Biocon Limited (Biocon) reported lower than estimated Q3FY21 performance in biosimilars and generics segment. Consolidated revenues grew 7.8% to Rs18.5bn, adjusted EBITDA margin was down 430bps to 21.6% and adjusted PAT declined 16.9% to Rs1.7bn.

Lower margin is attributed to higher R&D expenses and employee costs. Delay in new launches and recovery in the environment would suppress margins in the near term but are expected to improve over medium term as the market normalises from impact of COVID-19. Dr Christiane Hamacher, has stepped down as the MD of Biocon Biologics and will be succeeded by Dr Arun Chandavarkar. Reiterate ADD with a revised target price of Rs443/share (earlier: Rs490/share).

Research steady while generics and biosimilars disappoint: Research services grew 12.6% YoY with steady performance across its business segments. Company added a new project from 3DC that will support growth over medium term. Generics declined 2.6% YoY (-6.4% QoQ) to Rs5.6bn due to inventory correction of API products in the channel which were high in the distressed environment. Biosimilars segment grew 11.0% YoY during the quarter supported by steady market share in Ogiviri and Fulphila in the US and sales from the recently launched Semglee in US market. However, growth has been lower than expected as the company faced operational challenges due to lockdowns, delays in acquiring new tenders and reduced footfalls in hospital services and critical care due to the pandemic.

Higher R&D and staff costs restrict margin: Biocon reported an improvement of 170bps in gross margin with improving business mix and higher contribution from biosimilar segment. However, staff and R&D expense jumped 23% and 31% respectively on a YoY basis. This sharp jump in costs is related to higher investment towards the biosimilars and generics pipeline and has hit EBITDA margin, which dropped 430bps YoY (-80bps QoQ) to 21.6%. PBT margins for biosimilars and generics segments declined to 14.4% and 9.6% respectively. Delay in recovery and new launches would suppress margins in the near term but are expected to improve over medium term as the market normalises from impact of COVID-19.

Outlook: We expect revenue CAGR of 19.3% over FY20-FY23E resulting in EBITDA margin expansion of 450bps (with rising contribution from the high-margin biosimilars segment) and earnings CAGR of 34.2% over FY20E-FY23E. This would help generate healthy FCF of ~Rs11bn over FY21E-FY23E and improve return ratios.

Valuation and risks: We reduce revenue and EBITDA estimates by 2-4% and 9-12% respectively over FY21E-FY23E to account for delay in new product launches and higher expenses towards R&D and personnel. Maintain ADD with a revised SoTP-based target price of Rs443/share (earlier: Rs490/share)