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Nath Balakrishnan

Intensifying competition in the statins space is a concern.

SHAREHOLDERS could consider reducing their holdings of the Biocon stock, which trades at Rs 399. At this price, the stock trades at a price-earnings multiple of 18 times its expected per share earnings for the current fiscal. Rising competitive pressure in the statins space, which is gradually impeding margins, and the lack of any big-ticket earnings triggers in the near term underpin our view on the stock. The stock has also ruled weak this calendar, shedding 20 per cent since the beginning of the year; in the same period the Sensex has lost 5 per cent.

On a yearly basis, sales growth at 32 per cent (Rs 713 crore) and earnings growth of 42 per cent (at Rs 196 crore) are impressive. But a look at the quarterly numbers shows that margins are on the decline. Operating margins for the quarter ended March 2005 at 28.1 per cent are lower by about 5.7 percentage points compared to the year-ago period. The drop in margins is of almost the same magnitude when the numbers are reckoned on a sequential basis.

The fall in margins can be attributable to the rise in material costs as well as the pricing pressure seen in Europe for statins, Biocon's key drivers of growth.

Biocon does enjoy the benefit of scale as also the advantage of being an early mover in this segment; however, the compression in margins might well be a more permanent trend as new entrants resort to aggressive pricing tactics to gain a foothold in this space. We also note that other Indian players such as Ranbaxy and Lupin have capacities in this segment.

A greater opportunity for Biocon would be the commencement of statins supplies to the US market, which is likely to take off by the end of this fiscal. Here, Biocon is likely to have an edge over competition, considering that regulatory norms to commence supplies to the US are more stringent compared to what prevails in Europe.

However, these benefits are likely to manifest more in the first half of FY07 than in this fiscal. Biocon is setting up facilities to cater to the demand of statins going off patent in the US market. This should also lead to a higher incidence of depreciation, thereby capping earnings growth.

We are positive about Biocon's initiatives in the area of drug development: The anti-cancer molecule being developed with CIMAB of Cuba, the oral insulin product with Nobex, and a couple of products being co-developed with Vaccinex.

The first is in clinical trials and fasttrack approval might see it being made available by the end of the current fiscal. However, a meaningful contribution to the bottomline from such products is still some time away, in our view.

We continue to maintain that Biocon represents one of the better-integrated plays in the Indian pharma landscape and needs to be monitored closely for news flow. As such, price dips from the current level should be evaluated for a possible re-entry into the stock.

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