china healthcare sector 2018 outlook include potential rmb depreciation, continued tender price...
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China Healthcare Sector 2018 Outlook
January 5, 2018
In 2017, leading drug manufacturers were re-rated significantly while small-medium
drug manufacturers, distributors, device manufacturers and hospitals all
underperformed. Looking ahead, we should continue to see opportunities and
challenges in 2018. Opportunities include (i) national medical insurance payment
method reform, which is expected to benefit innovative and clinically indispensable
drugs, (ii) approval of new drugs, (iii) consistency assessment completion of the
chemical quality and efficacy of generics that calls for generics consolidation, and (iv)
completion of the two-invoice system by end-2018, which will benefit the leading
distributors in the long run. Also, M&A and overseas new drug applications/approvals
(U.S. ANDA) should provide new growth engines for pharmaceutical companies.
Challenges include potential RMB depreciation, continued tender price cuts, expensive
BE tests, the removal of the 15% price mark-up for drugs (ex-CTCM), and medical
insurance cost controls, which could cut into the sales growth and margins of
pharmaceutical companies.
On this basis, our two key directions for stock picks in 2018 are 1) the expectation that
leading innovative drug manufacturers will continue outperform; and 2) catch-up
opportunities for value investment in quality large caps in some sub-segments.
2018 key recommendations
1) CTCM [0570.HK; BUY]: (i) attractive valuation; (ii) strong growth expected from
CCMG business; (iii) the potential of introducing a strategic investor to remove
concern about a potential share disposal by ex-management.
2) Sinopharm [1099.HK; initiate with BUY]: (i) bottoming-out in 2018; (ii) historically
low valuation; (iii) promising retail and high margin medical device distribution
business development.
3) CSPC [1093.HK; BUY]: (i) strong R&D capability; (ii) expected launch of Paclitaxel-
albumin; (iii) premium execution that consistently delivers results; (iv) strong cash
flow from the Vitamin C business as a cash cow; (v) continued re-rating given
investors’ limited alternatives for tracing healthcare industry consolidation
opportunities.
China Healthcare Sector
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Divergence to continue, catch-up plays in quality big caps
Source: CGIS research estimates, data as of Jan 04, 2018
Figure 1: CGIS research healthcare sector coverage summary
Company Ticker Rating Remarks
Sino Pharm 1099 BUY Initation 34.3 40.9 19.2% Top pick
CTCM 570 BUY - 4.53 5.72 26.3% Top pick
CSPC 1093 BUY - 17.6 20 13.6% Top pick
3SBio 1530 HOLD - 16.94 17.1 0.9%
Luye Pharm 2186 HOLD 6.45 6.3 -2.3%
TUL 3933 HOLD - 6.51 6.21 -4.6%
HEC 1558 HOLD 30.05 27.8 -7.5%
CMS 867 HOLD - 18.98 16.76 -11.7%
SSY 2005 HOLD 5.11 4.46 -12.7%
Rating
change
CGIS research
target price (HK$)
Close
(HK$)
Upside
(%)
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Figure 2: 2017 healthcare sector performance overview (data as of Jan 04, 2018)
Source: Bloomberg
Company name Ticker 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E WTD MTD QTD YTD
China Tradition Medicine
TRAD CHI MED 570 4.53 20,075 17.5 14.2 11.9 1.4 1.3 1.2 8.0 9.3 10.4 11.8 9.3 8.0 8.9% 10.0% 4.1% 26.2%
TONG REN TANG-H 1666 11.40 14,601 19.1 18.2 16.2 2.4 2.1 1.8 15.2 11.8 11.3 n.a n.a n.a 0.9% 4.2% 14.1% -20.7%
TONGRENTANGCM 8138 11.08 9,275 21.2 19.0 16.5 4.3 3.7 3.2 21.7 21.3 20.9 14.3 12.6 10.5 4.3% 1.3% 9.5% 5.7%
Simple average 19.3 17.1 14.9 2.7 2.4 2.1 14.9 14.1 14.2 13.1 10.9 9.2 4.7% 5.1% 9.2% 3.7%
Median 19.1 18.2 16.2 2.4 2.1 1.8 15.2 11.8 11.3 13.1 10.9 9.2 4.3% 4.2% 9.5% 5.7%
Drugs manufacturer
CSPC PHARMACEUTI 1093 17.60 109,877 50.0 39.0 31.2 10.3 8.6 7.3 21.8 24.1 25.2 32.9 25.8 20.5 11.5% 13.5% 34.6% 112.6%
FOSUN PHARMA-H 2196 50.60 133,152 35.3 31.5 26.6 4.7 4.1 3.7 13.9 13.7 15.5 47.1 41.1 32.6 0.9% 34.2% 56.2% 113.1%
ESSEX BIO-TECH 1061 4.70 2,647 20.4 15.9 13.1 5.0 3.7 2.9 26.9 n.a n.a n.a n.a n.a 2.6% -1.5% -4.1% 41.1%
GENSCRIPT BIOTEC 1548 25.35 44,015 n.a 180.1 154.4 n.a 29.5 9.8 n.a 15.1 11.8 n.a n.a n.a 26.9% 155.3% 239.8% 585.1%
BAIYUNSHAN PH-H 874 23.95 38,938 20.4 17.7 15.8 2.1 1.7 1.6 12.3 10.4 11.2 16.0 n.a n.a 3.9% 6.7% 17.4% 19.5%
SINO BIOPHARM 1177 14.14 104,808 48.3 42.3 36.6 9.5 8.3 6.9 22.8 23.7 22.2 27.7 23.4 19.9 2.0% 38.4% 71.2% 159.0%
LIVZON PHARM-H 1513 64.00 43,731 36.6 14.5 24.8 4.9 3.0 2.7 14.2 20.5 11.5 26.9 21.8 18.7 3.7% 14.2% 41.6% 83.3%
3SBIO INC 1530 16.94 43,007 47.2 40.7 31.1 5.7 5.0 4.4 11.9 12.7 14.8 34.0 27.8 21.2 10.4% 11.4% 35.3% 124.4%
SIHUAN PHARM 460 3.06 28,982 15.9 14.4 12.7 2.2 2.0 1.8 13.6 15.0 14.0 10.6 8.7 7.7 8.9% 11.3% 7.7% 41.7%
LUYE PHARMA GROU 2186 6.45 21,421 20.1 18.9 16.7 2.8 2.4 2.2 14.0 13.7 13.7 16.0 14.0 12.3 4.5% 24.8% 41.4% 40.2%
SSY GROUP LTD 2005 5.11 14,674 30.1 23.2 18.6 5.5 4.6 3.8 18.3 21.3 21.6 n.a n.a n.a 6.2% 16.1% 43.1% 106.9%
THE UNITED LABOR 3933 6.51 10,591 130.2 25.6 18.2 1.6 1.7 1.6 1.4 7.0 9.0 10.4 7.2 5.4 2.5% 3.3% 11.9% 23.3%
CK LIFE SCIENCES 775 0.59 5,671 n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a -1.7% -1.7% -3.3% -14.5%
SHANGHAI FUDAN-H 1349 4.48 4,135 21.9 21.3 17.7 4.1 3.5 3.1 19.4 17.0 17.9 14.5 14.6 11.7 -3.4% 3.5% 12.3% -30.9%
SHANDONG XINHU-H 719 8.10 6,737 24.0 n.a n.a 1.5 n.a n.a 6.3 n.a n.a n.a n.a n.a -2.4% 3.2% 7.1% 54.6%
LEE'S PHARM 950 7.99 4,722 19.0 17.6 15.4 2.8 2.6 2.3 16.7 14.5 14.3 n.a n.a n.a 16.6% 19.6% 29.3% 27.2%
CONSUN PHARMACEU 1681 7.54 6,587 20.9 13.2 11.4 n.a 2.4 2.0 18.3 22.1 22.8 n.a 8.2 6.8 6.5% 4.7% 14.6% 95.3%
YICHANG HEC CH-H 1558 30.05 13,583 28.2 22.2 18.1 4.6 3.9 3.4 14.5 18.5 19.6 22.0 18.9 15.4 9.9% 27.6% 51.8% 93.9%
DAWNRAYS PHARMAC 2348 4.57 3,625 9.6 10.3 9.0 1.9 n.a n.a n.a n.a n.a 5.2 n.a n.a 7.0% 8.8% 1.6% -1.9%
Simple average 34.0 32.3 27.7 4.3 5.4 3.7 15.4 16.6 16.3 21.9 19.2 15.6 6.1% 20.7% 37.3% 88.1%
Median 24.0 21.3 18.1 4.4 3.6 3.0 14.3 15.1 14.8 19.0 18.9 15.4 4.5% 11.4% 29.3% 54.6%
Distributor
SINOPHARM-H 1099 34.30 94,911 17.0 15.8 14.0 2.3 2.0 1.8 14.1 14.4 14.3 8.8 8.4 7.1 1.5% 11.7% -0.3% 7.4%
SHANGHAI PHARM-H 2607 21.50 74,459 14.8 13.6 11.8 1.5 1.4 1.3 10.2 10.6 11.0 12.4 11.8 10.4 1.7% 9.6% 12.7% 20.9%
CHINA MEDICAL SY 867 18.98 47,208 29.6 23.4 19.9 6.0 5.2 4.4 22.4 24.0 23.7 25.7 18.9 16.2 4.2% 16.3% 39.1% 54.6%
CHINA RESOURCES 3320 10.38 65,233 21.6 19.2 16.8 1.5 1.4 1.3 8.9 8.1 8.4 8.5 8.3 7.4 2.6% 0.2% 11.9% 18.6%
YESTAR HEALTHCAR 2393 3.29 7,156 22.2 21.4 17.1 6.0 5.3 4.1 26.4 21.9 22.9 10.2 9.2 8.4 -0.9% -2.9% -4.6% -12.5%
PIONEER PHARM 1345 2.38 3,146 13.2 n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a -1.2% 1.3% -8.5% -15.0%
Simple average 20.7 18.0 15.6 2.8 2.5 2.2 13.9 14.3 14.3 13.8 11.8 10.3 2.5% 9.5% 15.8% 25.4%
Median 19.3 19.2 16.8 2.3 2.0 1.8 14.1 14.4 14.3 10.2 9.2 8.4 1.6% 5.4% 5.8% 13.0%
Device manufacturers
SHANDONG WEIG-H 1066 5.62 25,157 16.5 14.7 13.0 1.7 1.6 1.5 9.8 11.6 11.9 12.4 8.4 7.1 -1.2% 5.0% 1.6% 8.5%
SHANGHAI HAOHA-H 6826 40.80 6,530 18.0 14.4 12.1 1.9 1.9 1.7 10.7 12.9 14.6 10.3 8.7 6.6 8.8% 13.0% 16.6% 7.7%
PW MEDTECH GROUP 1358 1.48 2,322 9.1 7.7 7.2 0.8 0.8 0.7 9.5 10.0 9.7 n.a n.a n.a 4.2% -3.9% -11.4% -26.7%
MODERN DENTAL GR 3600 2.22 2,220 13.1 13.5 10.8 1.1 1.1 1.0 8.5 8.7 10.7 7.4 7.4 5.9 2.8% 2.8% -20.4% -22.1%
BEIJING CHUNLI-H 1858 12.80 885 n.a n.a n.a n.a n.a n.a 12.8 n.a n.a n.a n.a n.a -1.1% 11.5% 9.4% 1.9%
YESTAR HEALTHCAR 2393 3.29 7,156 22.2 21.4 17.1 6.0 5.3 4.1 26.4 21.9 22.9 10.2 9.2 8.4 -0.9% -2.9% -4.6% -12.5%
MICROPORT SCIENT 853 7.59 11,052 74.7 36.0 23.7 4.2 4.0 3.6 5.3 10.8 12.0 18.8 n.a n.a 0.5% -15.7% 5.4% 30.0%
LIFETECH SCI 1302 1.94 8,399 70.1 40.3 40.3 14.7 n.a n.a 36.0 17.8 14.8 59.5 n.a n.a 3.7% 8.4% 5.4% 4.3%
Simple average 31.9 21.1 17.8 4.3 2.4 2.1 14.9 13.4 13.8 19.8 8.4 7.0 2.1% 2.3% 0.3% -1.1%
Median 18.0 14.7 13.0 1.9 1.7 1.6 10.3 11.6 12.0 11.3 8.5 6.9 1.7% 3.9% 3.5% 3.1%
Hospitals
CHINA RESOURCES 1515 10.36 13,434 31.5 24.9 22.8 2.9 1.9 1.8 13.9 8.4 7.9 27.3 16.2 14.2 5.1% 3.6% 6.4% 4.4%
HARMONICARE MEDI 1509 3.12 2,366 17.9 21.8 17.3 1.3 1.3 1.2 7.7 5.9 7.3 5.3 8.0 5.9 -0.3% 4.0% 2.0% -39.3%
HUMAN HEALTH HOL 1419 1.80 651 15.0 n.a n.a n.a n.a n.a 15.1 n.a n.a n.a n.a n.a 12.5% 8.4% -3.7% 9.1%
RICI HEALTHCARE 1526 2.06 3,280 11.8 n.a 85.6 3.0 2.5 2.4 7.0 n.a n.a 11.8 33.4 10.0 -1.4% -15.9% -1.4% 5.1%
WENZHOU KANGNI-H 2120 45.05 3,290 37.2 33.0 26.3 2.7 2.5 2.4 7.1 7.6 8.9 23.2 17.8 13.8 5.8% 18.9% 25.1% 32.5%
GUANGDONG KANG-H 3689 13.18 4,407 22.8 21.9 19.0 3.0 2.8 2.5 17.5 14.1 14.4 n.a #N/A N/A #N/A N/A 1.5% 23.2% 22.3% 16.6%
UMP HEALTHCARE H 722 1.85 1,393 48.7 n.a 20.6 3.4 2.6 2.7 11.4 (0.5) 12.6 n.a n.a n.a 6.9% -9.3% -11.9% 36.0%
Simple average 22.7 25.4 34.2 2.6 2.2 2.1 11.4 9.0 9.6 16.9 18.8 11.0 3.9% 7.0% 8.4% 4.7%
Median 20.3 23.4 22.8 2.9 2.5 2.4 10.8 8.0 8.4 17.5 17.0 11.9 3.3% 6.2% 4.2% 7.1%
Others
WUXI BIOLOGICS C 2269 48.00 55,827 362.5 134.3 82.0 n.a 11.6 10.3 105.9 14.6 13.5 n.a 79.3 47.8 9.8% 3.3% 21.7% 133.0%
UNION MEDICAL HE 2138 3.74 3,668 n.a 17.0 15.6 n.a 4.3 4.4 n.a 26.0 32.5 n.a 11.7 9.9 -1.6% 5.4% 41.7% 33.6%
Hang Sang Index 2.7% 5.3% 11.5% 39.7%
Market cap
(HK$m)
Price
(HK$)
Share price performancePE PB ROE EV/EBITDA
3
2017 healthcare sector performance summary (Figure 2):
1) Leading chemical/biological drug manufacturers outperformed the HSI as a result of favora-
ble government policies (NRDL, stringent regulation calls for consolidation, etc.) .
