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Steady progress in generics/research services

* Biocon (BIOS) delivered lower-than-estimated earnings in 1QFY24, mainly led by inferior performance in the biologics segment (57% of 1QFY24 sales). This was offset to some extent by a healthy show in generics and research services. BIOS continues to make efforts to enhance offerings and resolve regulatory issues in the biologics segment.

* We cut our earnings estimates by 14%/5% for FY24/FY25, factoring in a) higher rebates for certain products in the biologics segment, b) delay in building market share for b-Adalimumab, and c) lower operating leverage. We value BIOS on an SoTP basis (15x EV/EBITDA for 70% stake in Biocon Biologics (BBL), 54% stake in Syngene, and 10x EV/EBITDA for generics business) to arrive at a TP of INR240.

* While investments in building a product pipeline and manufacturing infrastructure in the biologics segment remain on track, the commercial benefit is delayed to some extent, which affects return ratios. In addition to biologics and research services, BIOS is building generics as another growth lever with a portfolio of injectable/peptides. However, the current valuation factors in the earnings upside adequately. Maintain Neutral

Inferior product mix offset by controlled cost to some extent YoY

* BIOS 1QFY24 revenues grew 58% YoY to INR34b (our est. INR33b).

* Revenue growth was led by: Biosimilar (57% of sales), up 106% YoY to INR20b owing to the consolidation of acquired biosimilar business; research services (23% of sales), up 25% YoY to INR8.1b; and generics sales, up 15% YoY to INR7b (20% of sales).

* Gross margin contracted 200bp YoY to 61.3% due to a change in the product mix.

* However, EBITDA margin contracted 60bp YoY to 20.8% (est. 23.6%) due to a decline in gross margins and higher R&D/other expenses (+10bp/+470bp YoY as a % of sales), offset by lower employee expenses (-620bp YoY as % of sales).

* EBITDA increased by 53.5% YoY to INR7.1b (est. INR7.9b) for the quarter.

* Adj. PAT declined by 52% YoY to INR1b (est. INR1.3b), due to higher depreciation/interest costs/tax rate.

Highlights from the management commentary

* Higher rebates in Pegfilgrastim (USD15m) based on legacy contracts with select customers and phasing of the tender business in emerging markets affected biocon biologics performance for the quarter.

* BIOS indicated a gradual than expected traction/market share gain in Hulio (b-adalimumab). BIOS continues to work on interchangeability status as well for Hulio.

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