Biocon's Q4FY19 results (Underperformer) - Below est; Biosimilar scale-up lags estimates

Q4FY19 result highlights

• Consolidated Revs came at Rs15.3bn vs est Rs16.1bn; Revs missed est despite beat on Syngene revs - Rs5.3bn vs est Rs5bn. Biologics revs were flat qoq at Rs4.5bn (vs est Rs5.3bn); Expectation was continued scale-up with growth in Pegfil US revenues, launch of multiple biosims in EU as well as biologics pickup in EMs; Branded formulations and small molecule revenues also missed estimates.
• EBITDA came at Rs4bn vs est Rs4.3bn; Q3 was Rs3.8bn; EBITDAM – 26.3% vs 24.7% in Q3. EBITDA aided by sharply higher R&D capitalization; Gross R&D spends of Rs1.7bn with Rs734m capitalized
• 36% growth in H2EBITDA vs H1 despite 45% growth in biologics revenues is surprising given expectations of biologics revs being significantly profitable; we believe that it is indicative of cost pressures in the business which are probably aren’t well understood. Further,  Biocon’s R&D spends are likely to increase meaningfully going forward. This will add to the profitability growth challenges
• PBT came at Rs2.8bn (flat qoq) and below est of Rs3.4bn. Negatively impacted by lower other income and JV losses. PAT below est despite lower taxes (14% vs est 20%); Rs2.13bn vs est Rs2.49bn; flat qoq
• Mgt has guided to flat EBITDA margins in FY20, despite strong growth in biologics, with pick-up from FY21 onwards. Announced 1:1 bonus.

Key positives: Strong Syngene performance

Key negatives: Lower revenues across segments; lower EBITDA margins 

Impact on financials: We reduce our FY20 /21 earnings by 13% / 7%.

Valuations & view

With commencement of Pegfilgrastim revenues in the US, Biocon’s biosimilar portfolio commercialization has well and truly begun. Going forward, Biocon-Mylan’s ability to compete with fairly formidable competitors/innovators will determine the scale of their success. We believe that while Biocon is best positioned amongst Indian players to leverage on the global biosimilar theme and will have the best earnings growth amongst peers over the next 2-3 years, the same is already adequately captured in current valuations. Given that meaningful biosimilar revenues are yet to accrue and a fairly muted core business, the current stock price factors in most positives and doesn’t account for uncertainties inherent in monetization of biosimilars in developed as well as emerging markets. Sharp increase in biosimilar linked selling expenses underline the possibility of negative surprises on the profitability front. Maintain Underperformer rating with a SOTP target price of Rs537.