2) Some sub-segment leading manufacturers (such as SSY [2005.HK], the second largest
player in the IV industry, HEC [1558.HK] in the anti-flu market, Genscript [1548.HK] in C-
ART and Consun Pharm [1681.HK] in the CKD therapeutic area) also outperformed due to
their unique market competitiveness.
3) The top three traditional distributors underperformed as a result of the “two-invoice-system”,
which had a short-term negative impact on their internal transfer business and constrained
end demand, triggered by public hospital reforms that squeezed their margins. Specific aca-
demic distributor CMS outperformed due to its unique position of marketing high-end/
exclusive drugs.
4) All medical device manufacturers underperformed the HSI, mainly due to tender price cuts
and medical insurance cost controls. A closer inspection shows that Microport [0853.HK]
underperformed the least thanks to its competitive product portfolio (Firehawk, etc.), helping
it carve out a niche market position.
5) Hospitals continued to underperform due to public hospital reforms.
Overall, the share price performance in 2017 illustrated structural divergence. This reinforced
our stock pick strategy for 2018 that innovative drug/sub-segment leading players should contin-
ue to be preferred. Also, quality large caps may present a catch-up opportunity following the
structural re-rating of leading innovative drug manufacturers.
Divergent performance of the
healthcare sector in 2017, which
we expect to continue in 2018
4
Challenges include the following:
1) Continued tender price cuts. This is a result of (a) execution of 2016/17 tenders, (b) ~18
provinces not yet having announced a new round of tenders, and (c) sharp cuts (especially
for competitive generics and non-therapeutic drugs) as a result of the national lowest tender
price linkage mechanism (Fujian cut the most; if other provinces copy its tender price, there
will be a severe ASP cut).
2) End-2018 is the deadline for chemical generics quality and efficacy consistency, so we ex-
pect increased R&D expenses (due to limited qualified BE clinical trial institutions, as there
are only ~130 nationwide) to hit some companies’ earnings, especially generic-heavy ones.
3) Medical insurance cost controls. In the upcoming national medical insurance reimbursement
reforms (Fujian announced pilot trial policies in March 2017), we expect hospitals to be moti-
vated to engage in secondary price negotiations. Over-treatment will also be reduced (i.e.
only clinical indispensable drugs will be used) due to the lump-sum payment mechanism on
a per capita/per disease basis by medical insurance funds.
4) Public hospitals drug sales percentage controlled at <30%. The drugs sales percentage will
be an important assessment factor in hospital dean/department head appraisals.
5) Zero price mark-up for drugs. This will turn hospital drugs sales from profit centres to cost
centres and therefore constrain drug usage, especially supplementary/nutritious drugs.
Since innovative and clinically indispensable drugs are used in standard treatment recom-
mended by clinical guidance, physicians will continue to prescribe them, so their sales vol-
ume may not be affected that much.
Challenges in 2018 include 1)
tender price cuts; 2) increased
R&D expenses; 3) medical insur-
ance cost controls; 4) public hos-
pitals drugs sales percentage
constraints; and 5) zero price
mark-up for drugs.
5
1. Pharmaceutical manufacturers—seeking α among challenges
In 2017, the share price performance diverged sharply. Only leading drug manufacturers have out-
performed the market (HSI) YTD, as a result of policy support. Many industry policies were pub-
lished in 2017, showing the authorities' determination to 1) support domestic innovative drugs; 2)
encourage foreign innovative drugs which are indispensable to Chinese patients (by accelerating
their import registration); 3) encourage R&D; 4) reduce unreasonably high drug prices and control
drug abuse or overtreatment to alleviate the burden on patients and medical insurance funds; and 5)
call for generics quality and efficacy upgrades through chemical generics consistency evaluation. All
these policies will benefit the leading players with strong R&D capability, sufficient cash flow to cap-
ture consolidation opportunities, and a solid product portfolio to support existing growth, while exert-
ing pressure on low-end generics-focused manufacturers and small to medium players which lack of
R&D capability.
Looking forward to 2018, we believe challenges and opportunities co-exist. The positives include the
following:
1) 2018 is the first year of implementation of the new version of NRDL. We expect newly added
drugs to generate fast volume growth, such as CSPC’s 91093.HK] NBP injection form (used for
strokes), and 3SBio’s [1530.HK] Yisaipu (used for RA).
2) Some compelling new products are expected to be launched in 2018 or complete milestone
steps in clinical trials. This includes Genscript’s [1558.HK] C-ART, for which it applied for a
CDE review in Dec 2017. 3SBio is expected to re-submit Herceptin (used for HER2 over-
expressed breast cancer) 341 clinical trial data. Hengrui’s [600276.CH] and CSPC’s Paclitaxel-
albumin etc., and Walvax Biotechnology’s [300142.CH] Pneumococcal 13-Valent Conjugate
Vaccine are expected to obtain production approval in 2018, and Walvax Biotechnology’s Her-
ceptin analog clinical trial phase III unbinding is expected.
3) Fast organic growth in some sub-segments, such as the oncology, CCV and diabetes markets.
The fast growth of bio-drugs will also provide opportunities (Figure 3): e.g. CSPC’s oncology
portfolio, TUL’s [3933.HK] 3rd generation insulin for diabetes, and 3SBio’s and Sino BioPharm’s
[1177.HK] positioning in the fast growing bio-industry.
4) Some companies' existing products are in a fast-growing life cycle and are expected to contin-
ue to drive these companies’ growth: e.g. HEC’s Kewei (used for flu) and 3SBio’s TPIAO.
5) We expect the challenging environment to provide more M&A opportunities for leading players
with strong financial capability. M&A will focus on i) acquiring candidates still in the clinical trial
stage but with a promising outlook; ii) industry mergers to gain market share and specific indus-
try oligopoly dominance (e.g. in the concentrated Chinese medicine granules (CCMG) industry
and IV infusion industry); and iii) other new products to compensate for the shortfall in organic
growth.
Leading drug manufacturers out-
performed in 2017. Opportunities
and challenges co-exist in 2018.
2018 positives include 1) new
NRDL implementation; 2) news
flow on new products or R&D; 3)
fast growth in some specific sub-
segments; 4) existing products in
a fast-growing life cycle; and 5)
M&A.
62.7
152.7
326.9
0
50
100
150
200
250
300
350
2012 2016 2021
Bio drugs market size
RMBbn
Figure 3: Expected fast growth of the bio-drugs market
Source: Frost & Sullivan
6
R&D policies benefit leading manufacturers
CFDA has released many R&D related policies, which we believe will continue to benefit the
leading players with strong R&D capability, as the policies call for consolidation.
Priority review makes the strong get stronger
For CSPC, there are five drugs on priority review by the CFDA, as summarized in Table 4.
Paclitaxel (albumin bound) is on the priority list, as it is classified as clinical and is urgently need-
ed. The other four drugs are included in the CFDA priority review because 1) they are already
approved for U.S. ANDA; 2) they have five equivalent production lines; and 3) they are applying
for domestic generics approval.
In principal, the CFDA is required to give review results within 180 days (i.e. starting from the
application date until the notice date) for drugs under Priority Review as compared to at least 1.5
years for regular review. In the long run, the leading players with strong R&D and capital capabili-
ties can accelerate their new product launch pace under this regulation.
BE testing helping to clean out small players and low-end generics
So far, ~475 institutions/hospitals have qualified for clinical trials, among which, only ~131 can
conduct Bioequivalence (BE) test clinical trial I for chemical generics, which are located mainly in
Beijing, Shanghai, Jiangsu, Guangdong and Liaoning. Thus, due to limited BE resources, drug
manufacturers will bear increased BE test costs (i.e. additional R&D expenses).
The chemical generics quality and efficacy consistency evaluation is required to be completed by
end-2018 for drugs launched prior to 1 Oct, 2007 and within three years for those marketed after
2007. However, the BE test is quite time consuming. Thus, we believe this implies that drug man-
ufacturers will carefully allocate their resources to complete their generics consistency tests by
focusing on key drugs or compelling products, given 1) BE costs and 2) the time required to com-
plete BE tests. This may offer industry consolidation opportunities. Small-to-medium companies
which abandoned projects with promising prospects may be acquired by leading players. Thus,
we believe that in the long run, this constraint will put pressure on generics-focused companies
and benefit leading innovative players, such as CSPC, Hengrui, and 3SBio.
