Tuesday, July 5, 2011

Valuation of Biocon Ltd

Valuation of a company is not a straightforward task. There is no particular formula that will give a fixed value for the share of the company. I have tried using DCF (Discounted Cash Flow) method for valuing Biocon Ltd.

In the process of arriving at a particular value, several assumptions are required to be taken. I have tried to keep those assumptions as conservative as possible. The assumption for the same are as follows:

1) CAGR of Sales for the next 5 yrs: 25% (The past 5 yr average for Biocon is 28%, with growth touching 40% in the yr before last)

2) Target Operating Profit Margin of 20% (Past 5 yr avg for Biocon is over 25%. Most of the global players have the same closer to 30%)

3) Sales to capital ratio: 1.16 (Past 5 yr average for Biocon)

4) As the debt ratio of Biocon is very low (less than 0.1), for simplicity, I have taken the cost of capital as the cost of equity, which I obtained using the CAPM model.

5) The terminal value of the return on capital is assumed to be 15.5%. This is much lower than current ROIC of Biocon which is 22%

6) I have considered tax rate as 34% [as Biocon is a domestic company. This rate is supposed to further go down after implementation of the Direct Tax Code]

Considering the above mentioned assumptions, the final value I obtained for Biocon Share was Rs 435. The valuation depends a lot on the assumptions, but I believe the assumption that I have considered for the valuation of Biocon are conservative.

Excel sheet containing the calculation:  Biocon Valuation

If you have any comments, please shoot :)

3 comments:

  1. I Bought biocon in january @426 30 shares what you suggest . should i sell and invest in another one to get @ least bank interest. I got dividend of INR 45.

    I request your suggestion
    rajansoma@gmail.com

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  2. Hi Rajan,

    Considering the growth opportunity of the stock from this level (360s), I suggest you hold it. If you are just going to switch over to another script, the risk will remain the same.

    It happened with me during the recession. I had purchased IndusInd Bank at 122 and during recession it fell to 40. I sold the same and got into Hindalco at 90. By the time Hindalco reached 160, IndusInd quoted at 260 (from 40).

    I hope you are getting what I want to say. Patience is very important. Biocon is a promising company. Wait a few years if you can, the growth can be tremendous.

    My valuation assumptions are very conservative, their growth can be a lot higher than what I assumed.

    So, my final reco is hold (for a long term 1+ yrs).

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  3. I would say that an option pricing model is more appropriate than a DCF for such companies, especially Biocon which sinks in a lot of money on developing drugs. Alternately, your DCF could factor in the formulations/API business value, with an option pricing model taking care of drug discovery. But yes, getting the information from the annual report/investor relations presentation would be difficult.

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