VALUE THE UNDERVALUED - BIOCON

SELL!!!

“Our ability to continuously scale new heights across the biopharmaceutical value chain enables us to realize the promise of future therapeutics.”

- Kiran Mazumdar-Shaw, Chairman & Managing Director

Some notable assets

1. Started divesting its enzymes division to Novozymes in 2007
2. Launched BIOMAb EGFR™- India's first anti-cancer, therapeutic Monoclonal Antibody-based drug for treating solid tumors of epithelial origin, such as head & neck cancers, in 2006
3. The first company globally to manufacture human insulin, INSUGEN®, using a Pichia expression system, in 2004
4. Biocon's proprietary bioreactor, the PlaFractor™, has a US patent
5. The first Indian company to be approved by US FDA for the manufacture of lovastatin, a cholesterol-lowering molecule
6. For the period between April 2006 and March 2007 Biocon has undergone 41 successful compliance audits by various national and international customers and regulatory authorities.Various other awards and recognitions.

Competitors' snapshot




Performance indicators

Valuation

A beta of 0.59 was calculated for the firm's stock. As the company was listed in 2003; so it might have performed quite differently from the index in earlier years. Now the stock is stabilizing; so present year values are bound to give a better beta for analysis.

For India, the market risk of 14.5% and 10-year treasury bond rate of 7.88% were taken from bloomberg.

Interest coverage ration being>12 yields cost of debt for the firm to be 8.22%. The cost of equity was calculated to be 11.17%. Average tax rate comes out to be 9.84%. This yields a WACC of 11.1%.

The low tax structure, the low beta, and fresh launch of equity gives a clear indication to use a three phased dividend model finding the intrinsic value of Biocon. Earnings are growing at high rate of 14.73% (Geometric mean of past five years growth) and are expected to continue the pace for an initial period of two years, and then start declining gradually over a period of five years maintaining an average growth rate of 12.86% (estimated from competitor growth) to reach a stable rate of 7.5% (economy growth rate) as the firm becomes larger and more firms enter the pharma space. The WACC for the subsequent years were calculated to be 12% for declining phas and 13.07% for the stable phase.

Looking at the highly fluctuating debt structure, we take the FCFF route to value the firm at Rs. 3378.86 crore yielding an intrinsic value of Rs. 337.89 per share.

Comment on Technical analysts’ view
Technical Analyst, Deepak Mohoni is of the view that one can hold Biocon for long term.
Mohoni told CNBC-TV18,

"Biocon is an interesting stock because it's not behaving like most of the other stocks in the market. It had been in a long-term decline till the middle of 2006 and since then it has been in a pretty persistent uptrend and now its actually started moving up quite quickly and is almost getting into the momentum category. So this looks like a good short-term trade whenever the opportunity comes and in the long-term it definitely looks like a hold. Other advantage with the stock is, it doesn’t usually go along with the index very much, it would go up or down against the direction of the index. So that makes good addition to a portfolio."

2007-11-16 14:52:39 Source: moneycontrol.com

The stock had been declining till mid 2006 because of its low net working capital followed by decline in PAT. It may no doubt move up in near future, given the supernormal growth calculated above continues for a longer period.
However, the observation that it does not go with the index seems hazy to us because it has a beta of 0.58 which is quite high. So with so high markets, if the risk associated with the index in 2 months time is 80%, that of this stock is 46.5%, which is a fairly high figure.
The stock may no doubt pick up in the near future; but the intrinsic value as given by the ‘g’ calculated above is quite low to make it fall. Well, it may be a good bet after a correction.

Looking at the strong India growth story, maybe, the analyst is looking at at short term gain of around 20%.

What does pharma sector say?

To further reaffirm our findings we looked at the major players in the pharma sector.

As per the PE figures, Biocon should be valued at Rs. 306.12 per share. P/BV ratio values the firm at Rs. 316.70 per share. PS prices the stock at Rs. 312.37 per share.

Hence, at current price level of Rs. 579.5, the stock seems too much overvalued.

Result

Biocon witnessed a 23.5% drop in PAT in 2006 due to increased pricing pressures, which impacted the net margins by 7.08%. This in turn affected its ROE. Biocon has a very high retention ratio, so it probably believes in reinvesting a major chunk of its earnings and allow capital benefits to its investors. It has however been reducing its retention over the years which in turn is reducing its growth rate. Well, this is a good sign for people who'd like to earn good dividends; but as far as capital appreciation is concerned, if conditions do not improve in the near future, the stock may fall badly.

We therefore recommend a Sell Rating for this stock.

In times to come, due to so many plus points that the firm has, maybe its PAT figures improve and then may be it becomes an investing opportunity. But with the present pricing policies of the GOI, that certainly is not an option.