Application NO. Drug name EN Drug name CN Indication Applicant Application date Notice date
CYHS1600152Paclitaxel (albumin
bound)
注射用紫杉醇（白蛋
白结合型）Oncology CSPC 12/15/2016 6/20/2017
CYHS1790024 Metformin 盐酸二甲双胍缓释片 Diabete CSPC 3/14/2017 6/1/2017
CYHS1790026Clopidogrel Bisulfate
Tablets硫酸氢氯吡格雷片 Antithrombosis CSPC 3/31/2017 6/1/2017
CYHS1790014 Metformin 盐酸二甲双胍片 Diabete CSPC 3/2/2017 4/13/2017
CXHS1500143 Dronedarone 盐酸决奈达隆片
antiarrhythmic medication
used to treat atrial fibrillation
and atrial flutter
CSPC 10/21/2015 10/10/2016
All R&D-related polices point out
that only strong companies can
stand out. Innovation is highly
recommended. High quality ge-
nerics are also required.
Figure 4: CSPC R&D candidates in priority review
Source: CFDA
7
Innovative drugs and high-quality generics are strongly encouraged
On October 8, 2017, the General Office of the Communist Party of China and the State Council
jointly released the guideline “Opinion on deepening review and approval system reform and
encouraging the innovation of drugs and medical instruments” (关于深化审评审批制度改革鼓励药
品医疗器械创新的意见). This opinion was based on the “Opinion on medicine equipment review
approval system” (关于改革医疗器械审查审查制度意见）in 2015. The main difference between
the two is that the new policy has put forward more detailed implementation measures, which are
closely based on the current healthcare industry situation, with much stronger determination,
primarily aiming at 1) encouraging the use of innovative drugs (both local and imported, as long
as they are indispensable to China); 2) making innovative drugs affordable; 3) encouraging R&D
of drugs and medical instruments; and 4) rectifying the healthcare industry through more strin-
gent regulation of the review and approval of new drugs and instruments. This is a critical long-
term, top-level policy, which indicates the healthcare industry’s development direction in next few
years and illustrates the authorities’ determination to improve the industry.
1) Clinical trial supervision reforms
Under this principle, the government is aiming at 1) increasing qualified clinical trial institution
numbers to alleviate congested clinical trial demand (according to government statistics, there
are currently >10,000 Grade II hospitals and >2,000 Grade III hospitals, but only about 600 hos-
pitals are qualified for clinical trials, and of these, only about 100 can conduct Phase I clinical
trials), so social capital is encouraged to set up qualified clinical centers (qualifications of clinical
trials centers will be approved by the CFDA); 2) ensuring scientific clinical trial design and relia-
ble clinical trial data; and 3) accepting foreign multi-center clinical trial data (境外多中心臨床數據)
to be applied in domestic clinical trials, which will enable foreign drug companies to launch their
products in China faster.
Beneficiaries will include contracted research organizations (CRO), such as Genscript and Wuxi
Bio, with government encouragement of social capital investment in clinical trials. Larger interna-
tional pharmaceutical players with strong R&D capability will also share the Chinese cake more
easily, as foreign clinical trail data can be applied domestically.
2) Accelerating the new drug review progress
1) There will be more stringent regulation of drugs forms. The authorities’ drug form priority is
oral> muscle injection > IV injection, following the sequence of safety risks.
2) There is continued support for Traditional Chinese Medicine (TCM). A related company is
CTCM [570.HK; BUY].
Top-level authorities are deter-
mined to improve the healthcare
sector. Innovative drugs, high
quality generics, and strong R&D
are recommended.
8
3) Pushing drug innovation and generics development
1) A marketed drugs catalogue will be set up, which will include newly approved innovative drugs
and generics which have passed the efficiency and quality consistency assessment (仿製藥一致
性評價).Drugs included in the catalogue will have active ingredients, names, specifications, for-
mulations, reference listed drugs, manufacturers and other basic information, and thus will have
an advantage in tendering and prescriptions.
2) We see strong support for innovative drugs in terms of more stringent patent protection regula-
tions. Also, hospitals and medical institutions are encouraged to prioritize their purchases of inno-
vative drugs (of course, there is expected to be an ASP cut to some degree at the same time).
The authorities’ strong determination is due to the fact that there were 433 new drugs approved
in developed countries in 2001-2016, of which only ~30% or ~100 drugs have been imported into
China. On average, new drug launches in China are delayed by 5-7 years compared to those in
developed countries.
3) We also see strong support for generics because this is an effective way to lower drug costs
for both patients and medical insurance funds. The CFDA will allow the timely release of innova-
tive drugs whose patents expire to encourage generics manufacturers to produce related gener-
ics to reduce the financial burden on medical insurance funds and patients. (Note that this does
NOT contradict the policy of encouraging innovative drugs. Pushing such generics is just a way
of reducing the financial burden on medical funding and patients by replacing original drugs with
cheaper generics with similar efficacy. Innovative drugs are still the origin and key foundation for
long-term improvement in medical care) Therefore, companies with strong R&D capability and a
wide product spectrum will benefit.
4) Full life-cycle management for drugs and medical instruments
The key is to implement the Marketing Authorization Holder (MAH) (上市许可持有人）. The
MAHs of drugs or medical instruments will bear all legal responsibility for the full life span of the
drugs/instruments from pre-clinical study and clinical trials to production, distribution and report-
ing side effects. This will accelerate industry consolidation and eliminate low-end manufacturers.
5) Improving technical review capability
This principal is intended to strengthen the new drugs/instruments review and approval process,
which will help alleviate review pressure and benefit companies with strong R&D. Previously,
many applications were congested due to the lack of professional review staff, which is one of
the bottlenecks slowing the launch of innovative Chinese drugs and medical instruments.
9
Tender price cut pressure to continue in 2018
Tendering progress Provinces
Announced in 2015 and excecuted Sichuan, Chongqing, Hunan, Anhui, Zhejiang, Shanghai
Announced in 2016 and excecuted Gunagxi, Hebei
Announced in 2H2016 and excecuted in 1H2017 Beijing
Announced in 2H2016 and not excecuted Inner Mogolia, Shandong
Announced in 1H2017 but not excecuted Fujian, Gunagdong
Not announced yet Remaining 18 provinces
Over half of the provinces still haven't announced a new round of tenders. We thus believe tender
price cuts are still a major risk for drug manufacturers in 2018. There are two things particularly
worth further mentioning:
1. We expect generics to be under great pressure, as they have limited bargaining power, such
as CSPC’s generics business and Dongrui Pharm.
2. Currently, the remaining provinces’ tender prices will take existing tender prices as the bench-
mark (national lowest price linkage mechanism). In 1H2017, Fujian province announced a
>30% tender price cut, which may set a quite low price standard for the remaining provinces’
tenders. The reason behind Fujian’s sharp tender price cut is the medical payment method
policy in Fujian, which includes the following key points:
a) Fujian’s tenders divide drugs into therapeutic, supplementary and nutritional categories,
with drugs in the therapeutic category having a relatively higher medical settlement price
(醫保支付結算價),which is the basis for calculating medical insurance reimbursement.
b) Fujian’s policy encourages hospitals to negotiate the price after tendering.
c) Fujian’s policy forces hospitals to negotiate drug prices with manufacturers because the
difference between the drugs’ sales price and the purchase cost can be retained by the
hospitals as profit.
d) There is a relatively lower reimbursement ratio for non-competitive bidding (非競價組）
drugs, which mainly include original drugs, FDA-approved drugs, and generics which have
passed the consistency assessment. Although they have a significant higher medical max-
imum selling price (醫保最高銷售限價),their medical insurance settlement price has been
limited to the lower of 70% of its medical maximum selling price or 150% of a similar cate-
gory drug in a competitive bidding group （競價組同類產品).Thus, their usage may be
restrained for cost reasons.
We do not think the low medical insurance payment percentage in point (d) will be retained in the
nationwide medical insurance fund policy, as this may reduce the use of innovative drugs and
violate the spirit of medical reform. Basically, we think the government will take a supportive atti-
tude towards innovative drugs, as can be seen in recently released policies intended to accelerate
the introduction of innovative foreign drugs in China. Moreover, Fujian’s policy may force hospitals
to selectively choose patients due to cost controls. Thus, we need to wait and see how the nation-
al payment policy differs from Fujian’s.
At this stage at least, drug manufacturers may forgo Fujian tendering to protect their national low-
est price. Also, we believe innovative drugs will have much stronger bargaining power than gener-
ics. Therefore, given tender price cuts, leading/innovative drugs are still preferred over generics or
non-therapeutic drugs.
Figure 5: Provincial drug tendering progress
Source: Provincial tendering offices, CGIS research
Leading/innovative drugs are still
preferred over generics or non-
therapeutic drugs, given the mac-
ro trend of tender price cuts going
forward.
18 provinces have still not yet
announced a new round of ten-
ders. Tender price cuts are still
expected to put pressure on the
drug manufacturing industry in
2018.
10
Downstream cost controls restrain drugs usage
Zero price mark-up
This policy has changed drug sales from a profit center to a cost center for hospitals. This may
encourage hospitals to initiate secondary price negotiations with drug manufactures, especially
for competitive bidding drugs (競價組藥品),where manufacturers have relative less bargaining
power: In comparison, supplementary/nutritious (輔助性/營養性) drugs will be negatively im-
pacted. Since innovative and clinically indispensable drugs are used in standard treatment rec-
ommended by guidance, physicians will continue to prescribe them, so their sales volume may
not be affected. Moreover, they are usually in the non-competitive bidding group (非競價組), so
manufacturers have relative more bargaining power than hospitals (i.e. their ASP cut should be
milder than that for supplementary/nutritious drugs). Thus, innovative/high-end generics should
not be very negatively impacted by the zero price mark-up policy.
In contrast, this policy will directly benefit Chinese Traditional Medicine (CTM) manufacturers, as
they can continue to mark up prices up to 25%, and they do not count in the drugs sales percent-
age.
Drugs sales percentage
First-line practitioners believe targeting the drugs sales percentage to total hospital revenue
<30% (藥佔比低於30%) from the current 45%+ in some Grade III hospitals can lead to potential
abuse. While the drugs sales percentage can be reduced by reducing the use of unnecessary
drugs, the ratio can also be attained through higher consultation fees: and this may lead to over-
diagnosis and more surgeries. Thus, we believe medical insurance payment reforms should co-
ordinate with drugs sales percentage reforms to avoid possible over-diagnosis and unnecessary
surgeries.
Zero price mark-up and drug sales
percentage constraints will exert
pressure on terminal demand for
drugs.
11
Drugs manufacturers investment thesis
In summary, in 2018 where opportunities and challenges co-exist, we continue to prefer leading
drug manufacturers because of their 1) solid existing product portfolio; 2) strong R&D capability,
benefiting from R&D-related policies; and 3) relative high earnings growth visibility. Although they
were re-rated significantly in 2017 (Figure 2, strong YTD performance), we believe there is still
further room for re-rating, on the basis of 1) the valuation base year rollover to 2018; 2) potential
milestone progress for new products (e.g. premium clinical trial data in the R&D pipeline, new
product launches, and completion of consistency evaluations); 3) potential strategic investors
with a strong reputation; 4) M&A; and 5) solid results from the existing portfolio, etc.
On the other hand, small-to-medium drug manufacturers will suffer from existing product tender
price cuts and the lack of sustainable growth drivers (i.e. R&D pipeline), and will feel more and
more pressure, with many eventually forced out of business or acquired.
Some sub-segments are worth closely monitoring, such as the bio-tech sub-segment, including
3SBio, Genscript and Sino Biopharm, which will benefit from the expected high-teen market
CAGR in next few years (Figure 3); chemical drug leading players, such as CSPC, which will
benefit from stringent industry policies that call for sector consolidation; and TCM leading player
CTCM, which offers a catch-up opportunity on the back of a low valuation and the fact that it will
be a beneficiary of the drug zero price mark-up policy.
Two investment themes for drug
manufacturers: 1) prefer leaders,
and 2) play fast-growing sub-
segments.
