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Biocon: Upgrade to ‘buy’ with revised TP of Rs 300

Axis Capital

Strong sales growth in higher margin businesses (biologics) led to gross and Ebitda margin beat. Biocon guided for strong year-on-year (gradual quarter-on-quarter) growth in biosimilar sales - skewed towards H2FY20. Despite strong sales growth momentum, core Ebitda margin (ex-R&D, licensing, forex) to remain steady in FY20 due to higher operating costs and improve from FY21. Q1 gross R&D of 10.5% vs guidance of 15% of FY20 sales (ex-Syngene) implying higher R&D expense in remaining quarters. While we factor in recent 483 by USFDA on Malaysia insulin plant and increasing competition in biosimilars, we upgrade to 'buy' from 'add', given - (1) monetisation of trastuzumab & glargine from H2FY20 in US, (2) further scale-up in peg-filgrastim in US going ahead, (3) potential listing of biosimilar entity - and price correction (22% in last 3 M). We set revised target price at Rs 300 (30x FY21E EPS) vs Rs 340 (33x) earlier.

Biologics (96% y-o-y/9% q-o-q), largely driven by expansion in new markets and increased penetration in key developed/emerging markets - Pegfilgrastim biosimilar in US (20% share in May 2019 vs 13-19% in Jan-March 2019, as per Bloomberg) & biosimilars Trastuzumab, Insulin Glargine and rh-Insulin in key markets of LatAm, Africa and West Asia. Small molecules business (20% y-o-y) led by multifold growth in generic formulations and steady API sales. Research services - Syngene (4% y-o-y) due to impact from project phasing in development & manufacturing services; adjusted for one-time pass-through of Rs 400 million in Q1FY19 revenue/cost of materials, it grew 15% y-o-y. Branded formulations (-9% y-o-y) fell due to pricing headwinds in the UAE; India registered moderate growth due to discounts and restructuring in the metabolics team.

Gross margin at 71% was up 965 bps/296 bps q-o-q on improved sales mix and higher profit share from Mylan. Other expenses (net of cost recovery from co-development partners) and staff expenses grew 26% y-o-y/30% y-o-y, respectively. While gross R&D was up 25% y-o-y at Rs 1.7 billion, net R&D expense grew 78% y-o-y to Rs 787 million. Ebitda grew 84% y-o-y to Rs 4.4 billion (28% above our estimate) with margin of 29.8% (+868 bps y-o-y/+348 bps q-o-q).