Margins likely to be under pressure; FY21e EPS down 13%; ‘Reduce’ retained as risk-reward is unfavourable.
Biocon (BIOS) posted a weak Q4FY20 print. Operational challenges due to COVID-19 led to a 40% q-o-q decline in the Biologics revenue. Ebitda margin slid 620bps y-o-y to 20%—despite launch of trastuzumab and supply of pegfilgrastim—due to logistic issues and lower profit from partners. Going forward: (i) management expects Biologics to normalise from Q2FY21; (ii) company remains on track to launch insulin glargine in mid-CY20;
(iii) partner Mylan is expected to launch etanercept in H2CY20, where Biocon has an economic interest.
Management maintained its aspirational Biologics revenue target of $1 bn by FY22, to be achieved on the back of uptake in pegfilgrastim and trastuzumab, and the launch of insulin glargine, bevacizumab, and insulin aspart. We are cutting FY21e EPS by 13% with challenges in Biologics likely to persist in Q1FY21. Our FY22 estimates remain intact. Maintain Reduce with an SoTP-based TP of Rs 250 (earlier Rs 240) as we roll forward our DCF valuations.
Subdued biologics business
Small molecules grew 15% y-o-y led by an uptick in demand from global markets while branded formulations fell 12% y-o-y mainly due to the repricing of generics in the UAE. Biologics plunged 40% q-o-q and margins slid to 7% from 25% in Q3FY20 as: (i) movement of inventory in the US distribution partners affected Biocon; and (ii) hospitals were not able to offer treatments for non-COVID-19 ailments. Gross R&D (~Rs 1.4 bn) came in at 14.3% of ex-Syngene sales (12.6% in Q3FY20).
Investments to gather pace; margin to remain under pressure
The company is looking to put in $200 mn per year for the next two years ex-Syngene, split between Biologics and Small Molecules. Future margin levers are limited despite growth in biosimilar revenue as: (i) gross R&D is likely to rise and its capitalisation would decline; and (ii) pricing pressure in biosimilars is palpable as competition starts building in pegfilgrastim.
Outlook: Risk-reward unfavourable
As gross R&D increases, capitalisation declines and competition builds in, levers for margin expansion look limited. The stock is trading at 32x FY22e EPS, which factors in the benefit from potential launches, but not the risks involved. Maintain ‘REDUCE/SU’ with an SoTP-based TP of Rs 250 (earlier Rs 240).