12
Distributors—leading distributors catch-up plays in 2018
Distributors are in the middle of the supply chain in the healthcare industry. Their primary value is
to provide logistics services for drug distribution and facilitate purchases by downstream users
(hospitals, clinics, medical institutions, retail drug stores, etc). Some specialist distributors serve
market niches by providing academic promotion services for foreign drug manufacturers that wish
to push product sales in China through the local distributor sales networks.
The main policy affecting the distribution sub-segment is the “two-invoice system”, which calls for
fewer distribution layers and more distribution consolidation. We expect to see consolidation in the
distribution sub-segment, as the core value of big distributors lies in their logistics network cover-
age. The government wants to push the two-invoice system in the pharmaceutical distribution field
to compress the drug-distribution process, as this is the low value-added part of the whole indus-
try value chain. In 2015, there were ~11,000 distributors (2012: ~13,700), with the top three play-
ers having a combined 30% market share and the biggest 100 players having a 70% market
share. We expect to see fewer small companies with no upstream or downstream sales network
survive. The most promising way out for small-to-medium size companies with certain resources
is to seek coordination with the leading distributors or be acquired by big players. This basically
offers plenty of M&A opportunities for the leading players with an acquisition cost as low as 5-8x
PER.
The pharmaceutical distribution market grew from RMB749bn in 2011 to RMB1,291bn in 2015,
representing a CAGR of 14.6%, and is expected to grow to RMB1,860bn in 2020, representing a
CAGR of 7.6%, according to the Frost & Sullivan Report (Figure 6), which we believe is driven
mainly by 1) the aging population; 2) extended healthcare commercial insurance coverage; and 3)
upstream drug manufacturing development.
749.3
1291.3
1860.1
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2011 2015 2020
China distribution market
RMBbn
Sources: Frost & Sullivan estimates
Figure 6: China drug distribution market size
Consolidation trend in China’s
distribution industry; leading
distributors to benefit in the long
run, despite short-term pain (i.e.
some internal allocation business
will be affected).
13
Good timing to build up a long-term position in distributors
The macro trend in the pharmaceutical industry has been from rapid high-teen YoY growth (i.e.
the fast-developing stage, where both big and small players set up sales channels) to slower
growth in the past few years (when the big players began to take market share from the small
players by leveraging their capital and scale) to the more recent stable high-single-digit growth as
a result of 1) the impact of medical reforms; 2) tender price cuts in recent years; and 3) more and
more stringent regulations. This can be seen from the growth history of the top three distributors.
Looking ahead, we expect the distribution industry growth to further slow down to ~6-7% in 2018E
due to policy impact. However, we believe distributors will bottom out in 2018, making 2018 the
best time to take a long-term position in leading distributors for the following reasons:
1) The “two invoice system” calls for industry consolidation, and thus the leading distributors will
stand out in the long run.
2) In 2019E, we expect the growth rate to recover a bit to ~7-8% with completion of the two-
invoice-system (the impact on their internal transfer business will be fully reflected in 2018)
and chemical generics quality and efficiency consistency assessment, which will be complet-
ed by end-2018 (which will help increase the bargaining power of some generics).
3) Tender price cuts should be largely reflected in 2018 (i.e. tender prices in 2019 will show a
moderate decline YoY compared with those in 2018).
4) Some new growth engines are emerging. Leading distributors have put effort into building a
retail business (prescriptions outgoing opportunities, 處方外流), distributing high-margin
medical devices, and SOE reforms, such as employee stock option plans).
5) Their attractive valuations make them a catch-up play in 2018.
We believe 2018 is a good time to
build up long-term positions in
leading distributors, as they will
likely bottom out in 2018.
14
Hospitals—expected to continue to underperform
The ultimate winners of hospital reform will be the medical reimbursement fund (醫保基金)and
patients, as their funds will be spent on necessary treatment rather than on overtreatment and
higher drug prices. Physicians will also benefit as their value to patients is now easily identified
(i.e. much higher physician service fees), and this will eventually be reflected in a more competi-
tive compensation package. Their gains will come from losses in the whole healthcare value
chain, including drug manufactures, distributors and hospitals. Drug manufactures will lose mainly
on lower tender prices (except for some innovative drugs). Distributors will also see certain pres-
sure, but this will be relatively mild compared with manufacturers, as they will basically share the
ASP cut, and leading distributors will benefit from consolidation triggered by the “two-invoice-
system”. For hospitals, in the short term, public hospital reforms call for a revenue structure
change from the original “drugs sales + government subsidy + medical services” to the targeted
“higher medical services charges + government subsidy”. But higher medical services charges
currently don't have clear time schedule. We previously expected 2-3 years for the reform to be
fully implemented, but first-line practitioners expect an even longer time frame. Overall, the re-
forms are short-term pain for long-term gain for hospitals. We thus reiterate our view that hospi-
tals are likely to underperform the drug manufacturer and distributor sub-segments in next 1-2
years.
15
INITIATION-Sinopharm [1099.HK]
BUY (Initiation coverage)
Close: HK$34.3 (Jan 04, 2018)
Target Price: HK$40.9 (+19.2%)
Price Performance
Market Cap US$12139.0m
Shares Outstanding 2,767m
Auditor E&Y
Free Float 43.1%
52W range HK$30-38
3M average daily T/O US$24.7m
Major Shareholding China National Pharmaceuti-
cal Group (29%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research estimates
China Healthcare Sector
Sinopharm is the leading pharmaceutical distributor in China. The traditional pharmaceutical
distribution business is expected to bottom out in 2018. In addition, the retail and high-margin
medical device distribution business is expected to become a new profit contributor for the
Company. It underperformed in 2017 and is now trading at 16/14.2/12.5x 2017/18/19E PER,
close to 1sd below its historical average (Figure 15). We believe the following factors will help
the Company bottom out in 2018 and trigger a re-rating: 1) distribution product upgrades with
more high-margin medical devices; 2) further cost controls; 3) more M&A to facilitate economies
of scale; 4) a retail business opportunity from the zero price mark-up policy; 5) short-term nega-
tives from the two invoice system (on its internal transfer business) will be relieved in 2018; and
6) completion of the chemical consistency evaluation is expected to increase the bargaining
power of some generics to mitigate tender price cut pressure on its margins. We set our target
price at HK$40.9, equivalent to 17x 2018E PER, close to Sinopharm’s historical average
(~16.2x) and the industry average (15-16x, Figure 2). Initiate with a BUY rating.
Investment thesis
Distribution business product mix upgrade: Currently, over 90% of the Company’s
segment profit comes from its distribution business (including drug and medical device
distribution). In addition to its traditional pharmaceutical distribution business, its medical
device distribution business (expected to account for ~7% of 2017 total revenue) may be-
come an important growth driver and profit contributor for the Company from 2018 on. We
estimate that its medical device distribution business will contribute 8.3%/9.7% of total
revenue in 2018/19E, respectively, and as a result of its higher margin, we expect a stable
gross margin at 8% in 2018/19E even under price cut pressure and terminal medical insur-
ance cost controls.
Retail the new growth driver: Sinopharm’s unique advantages (capital, relationship with
local governments, etc.) in capturing drug retail business opportunities resulting from the
zero price mark-up policy (drugs sales have become cost centres for hospitals instead of
previously profit centres, so hospitals will outsource drug sales to retail stores, providing a
great opportunity for retailers), enabling this segment to deliver 20% revenue growth in
2018/19. We project its segment profit contribution will increase from 3.2% in 2017 to 4% in
2019.
Bottoming out and catching up: Sinopharm underperformed the HSI, as the market was
concerned about its internal transfer business being impacted by the two-invoice system
and increasing pressure on its margins from price cuts. We believe these two major nega-
tives will be largely relieved in 2018, as the implementation of the two-invoice system will
be completed by 2018. We also expect generics manufacturers’ tender bargaining power
to increase after the completion of the Quality and Efficacy Consistency Evaluation by end-
2018, which will help stabilize Sinopharm’s margins. Therefore, we believe the bottoming-
out of the business will help trigger a re-rating and help its valuation to catch up, since its
EPS growth is expected to accelerate from 7.5% in 2017E to ~12% in 2018/19.
Expected to bottom out in 2018, initiate with BUY
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Revenue (RMBm) 228,673 258,388 278,973 307,081 341,651
Core net profit (RMBm) 3,772 4,647 4,997 5,620 6,381
Core net margin (%) 1.6 1.8 1.8 1.8 1.9
Core EPS (RMB) 1.363 1.684 1.810 2.036 2.312
PER (x) 21.2 17.2 16.0 14.2 12.5
PBR (x) 2.7 2.5 2.2 2.0 1.8
ROE(%) 13.1 15.0 14.8 14.9 15.1
EV/EBITDA (x) 10.8 9.8 8.6 7.7 6.7
0
100
200
300
400
500
600
700
25
27
29
31
33
35
37
39
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
16
Key financials
Source: Company, CGIS Research estimates
Balance Sheet Profit and Loss
Year ended Dec 31 Year ended Dec 31
(RMBm) (RMBm)
Cash & cash equivalents 24,568 30,590 40,343 52,706 63,008 Pharmaceutical distribution 215,597 243,883 263,313 288,674 319,986
Inventories 22,553 25,760 24,868 29,342 30,971 Retail 8,715 10,202 11,811 14,174 17,008
Trade & note receivables 65,033 69,245 72,916 76,839 86,031 Other business 4,361 4,303 3,848 4,233 4,656
Others 5,746 7,164 8,269 9,141 10,965 Revenue 228,673 258,388 278,973 307,081 341,651
Current assets 117,900 132,760 146,395 168,028 190,974 Cost of goods sold (209,953) (237,717) (256,655) (282,668) (314,490)
PP&E 7,642 6,752 7,219 7,639 8,017 Gross profit 18,720 20,671 22,318 24,413 27,161
Intangible assets 6,723 6,283 6,127 5,977 5,833 Other income 244 272 307 338 376
Others 7,165 11,917 13,715 15,795 18,277 Selling expense (6,025) (6,619) (6,983) (7,497) (8,237)
Non-current assets 21,530 24,952 27,061 29,411 32,127 Admin & other expenses (3,712) (4,110) (4,656) (4,998) (5,491)
Operating profit 9,227 10,214 10,986 12,256 13,808
Other gains-net 65 411 300 300 300
Total assets 139,430 157,712 173,457 197,439 223,101 Finance cost-net (1,988) (1,932) (1,969) (2,137) (2,462)
Share of Associates 165 232 534 611 690
Trade and bills payables 59,563 66,746 76,700 82,834 96,382 Pretax income 7,469 8,925 9,851 11,030 12,337
Other payables 7,023 9,680 8,603 11,533 10,869 Income taxes (1,728) (2,033) (2,246) (2,515) (2,813)
ST borrowings 28,355 22,363 23,725 29,254 32,708 MI 1,969 2,244 2,609 2,895 3,143
Others 680 949 949 949 949 Net profit 3,772 4,647 4,997 5,620 6,381
Current liabilities 95,622 99,737 109,976 124,569 140,909 Core net profit 3,772 4,647 4,997 5,620 6,381
LT borrowings 608 11,135 10,168 12,537 14,018 EBITDA 10,233 11,281 12,012 13,322 14,911
Others 2,321 2,306 2,306 2,306 2,306 Basic EPS (RMB) 1.363 1.684 1.810 2.036 2.312
Long-term liabilities 2,929 13,442 12,474 14,844 16,324 Fully diluted EPS (RMB) 1.363 1.680 1.806 2.031 2.306
Basic core EPS (RMB) 1.363 1.684 1.810 2.036 2.312
Total liabilities 98,551 113,179 122,450 139,413 157,233 Fully diluted core EPS (RMB) 1.363 1.680 1.806 2.031 2.306
Dividend (RMB) 0.410 0.410 0.542 0.609 0.692
Shareholders' equity 30,110 31,811 35,676 39,801 44,500 Payout 30.1% 24.4% 30.0% 30.0% 30.0%
Minority interests 10,768 12,722 15,330 18,225 21,368
Total equity 40,879 44,532 51,006 58,026 65,868
Key Ratios
Cash Flow Year ended Dec 31 2015A 2016A 2017E 2018E 2019E
Year ended Dec 31 2015A 2016A 2017E 2018E 2019E
(RMBm) Growth (% YoY)
Profit before tax 7,469 8,925 9,851 11,030 12,337 Sales 14.3 13.0 8.0 10.1 11.3
Depreciation & amortization 1,006 1,068 1,026 1,066 1,102 Operating profit 17.4 10.7 7.6 11.6 12.7
Change in working cap. 4,804 (128) 3,645 (1,746) (1,763) EBITDA 17.7 10.3 6.6 11.0 12.0
Income tax paid (1,793) (2,046) (2,246) (2,515) (2,813) Core net profit 31.2 23.2 7.5 12.5 13.5
Others 1,926 1,439 (534) (611) (690) Basic EPS 22.8 23.5 7.5 12.5 13.5
Operating cash flow 13,412 9,258 11,742 7,224 8,174 Core EPS 22.8 23.2 7.5 12.5 13.5
Profitability (%)
CAPEX (1,330) (1,414) (1,280) (1,280) (1,280) Gross margin 8.19 8.00 8.00 7.95 7.95
Change in other assets (313) (192) 27 15 155 Operating margin 4.0 4.0 3.9 4.0 4.0
Investment cash flow (1,643) (1,606) (1,253) (1,265) (1,125) EBITDA margin 4.5 4.4 4.3 4.3 4.4
Core net profit margin 1.6 1.8 1.8 1.8 1.9
Net change in debt (6,857) 26,885 394 7,899 4,934 ROA 2.8 3.1 3.0 3.0 3.0
Others (303) (28,912) (1,132) (1,495) (1,682) ROE 13.1 15.0 14.8 14.9 15.1
Financing cash flow (7,160) (2,027) (737) 6,404 3,253 Balance sheet ratios
Current ratio (X) 1.23 1.33 1.33 1.35 1.36
Net change in cash 4,609 5,625 9,752 12,364 10,301 Quick ratio (X) 1.00 1.07 1.11 1.11 1.14
Cash at beginning of the year 15,306 19,966 25,573 35,325 47,689 Cash ratio (X) 0.26 0.31 0.37 0.42 0.45
Effect from foreign exchange 51 (18) 0 0 0 Trade & bill receivables days 105 95 93 89 87
Cash at the end of the year 19,966 25,573 35,325 47,689 57,990 Trade & bill payable days 104 97 102 103 104
Inventory turnover days 39 37 36 35 35
Total debt to equity ratio (%) 96.2 105.3 95.0 105.0 105.0
Net debt to equity ratio (%) 14.6 9.1 Net cash Net cash Net cash
2019E2018E2015A 2016A 2017E 2018E 2019E 2015A 2016A 2017E
17
Distributors are in the middle of the supply chain in the healthcare industry. Their primary value is
to provide logistics services for drug distribution and facilitate purchases by downstream users
(hospitals, clinics, medical institutions, retail drug stores, etc.). Pharmaceutical distribution ser-
vices consist mainly of the marketing, sales, tendering and logistics of pharmaceutical products.
