focus

Going forward, the problem for Syngene, which has enough manpower and technical know-how, may come from a different quarter — currency risk. Biocon, which has covered (with hedging contracts) a major portion of research order-book, may be fenced in by rupee depreciation. In the first quarter of this year, Biocon has made a mark-to-market provision of Rs 26 crore, because of long-term annual (derivative) contracts on the rupee against dollar. According to management, every adverse movement of the rupee vis-À-vis the dollar may affect the bottomline to the tune of Rs 10 crore.

Biopharmaceuticals, Biocon’s cash cow, grew 16 per cent in last quarter. Statins, a cholesterol-lowering drug which forms a major portion of Biocon’s biopharma portfolio, had previously encountered erosion in pricing. However, relief on the pricing front may give Biocon some respite though it depends heavily on this business.

Biopharma steady

With Biocon right now participating in categories such as Simvastatin (the biggest contributor), Pravastatin and Lovastatin, where they continue maintaining a significant market share in US and Europe, the order-book appears healthy enough to translate into good sales growth. In the June quarter, biopharma sales were largely driven by insulin and formulation sales in the domestic markets. Biocon has insulin registrations in 31 countries and enjoys hefty market share in select ones, aiding growth.

Insulin revenues constitute around 12-15 per cent of sales. Insulin analogues such as glargine will aid growth, when launched in the next 12-18 months. While the regulatory pathway for biosimilars is yet to evolve in major markets, immunosuppressive drugs, for which Biocon may supply building blocks in the near future, could be an area of opportunity. Oncology finished dosages — another major segment — has seen lot of growth and Biocon remains best placed to capitalise on that segment by 2010. While Biocon has an advantage over others here, it will take some more time for the segment to scale up and make a noteworthy impact on profits.

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