Large pharmaceutical distributors in China typically offer complementary logistics and value-
added services to both the pharmaceutical manufacturers and dispensers, including distributor
data integration and reprocessing, payment collection for pharmaceutical manufacturers, delivery
of special pharmaceutical products, technical support and assistance, import assistance, customs
clearance and free trade zone warehousing. The capacity and quality of these services in China
are highly valued and are in increasing demand by many larger dispensers, such as hospitals.
Consequently, large distributors that provide these value-added services have significant competi-
tive advantages over distributors that do not.
The pharmaceutical distribution market grew from RMB749bn in 2011 to RMB1,291bn in 2015,
representing a CAGR of 14.6%, and is expected to grow to RMB1,860bn in 2020, representing a
CAGR of 7.6%, according to the Frost & Sullivan Report. The growth rate slowdown is due to 1)
the impact of medical reforms; 2) tender price cuts in recent years; 3) and more and more strin-
gent regulations (Figure 7, Sinopharm, the leading pharmaceutical distributor’s revenue growth
deceleration is a typical example). In the long run, we believe the organic growth drivers of the
distribution sector are 1) the aging population; 2) extended healthcare commercial insurance cov-
erage; and 3) upstream drug manufacturing development.
China pharmaceutical distribution industry overview
33.6%
23.8%
20.4%
13.4% 13.1%
127,559
157,864
190,133
215,597
243,883
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
0
50,000
100,000
150,000
200,000
250,000
300,000
2012 2013 2014 2015 2016
Distribution revenue YoY (RHS)
RMBm
Figure 7: Sinopharm distribution revenue deceleration
Source: Company
New growth norm of the pharma-
ceutical distribution sector.
18
Looking ahead, we expect distribution industry growth to further slow down from ~8% in 2017 to
~6-7% in 2018E. Because distributors will see margin pressure from lower tender prices, de-
creased demand from hospital drugs sales as a result of the 30% drugs sales percentage cap,
and the adverse impact of the two-invoice system on the distributors’ internal transfer business,
as only one distribution layer is allowed between drug manufacturers and hospitals or just one
more invoice within the same Company’s subsidiaries. On the other hand, considering leading
distributors will benefit from consolidation (i.e. gaining market share) triggered by the two-invoice
system and their advantages of economies of scale, capital and network, we expect them to grow
faster than the industry average by 2-3ppts to reach ~8-9% YoY growth.
In 2019E, we expect the distribution industry growth rate to recover a bit to ~7-8% 1) with comple-
tion of the two-invoice system (i.e. the impact on their internal transfer business will be alleviated);
and 2) completion of the chemical generics quality and efficiency consistency assessment (i.e.
enhanced generics’ bargaining power). We expect the top three players to continue to gain mar-
ket share by acquiring small and medium pure distributors and benefit from the two-invoice sys-
tem, which calls for consolidation. That is, we expect the top leading players to continue to grow
at a higher-than-average pace for the distribution industry.
Overall, if we look at it from a macro perspective, as medical reform policies are implemented and
consolidation in the pharmaceutical wholesale industry accelerates, the Chinese pharmaceutical
distribution market will show the following trends: 1) pharmaceutical supply chain management
will be upgraded; 2) capital markets will play a bigger role in the integration of enterprises; 3) the
cross-border integration of pharmaceuticals will continue; 4) and there will be continued industry
consolidation.
Distribution industry 2018 outlook
2018 will be the bottom for the
distribution sub-segment. Leading
distributors are expected to con-
tinue to outpace the market
growth rate.
19
Fragmented nature of the distribution industry
The PRC pharmaceutical distribution market is highly fragmented, with more than 13,000 distribu-
tors as of 2014, most of which distribute locally. In the past few years, driven partly by stricter
GSP rules that have disqualified many smaller pharmaceutical distributors and favorable govern-
ment policies that have encouraged consolidation, the PRC pharmaceutical distribution industry
has undergone significant consolidation. The market share of the top five pharmaceutical distribu-
tors in the PRC pharmaceutical distribution market increased from ~33% in 2011 to ~45% in
2017. However, this market remains fragmented compared to those of more developed countries.
For example, the top three pharmaceutical distributors in China accounted for only <40% of the
PRC pharmaceutical distribution market by sales in 2017, as compared to over 90% in the United
States.
In summary, on the positive side, we believe there is still plenty of room for distribution industry
consolidation, and fierce competition will benefit the leading players, which have more resources
to develop retail and e-commerce business. On the other hand, distributors will face systematic
industry-wide risks, such as medical reform policy uncertainties, which will affect downstream
demand.
Figure 8: China pharmaceutical distribution market share in 2017
Source: Frost & Sullivan, CGIS research estimate
Note: The top three refers to Sinopharm, CR Pharm and Shanghai Pharm.
The distribution sector is frag-
mented compared with the devel-
oped market, i.e. plenty of room
for consolidation.
Top three, 39.0%
Others, 61.0%
Top three
Others
20
Sinopharm is the largest pharmaceutical distributor in terms of revenue, with CR Pharm the se-
cond and Shanghai Pharm the third. Sinopharm is the cost leader with highest gross margin as a
result of economies of scale. As Figure 10 shows, Sinopharm has the largest sales network.
Comparison of the top three distributors
Figure 9: Revenue comparison of the top three pharmaceutical distributors
Source: Company, CGIS research
Sales network Provinces Hospitals Small medical institutions Retail terminals Total
Sino pharm 31 14,279 112,041 74,108 200,428
CR pharm 27 5,085 32,164 21,789 59,038
Shanghai Pharm 22 n.a n.a n.a 27,712
Source: Company, CGIS research
Figure 10: Sales network comparison of the top three pharmaceutical distributors
1H2017 Currency Distribution revenue (m) YoY Gross profit GPM
Sino pharm RMB 130,393 9.0% n.a 6.5-7%*
CR pharm HKD 69,070 10.2% 4,485 6.5%
Shanghai Pharm RMB 56,615 9.8% 3,431 6.06%
* Estimate by CGIS research
21
Investment thesis of Sinopharm
1) Distribution business product mix upgrade
Going forward, the Company is set to upgrade its product mix by introducing more high-margin
medical device distribution business (expected to account for ~7% of 2017 total revenue). The
distribution margin for medical devices is higher than that of drugs, so we believe its fast growth
will help the Company stabilize its margins in a tough environment, but accounts receivables may
lengthen. We estimate that the medical device distribution business will contribute 8.3%/9.7% of
total revenue in 2018/19E, and as a result of its higher margin than that for drug distribution, we
expect flat gross margin of 8% in 2018/19E, even under price-cutting pressure and terminal medi-
cal insurance cost controls.
2) Retail business offers fast growth
Sinopharm’s unique advantages (capital, relationship with local governments, etc.) in capturing
drug retail business opportunities brought about by the zero price mark-up policy (making drug
sales a cost centre for hospitals instead of the previous profit centre, thus encouraging hospitals
to outsource drug sales to retail stores) will enable it to deliver 20% segment revenue growth in
2018/19. We project its segment profit contribution will increase from 3.2% in 2017 to 4% in 2019.
3) More bargaining power after the generics consistency assessment
The chemical generics quality and efficiency consistency assessment is required to be completed
by 2018. We expect some generics manufacturers’ bargaining power in tenders to increase after
completion of the Quality and Efficacy Consistency Evaluation, which will help stabilize Si-
nopharm’s margins.
4) The two-invoice system will increase the leading players’ market share in the long run
The policy most affecting the distribution sub-sector is the two-invoice system, which calls for
fewer distribution layers and more distribution consolidation. We expect to see consolidation in
the distribution sub-segment, as the core value for big distributors lies in their logistics network
coverage. The government wants to push the two-invoice system in the pharmaceutical distribu-
tion field to compress the drug-distribution process to serve patients and national medical insur-
ance fund more effectively with reasonable drug prices. Based on the spirit of the two-invoice
system, we expect to see distributor consolidation as:
i. we expect to see fewer small companies with no upstream or downstream sales network
survive; and
ii. the most promising way out for small-to-medium size companies with certain resources is to
seek coordination with the leading distributors or be acquired by big players. This basically
offers plenty of M&A opportunities for the leading players with an acquisition cost as low as 5
-8x PER.
Thus, in the long run, after gaining market share and completing industry consolidation, the lead-
ing players should have better economies of scale and better cost control, allowing them to bene-
fit from China’s overall healthcare industry growth.
22
Earnings projection
1) Drug distribution revenue growth to bottom out in 2018
Overall, we expect drug distribution business revenue in 2018E to grow at a slower pace than in
2017E, at about 8%, but still higher than the industry average of ~6-7%, considering its leading
position and economies of scale as we stated earlier.
In 2019E, we expect the drug distribution business growth rate to rebound to about ~9% (~2 ppts
faster than distribution industry average growth) with 1) the completion of the execution of the two
-invoice system, as its associated impact on Sinopharm internal transfer business will be alleviat-
ed; and 2) the completion of the chemical generics quality and efficiency consistency assessment
by end-2018, when the bargaining power of drug manufacturers is expected to improve.
2) Fast growth of high-margin medical device distribution business
The medical device distribution business delivered ~40% YoY revenue growth in 2017, and we
expect this robust growth to continue with Sinopharm putting more resources into it. As a result,
we project the revenue percentage of medical device distribution will increase from 7% in 2017E
to 8.3/9.7%% in 2018/19E, respectively.
3) Robust growth of retail business an emerging growth driver
Retail business has achieved high-teen top-line growth in the past few years. We expect this
growth momentum to continue in 2018E and 2019E due to 1) M&A; 2) expansion of retail stores;
and 3) zero price mark-up, which motivates hospitals to outsource drugs sales to retail stores or
other third parties, which will open up huge opportunities for retail business, especially for Si-
nopharm, given its sales network, capital, cost management and economies of scale advantages.
Therefore, we project that Sinopharm will deliver ~20%/20% retail revenue growth in 2018/19E
and that the retail business profit contribution will increase from 3.2% in 2017 to 4% in in 2019E.
Drugs distribution
88%
Medical device distribution
7%
Retail4%
Other business1%
Figure 11: 2017E revenue breakdown
Source: CGIS research estimate
Drugs distribution
86%
Medical device
distribution
8%
Retail5%
Other business
1%
Figure 12: 2018E revenue breakdown
Source: CGIS research estimate
23
Earnings projection (Cont.’)
4) Gross margins to largely remain stable
Looking ahead, Sinopharm’s gross margin will remain under pressure in 2018E and 2019E, given
1) secondary price negotiation by hospitals; 2) uncertainty related to medical insurance fund reim-
bursement standards (i.e. if the reimbursement standards are too stringent, it will motivate hospi-
tals to further control their drugs/medical device procurement costs); and 3) the 30% drugs sales
cap on hospitals. On the other hand, as we expect fast growth in the high-margin medical device
distribution business, this will help alleviate margin pressure.
On the basis of these factors, we expect the gross margin to remain stable at 8% in 2017E
(excluding the impact of the disposal of drug manufacturing assets in 1H2017). We expect the
gross margin to remain largely stable at 7.95% in 2018/19E.
5) SG&A expenses ratio
Considering the Sinopharm economies of scale and historical premium cost control practices, we
expect it to continue execute good cost management in 2018E/19E.
Hence, we expect the total SG&A ratio of the Company to decline from ~4.2% in 2017E to 4.1%
in 2018E and further to 4% in 2019E.
24
Financial summary
In summary, the distribution segment has a gross margin ranging from 6.5%-7%, the highest among
the top three distributors as a result of economies of scale. Sinopham's retail business has a gross
margin of ~26%, making the Company’s overall gross margin ~8%. The segment profit margin of
pharmaceutical distribution is ~4%, close to gross margin of 6.5-7%, while the retail business gross
margin is 26% vs. operating margin of ~4%, implying that the retail business needs far more SG&A (in
terms of segment revenue percentage). Thus, the outcome of the Company’s future cost control strat-
egy is sensitive to its retail business cost management.
We expect the Company to continue its premium cost control execution practice (i.e. SG&A) in 2018-
2019. Overall, CGIS research projects EPS CAGR of 11.1% for Sinopharm in 2016-2019E, faster than
the expected industry average of ~8-9%, implying the Company will continue to gain market share and
benefit from consolidation. EPS growth will come from 1) revenue growth from the fast-growing medi-
cal device and retail business; 2) stable gross margin; 3) good SG&A cost control; and 4) ~1-2ppts
from M&As of small to medium distributors as a result of the two-invoice system.
2015 2016 2017E 2018E 2019E
Segment revenue 228,673 258,388 278,973 307,081 341,651
Pharmaceutical distribution 215,597 243,883 263,313 288,674 319,986
Retail 8,715 10,202 11,811 14,174 17,008
Other business 4,361 4,303 3,848 4,233 4,656
Segment profit 9,247 10,273 11,012 12,126 13,493
Pharmaceutical distribution 8,413 9,373 10,119 11,094 12,297
Retail 216 298 354 439 544
Other business 618 602 538 592 651
Segment profit margin 4.0% 4.0% 3.9% 3.9% 3.9%
Pharmaceutical distribution 3.9% 3.8% 3.8% 3.8% 3.8%
Retail 2.5% 2.9% 3.0% 3.1% 3.2%
Other business 14.2% 14.0% 14.0% 14.0% 14.0%
Retail Other
Pharmaceutical distribution
80.9%
Retail14.7%
Other business
4.4%
Figure 13: 2018E gross profit estimated breakdown
Source: CGIS research estimate
Figure 14: Sinopharm margin breakdown
Source: Company, CGIS research
25
Valuation
Sinopharm underperformed the market in 2017, as the market may have been concerned about the
short-term impact of the two-invoice system. It historically trades at ~16x, but now it is trading at
close to two standard deviations below its historical average (Figure 13). We believe the Company
will bottom out in 2018 and trigger a re-rating for the following reasons: 1) a distribution product
upgrade with more high-margin medical device distribution; 2) further cost control; 3) more M&A to
facilitate economies of scale; 4) retail business opportunities from the zero price mark-up policy; 5)
relief in 2018 from the short-term negatives related to the two-invoice system (on its internal transfer
business); and 6) completion of the chemical consistency evaluation, which is expected to enhance
the bargaining power of some generics.
We set our target price at HK$40.9, equivalent to 17x 2018E PER, close to both Sinopharm’s histor-
ical average (~16.2x, Figure 15) and the industry average (15-16x, Figure 2).
Figure 15: Sinopharm historical PE band
Source: Bloomberg
20.0
25.0
30.0
35.0
40.0
45.0
50.0
6/2
015
9/2
015
12
/201
5
3/2
016
6/2
016
9/2
016
12
/201
6
3/2
017
6/2
017
9/2
017
12
/201
7
HK$
14.6X
19.4X
17.8X
16.2X
13.0X
26
1) Tender price cuts
The macro trend of drug tenders is price cuts, caused by medical reform policies. Some provinc-
es, such as Jiangxi, Zhejiang, Guangdong and Fujian, use provincial centralized drug procure-
ment, as in recent years the burden of medical fund deficits has become heavier, so the govern-
ments intend to cut drug prices to alleviate pressure on medical funding.
Also, the new medical insurance cost controls regulate medical reimbursement based on a cer-
tain percentage of patients’ qualified drugs and medical consumables to prevent abuse and over-
treatment. When the profit of upstream manufacturers is squeezed, the distributors will be forced
to share the burden, so their margins will be adversely impacted.
2) Drugs sales percentage not exceeding 30%
Starting in 2015, the State Council has stated that the drug sales percentage for the 100 trial cit-
ies public hospitals must be within 30% of total sales by the end of 2017. This policy is gradually
spreading nationwide. Usually the lower tier a hospital is, the higher the drug percentage. Accord-
ing to our channel checks, some county level hospitals’ drugs sales percentage could reach as
high as 50%-70%, far exceeding the 30% set by the authorities. When the drug sales percentage
becomes an important criteria for doctors’ appraisals, they have motivation to reduce the percent-
age, which can be done in several ways: 1) over-prescribing unnecessary medical screenings,
checks, etc; 2) using secondary price negotiation to reduce the cost of drugs; and 3) having pa-
tients buy the drugs from retail stores, since the drugs bought by patients outside are NOT count-
ed into hospitals’ drugs sales percentage).
Therefore, when downstream hospitals have a big incentive to force drug prices down, distribu-
tors will faces lower logistics fees from drugs manufacturers, so both their distributor margins and
their drug logistics shipment volume will be adversely impacted.
3) Zero price mark-up policy
When hospitals have cash flow pressure under the zero price mark-up policy (except for CTM),
they have an incentive to extend payables to distributors. Sinopharm will therefore have pressure
from prolonged AR days and associated increased finance costs.
4) Two-invoice system short-term impact
The two-invoice system will put short-term pressure on the drug distribution industry growth rate
due to market consolidation, since in the short term, small players will exit the market and thus
their channel inventory will need to be digested, impacting upstream shipments. Also, distributors’
internal transfer business will be affected.
Investment Risks
27
Overall, we believe that the risks are manageable and that they have already been largely per-
ceived by the market. We believe that unless the ongoing risks are more serious than the market
expects, they shouldn’t put pressure on the share price. Based on our channel check, practical
execution of the stringent policies may take longer than expected. For example, some lower-tier/
county-level hospitals cannot reduce the drugs sales percentage to <30% in a short time since
they cannot provide high value-added medical services and their drugs sales percentage may
stay high at >70%. Therefore, they are likely to take more time than expected to complete the
hospital reforms, so the negatives of hospital reforms will be spread over a longer time frame and
the impact will be delayed until after 2018/19.
Investment Risks (Cont.)
28
Shareholder structure
Source: Company
29
China Traditional Chinese Medicine Co. [570.HK]
BUY (Unchanged)
Close: HK$4.53 (Jan 04, 2018)
Target Price: HK$5.72 (+26.3%)
Price Performance
Market Cap US$2567.6m
Shares Outstanding 4,431.5m
Auditor KPMG
Free Float 45.7%
52W range HK$3.48-4.76
3M average daily T/O US$4.6m
Major Shareholding CNPGC (36.0%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research estimates
China Healthcare Sector The CCMG and finished TCM drugs businesses are well on track. The Company is also
actively acquiring upstream TCM manufacturers, i.e. vertical integration and economies of
scale. We believe market concern about former executive director and managing director
Yang Bin’s potential unloading of his 243m shares (5.5% of total outstanding) should NOT
be an overhang, as the Company is trying to help Yang unload the shares by introducing
strategic investors rather than dumping them in the secondary market. More importantly,
while the market has re-rated the healthcare sector sharply in the past few months, especial-
ly innovative drugs, we see a catch-up opportunity for CTCM in 2018, given its attractive
valuation among all the healthcare players (15/12.6/10.9x 2017/18/19E PER vs. projected
18% EPS CAGR in 2016-19E). Also, CTCM’s valuation is equivalent to only ~40% of that of
the leading innovative drugs players. We maintain our Target Price of HK$5.72 (16x 2018E
PER) and BUY recommendation and choose it as our 2018 top pick.
Investment Highlights
CCMG’s strong growth to continue: We maintain our positive view that CCMG will
continue to deliver >20% CAGR in 2H2017E and 2018E because of 1) expected fast
growth from non-TCM hospitals, as CCMG is not included in the drugs sales revenue
percentage for public hospitals, and CCMG can be marked up by up to 25% under the
zero price mark-up policy; 2) fast growth from lower-tier hospitals through hospital cov-
erage expansion and an increase in average sales per hospital; and 3) expected fast
growth of sales through medicine dispensing machines. This sales channel currently
accounts for ~30% of total CCMG sales and can reduce hospitals’ TCM decoction piec-
es management cost and greatly facilitate CCMG prescriptions.
Whether the CCMG market opens up or not, both are good for CTCM: As far as we
know, the CCMG market opening-up policy does not have a clear schedule yet. Before
the market opens up, the existing five players can continue to benefit from the oligopo-
listic market structure and fast CCMG market growth. After the market opens up, it will
be a trade-off between sharply enlarged market volume (more hospitals qualified to sell
CCMG) and increased competition. Based on our understanding, there will be a three-
year transitional period for the existing players and entry barriers for newcomers, i.e.
CTCM’s CCMG growth perspective is still visible and high-teen revenue growth can still
be expected after the CCMG license opens up to more players.
TCM finished drugs stable. Despite the impact from weak downstream demand as a
result of medical reforms, we expect TCM finished drugs to deliver single-digit growth in
next few years given 1) back-to-normal channel inventory; and 2) strong growth of
some key non-OTC products.
Promising CCMG outlook, Maintain BUY.
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMBm) 3,709 6,533 8,145 9,403 10,685
Net profit (RMBm) 546 967 1,152 1,371 1,589
Core net profit (RMBm) 536 974 1,152 1,371 1,589
Core net margin (%) 14.4 14.9 14.1 14.6 14.9
Core EPS (RMB) 0.145 0.220 0.260 0.309 0.358
YoY(%) -12.4 51.3 18.4 19.0 15.8
PER (x) 26.9 17.8 15.0 12.6 10.9
PBR (x) 1.6 1.5 1.4 1.3 1.2
ROE(%) 7.5 8.6 9.6 10.6 11.3
EV/EBITDA (x) 19.4 10.5 9.4 7.5 6.2
0
100
200
300
400
500
600
700
800
3
3.5
4
4.5
5
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
30
Key financials
Source: Company data, CGIS Research estimates
Balance Sheet Profit and Loss
As at Dec 31 Year ended Dec 31
(RMBm) (RMBm)
Cash & cash equivalents 2,138 3,423 5,319 6,057 6,155 CCMG 979 4,359 5,331 6,397 7,484
Inventories 1,236 1,894 1,626 1,674 1,819 TCM finished drugs 2,731 2,174 2,248 2,326 2,396
Accounts receivable 3,398 2,716 3,191 3,539 3,869 TCM decoction pieces - 463 555 655
Others 106 37 37 37 37 TCM healthcare complex - 104 125 150
Current assets 6,878 8,070 10,172 11,307 11,880 Revenue 3,709 6,533 8,145 9,403 10,685
Property, plant and equipment 1,974 2,356 2,527 2,570 2,541 Cost of goods sold (1,509) (2,745) (3,613) (4,184) (4,787)
Intangible assets 6,680 6,764 6,836 6,876 6,915 Gross profit 2,201 3,788 4,532 5,219 5,898
Goodw ill 3,341 3,456 3,456 3,456 3,456 Other gains / (losses) 128 82 34 39 44
Others 335 390 391 392 392 Marketing expenses (1,196) (1,968) (2,240) (2,567) (2,917)
Non-current assets 12,331 12,966 13,210 13,294 13,304 Admin & other expenses (385) (517) (626) (714) (807)
Operating profit 761 1,377 1,699 1,976 2,218
Total assets 19,209 21,037 23,382 24,601 25,184 Net interest income / (expense) (70) (73) (183) (170) (124)
Non-operating items (2) 0 1 1 1
Accounts payable 2,677 2,304 2,349 3,138 3,590 Pretax income 689 1,304 1,517 1,807 2,095
ST borrow ings 1,600 1,001 5,223 4,476 3,254 Income taxes (119) (217) (239) (285) (331)
Others 208 202 202 202 202 Non-controlling interests (24) (120) (125) (150) (176)
Current liabilities 4,485 3,507 7,773 7,816 7,046 Net profit 546 967 1,152 1,371 1,589
Long-term debts 850 423 0 0 0 Core net profit 536 974 1,152 1,371 1,589
Others 1,733 4,351 1,866 1,866 1,866
Long-term liabilities 2,583 4,774 1,866 1,866 1,866 EBIT 725 1,264 1,575 1,826 2,043
EBITDA 921 1,714 1,956 2,263 2,528
Total liabilities 7,068 8,281 9,638 9,681 8,912
EPS (RMB) 0.148 0.218 0.260 0.309 0.358
Shareholders' equity 11,133 11,588 12,451 13,476 14,653 Core EPS (RMB) 0.145 0.220 0.260 0.309 0.358
Minority interests 1,007 1,168 1,293 1,443 1,619 DPS (HK$) 0.000 0.100 0.104 0.093 0.108
Total equity 12,140 12,756 13,743 14,919 16,272 Payout ratio 0.000 40.2% 40.0% 30.0% 30.0%
Cash Flow Key Ratios
Year ended Dec 31 Year ended Dec 31 2015A 2016A 2017E 2018E 2019E
(RMBm) Growth (% YoY)
Profit before tax 689 1,304 1,517 1,807 2,095 Sales 40.0 76.1 24.7 15.4 13.6
Depr & amortization 160 337 257 287 310 Operating profit 37.9 80.9 23.4 16.3 12.2
Change in w orking cap. (195) (349) (161) 393 (23) EBITDA 37.3 86.0 14.2 15.7 11.7
Income tax paid (149) (217) (239) (285) (331) Core net profit 27.4 81.8 18.4 19.0 15.8
Others 14 389 182 170 123 Core EPS (12.4) 51.3 18.4 19.0 15.8
Operating cash flow 519 1,463 1,556 2,371 2,174 Profitability (%)
Gross margin 59.3 58.0 55.6 55.5 55.2
Capex (238) (760) (500) (370) (320) Operating margin 20.5 21.1 20.9 21.0 20.8
Cash for acquisition of subsidiaries (7,452) (742) 0 0 0 EBITDA margin 24.8 26.2 24.0 24.1 23.7
Change in other assets 531 (1,065) 0 0 0 Core net profit margin 14.4 14.9 14.1 14.6 14.9
Investment cash flow (7,158) (2,567) (500) (370) (320) ROA 4.4 4.8 5.2 5.7 6.4
ROE 7.5 8.6 9.6 10.6 11.3
Net change in debt 1,202 1,460 1,313 (747) (1,221) Balance sheet ratios
Proceeds from new shares 7,200 0 0 0 0 Current ratio (X) 1.5 2.3 1.3 1.4 1.7
Others (72) (84) (473) (516) (535) Quick ratio (X) 0.5 1.0 0.7 0.8 0.9
Financing cash flow 8,330 1,375 840 (1,263) (1,756) Cash ratio (X) 0.5 0.7 0.6 0.7 0.7
Trade & bill receivables days 87 69 63 64 62
Net change in cash 1,691 272 1,895 739 98 Trade & bill payable days 50 53 54 52 52
Cash at beginning of the year 439 2,102 2,373 4,269 5,007 Inventory turnover days 200 208 178 144 133
Effect from foreign exchange (28) 0 0 0 0 Total debt to equity ratio (%) 22.0 24.2 41.9 33.2 22.2
Cash at the end of the year 2,102 2,373 4,269 5,007 5,105
2017E
2015A 2016E 2017E
2015A 2016A 2017E 2019E
2018E
2018E 2019E
2019E
2018E2015A 2016A
31
CSPC Pharmaceutical Group [1093.HK]
BUY (Unchanged)
Close: HK$17.6 (Jan 04, 2018)
Target Price: HK$20 (+13.6%)
Price Performance
Market Cap US$14053.3m
Shares Outstanding 5,911.0m
Auditor Deloitte
Free Float 77.1%
52W range HK$8.17-17.2
3M average daily T/O US$39.9m
Major Shareholding Mr. Cai Dongchen and
management (30.0%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research
China Healthcare Sector We expect innovative drugs to continue to drive the Company’s growth. With a promising inno-
vative drug product mix focusing on cardio-cerebrovascular (CCV) and oncology, together with
a rich R&D product pipeline, we expect the Company to continue its robust growth in 2018.
We maintain our numbers and BUY recommendation and choose it as one of our key picks in
the sector this year, considering that 1) despite the market’s structural re-rating of the
healthcare sector, we believe CSPC still looks relatively attractive for southbound investors, as
its closest peer, Hengrui [600276.CH], also a leading player in the sector, is trading at >50x
2018E PER, a 70% premium to CSPC; and that 2) investors have limited alternatives which fit
the core healthcare investment thesis of innovative drugs benefiting from stringent industry
policies. Therefore, we believe the re-rating of CSPC will continue in 2018. We raise our Tar-
get Price from HK$17.13 (30x 2018E PER) to HK$20, or 35x 2018 PER, given an expected
26.3% EPS CAGR in 2016-2019E by CGIS research, equivalent to 1.3x PEG, also compara-
ble to its A-share peers’ average of ~32x. Our target multiple is still lower than the valuation of
Hengrui by >30%.
Investment Highlights
Innovative drugs to continue strong growth: CSPC’s innovative drug portfolio consists
of two CCV drugs, one neurology drug and four relatively new oncology drugs. Innovative
drugs are part of a fast-growing market, in which NBP’s intended stroke market and Ou-
laining’s intended oxiracetam market are expected to achieve >20% CAGR in 2014-
2020E. The oncology drug Duomeisu is continuing to gain market share from Libod, pro-
duced by Fudan Zhangjiang, via more market promotion efforts. Duomeisu’s market
share of the liposome doxorubicin market increased from 30% in 2012 to >50% in 2017.
Overall, with increasing hospital coverage and improved doctors’ recognition, we expect
CSPC innovative drugs to outperform and drive the Company’s growth. We expect the
contribution of innovative drugs to gross profit to increase from 59% in 2015 to 77% in
2018E.
Strong R&D pipeline: Currently CSPC has over 170 drugs under development, of which
14 are new class 1 drugs, 46 are new class 3 drugs and 17 are US ANDA drugs. About 3-
5 drugs will be launched each year per management. We expect the continuous launch of
new products to fuel the Company’s growth. Specifically, Paclitaxel-albumin is the most
promising candidate expected to come out in 2018, with its strong growth potential com-
ing from replacing the original paclitaxel market.
Stable contribution from generics and APIs: We expect slight GPM improvement each
year through generics product mix changes. Vitamin C and caffeine, in particular, remain
strong cash cows for the Company.
Growth story remains intact, maintain BUY.
0
100
200
300
400
500
600
700
800
0
5
10
15
20
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015 2016 2017E 2018E 2019E
Turnover (HK$ m) 11,394 12,369 15,053 17,747 20,654
Core net profit (HK$ m) 1,678 2,101 2,746 3,455 4,299
Core net margin (%) 14.7 17.0 18.2 19.5 20.8
Core EPS (HK$) 0.284 0.352 0.454 0.571 0.710
YoY change 32.6 24.1 28.7 25.8 24.4
PER (x) 62.0 49.9 38.8 30.8 24.8
PBR (x) 11.9 10.3 8.6 7.1 5.9
ROE(%) 19.2 20.8 22.6 23.5 24.1
EV/EBITDA (x) 37.3 31.6 24.5 19.6 15.7
32
Key financials
Source: CGIS Research estimates
Balance Sheet Profit and Loss
As at Dec 31 Year ended Dec 31
(HK$m) (HK$m)
Cash & cash equivalents 2,306 3,238 3,572 4,999 6,822 Innovative drugs 3,774 4,774 6,377 8,505 10,954
Inventories 1,819 1,933 1,716 1,944 2,163 Generics 4,019 4,193 4,612 4,935 5,182
Accounts receivable 1,878 1,835 2,803 3,269 3,770 Bulk medicines 3,600 3,402 4,063 4,307 4,518
Others 1,645 1,422 1,954 2,215 2,574 Revenue 11,394 12,369 15,053 17,747 20,654
Current assets 7,648 8,428 10,045 12,427 15,330 Cost of goods sold (6,173) (6,060) (6,113) (6,924) (7,705)
Property, plant and equipment 5,143 5,415 5,742 6,227 6,828 Gross profit 5,221 6,309 8,940 10,823 12,949
Intangible assets 96 79 154 241 333 Other gains / (losses) 87 107 120 90 90
Others 653 838 872 882 895 Marketing expenses (2,267) (2,788) (4,079) (4,792) (5,577)
Non-current assets 5,892 6,333 6,768 7,350 8,055 Admin expenses (535) (554) (662) (763) (888)
R&D and other expenses (339) (424) (828) (994) (1,157)
Total assets 13,540 14,760 16,814 19,777 23,385 Operating profit 2,166 2,649 3,490 4,365 5,418
Net interest income / (expense) (56) (42) (47) (44) (43)
Accounts payable 2,489 2,938 2,666 3,099 3,509 Share of results of JV & associates 11 28 23 25 28
ST borrowings 452 898 815 778 755 Non-operating items (9) 0 0 0 0
Others 544 249 491 511 566 Pretax income 2,112 2,635 3,467 4,345 5,402
Current liabilities 3,484 4,085 3,972 4,388 4,831 Income taxes (432) (522) (700) (869) (1,080)
Non-controlling interests 14 12 20 21 22
Long-term debts 1,011 240 349 333 324 Net profit 1,665 2,101 2,746 3,455 4,299
Others 232 244 244 244 244 Core net profit 1,678 2,101 2,746 3,455 4,299
Long-term liabilities 1,243 484 593 577 568
EBITDA 2,772 3,233 4,153 5,126 6,295
Total liabilities 4,727 4,569 4,565 4,965 5,399
EPS (HK$) 0.282 0.352 0.454 0.571 0.710
Shareholders' equity 8,738 10,108 12,145 14,687 17,838 Core EPS (HK$) 0.284 0.352 0.454 0.571 0.710
Minority interests 75 84 104 125 148 DPS (HK$) 0.110 0.120 0.154 0.194 0.242
Total equity 8,813 10,191 12,249 14,812 17,986
Cash Flow Key Ratios
Year ended Dec 31 Year ended Dec 31 2015A 2016A 2017E 2018E 2019E
(HK$m) Growth (% YoY)
Profit before tax 2,112 2,635 3,467 4,345 5,402 Sales 4.0 8.6 21.7 17.9 16.4
Depr & amortization 605 510 663 761 877 Operating profit 29.4 22.3 31.7 25.0 24.1
Change in working cap. 106 335 (1,313) (502) (614) EBITDA 24.4 21.3 16.6 28.5 23.4
Income tax paid (476) (522) (700) (869) (1,080) Core net profit 32.6 25.2 30.7 25.8 24.4
Others (10) (44) (47) (57) (70) Core EPS 32.6 24.1 28.7 25.8 24.4
Operating cash flow 2,337 2,913 2,070 3,679 4,515 Profitability (%)
Gross margin 45.8 51.0 59.4 61.0 62.7
Capex (669) (824) (1,050) (1,318) (1,555) Operating margin 19.0 21.4 23.2 24.6 26.2
Change in other assets 60 20 (1) 32 42 EBITDA margin 24.3 26.1 27.6 28.9 30.5
Investment cash flow (608) (804) (1,051) (1,287) (1,512) Core net profit margin 14.7 17.0 18.2 19.5 20.8
ROA 12.4 14.2 16.3 17.5 18.4
Net change in debt 237 (325) 25 (53) (32) ROE 19.2 20.8 22.6 23.5 24.1
Others (591) (650) (709) (913) (1,148) Balance sheet ratios
Financing cash flow (354) (975) (684) (965) (1,180) Current ratio (X) 2.2 2.1 2.5 2.8 3.2
Quick ratio (X) 0.8 0.8 1.0 1.3 1.6
Net change in cash 1,375 1,135 335 1,427 1,823 Cash ratio (X) 0.8 0.8 1.0 1.3 1.6
Cash at beginning of the year 1,468 2,299 3,235 3,570 4,997 Trade & bill receivables days 52.2 52.2 54.1 55.7 56.0
Effect from foreign exchange 0 (154) 0 0 0 Trade & bill payable days 50.4 47.5 53.2 47.0 47.6
Cash at the end of the year 2,299 3,235 3,570 4,997 6,820 Inventory turnover days 107.2 113.0 109.0 96.5 97.3
Total debt to equity ratio (%) 16.6 11.2 9.5 7.5 6.0
2016A 2017E2018E 2019E 2019E
2019E
2015A 2016A 2017E
2015A 2016E 2017E
2018E
2018E
2015A
33
HEC [1558.HK]
HOLD (Downgraded from BUY)
Close: HK$30.05 (Jan 04, 2018)
Target Price: HK$27.8 (-7.5%)
Price Performance
Market Cap US$1737.3m
Shares Outstanding 2,532.3m
Auditor E&Y
Free Float 36.6%
52W range HK$14.76-30.05
3M average daily T/O US$2.7m
Major Shareholding CS Sunshine Investment
(28.3%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research
China Healthcare Sector
In 2018, we expect the Company’s growth to continue to be driven by Kewei (anti-flu). Its
second generation insulin will take time to contribute meaningful profit to the Company.
Given its expected 17% EPS CAGR in 2017-2019E, driven mainly by Kewei, we believe
that its recent share price rally reflects its growth potential and that its current valuation of
23/19x 2017/18x PER, i.e. 1.1x PEG, is fair. Considering that the Company’s future
growth will rely largely on its existing product Kewei, while its new insulin products are
still far from making a meaningful profit contribution, we believe the Company’s further re
-rating room may be limited. Thus, we keep our numbers and our Target Price of
HK$27.8 (18x 2018 PER). Downgrade to HOLD.
Investment Highlights
Kewei growth expected to catch up in 2H17: Recall that in 1H2017 Kewei granu-
lar sales grew 17.1% to RMB372m, and capsule sales increased 29.2% to
RMB185m, i.e. overall Kewei sales grew 20.8% YoY, which lagged behind market
expectations and the Company’s full-year guidance of ~30%-40% growth YoY,
dragged down mainly by sales in Guangdong and Fujian due to a sales structure
change (these two provinces account for ~30% of total Kewei sales). However, we
expect Kewei sales to catch up in 2H2017 through recruiting more salesmen (from
currently ~600 to 800-1000 by end-2017) to boost sales in the traditional low season
(July-November) and exploit new markets in Chengdu, Xi’an, Beijing, etc. Overall,
we expect Kewei to deliver ~29/23/19% YoY revenue growth in 2017/18/19E and
account for ~79/80/82% of total revenue.
Margin improvement to continue: We see a largely improved gross margin in
1H2017 because of 1) economies of scale, and 2) HEC’s shifting some raw materi-
als from third-party procurement to in-house production. The gross margin thus im-
proved from 75.5% in 1H16 to 81.6% in 1H2017. We expect the >80% gross margin
to be maintained throughout FY2017 and continue in 2018. However, due to the
expected Kewei sales team expansion, we expect the full-year selling expense ratio
to reach ~20% in 2017 and 2018.
Insulin R&D schedule on track: Currently, the expected launch time of 2nd and
3rd generation insulin remains unchanged in 2018 and 2020, respectively. We ex-
pect insulin to contribute to profit starting in 2020.
Growth story remains intact but richly valued, downgrade to HOLD.
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4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMB m) 693 942 1,206 1,449 1,695
Reported net profit (RMB m) 266 381 521 619 716Core net profit (RMB m) 286 381 521 619 716
Core net margin (%) 41.3% 40.4% 43.1% 42.7% 42.2%
Reported EPS (RMB) 0.79 0.84 1.15 1.37 1.58
% Change - 6.6% 36.4% 18.9% 15.6%
Core EPS (RMB) 0.85 0.84 1.15 1.37 1.58
% Change - -0.9% 36.4% 18.9% 15.6%
PER (x) 33.4 31.3 23.0 19.3 16.7
PBR (x) 4.1 4.9 4.0 3.3 2.8
ROE(%) - 16.6 19.2 18.8 18.1EV/EBITDA (x) 21.0 21.6 16.7 13.6 11.2
34
Key financials
Source: Company data, CGIS Research estimates
B alance Sheet P ro f it and Lo ss
Year ended D ec 31 Year ended D ec 31
(R M B m) (R M B m)
Cash & cash equivalents 1,395 1,454 1,144 1,544 2,072 Kewei granluar 322 544 691 843 995
Inventories 155 111 111 138 165 Kewei Capusle 132 192 257 321 392
Trade & note receivables 261 337 434 522 610 Er tongshu 37 45 89 116 139
Others 0 0 0 0 0 Oumeining 50 43 45 45 45
C urrent assets 1,810 1,901 1,690 2,203 2,847 Xinhaining 32 31 32 32 32
PP&E 463 496 516 534 549 Xining 35 37 39 39 39
Prepayments for intangible assets Note 1 290 400 500 600 700 Others 86 51 53 53 53
Others 15 34 855 855 855 R evenue 693 942 1,206 1,449 1,695
N o n-current assets 767 930 1,871 1,988 2,104 Cost o f goods so ld (178) (214) (222) (275) (331)
Gro ss pro f it 515 727 984 1,174 1,365
T o tal assets 2,577 2,831 3,560 4,192 4,952 Other gains / (losses) 16 16 8 8 8
Selling expense (77) (181) (241) (290) (339)
Trade and bills payables 156 182 178 220 264 Admin & other expenses (120) (133) (133) (159) (186)
Other payables 6 28 28 28 28 Other expenses and losses 7 31 0 0 0
ST borrowings 105 70 30 0 0 Operat ing pro f it 340 460 618 732 847
Others 4 4 4 4 4 Finance cost (25) (7) (2) 0 0
C urrent liabilit ies 271 284 239 252 296 Pretax income 315 453 616 732 847
Income taxes (49) (72) (95) (114) (131)
LT borrowings 90 20 0 0 0 Net profit 266 381 521 619 716
Others 73 69 69 69 69 C o re net pro f it N o t e 2 286 381 521 619 716
Lo ng-term liabilit ies 163 89 69 69 69
EBITDA 365 488 648 765 881
T o tal liabilit ies 435 373 308 321 365 Basic EPS (RM B) 0.792 0.844 1.152 1.369 1.583
Fully diluted EPS (RM B) 0.792 0.844 1.152 1.369 1.583
Share capital 451 451 451 451 451 Basic core EPS (RM B) 0.852 0.844 1.152 1.369 1.583
Reserves 1,692 2,007 2,528 3,146 3,862 Fully diluted core EPS (RM B) 0.852 0.844 1.152 1.369 1.583
T o tal equity 2,143 2,458 2,978 3,597 4,313 Dividend (RM B) 0.150 0.300 0.345 0.411 0.475
C ash F lo w Key R at io s
Year ended D ec 31 2015A 2016A 2017E 2018E 2019E Year ended D ec 31 2015A 2016A 2017E 2018E 2019E
(R M B m) Gro wth (% Yo Y)
Profit before tax 315 453 616 732 847 Sales - 35.9 28.1 20.2 17.0
Depreciation & amortization 26 27 30 32 34 Operating profit - 35.5 34.3 18.5 15.6
Change in working cap. (51) (3) (102) (71) (72) EBITDA - 33.5 32.9 18.0 15.2
Income tax paid (57) (52) (95) (114) (131) Core net profit - 33.1 36.7 18.9 15.6
Others 55 (29) 2 0 0 Basic EPS - 6.6 36.4 18.9 15.6
Operat ing cash f lo w 287 397 450 580 678 Core basic EPS - (0.9) 36.4 18.9 15.6
P ro f itability (%)
CAPEX (28) (63) (50) (50) (50) Gross margin 74.3 77.2 81.6 81.0 80.5
Prepayment for intangible assets Note 1 (290) (110) (100) (100) (100) Operating margin 49.0 48.9 51.2 50.5 50.0
Change in other assets (26) (195) (545) 0 0 EBITDA margin 52.7 51.8 53.7 52.7 52.0
Investment cash f lo w (344) (368) (695) (150) (150) Core net profit margin 41.3 40.4 43.1 42.7 42.2
ROA - 14.1 16.3 16.0 15.7
Issuance of shares 1,613 2 0 0 0 ROE - 16.6 19.2 18.8 18.1
Net change in debt (220) (105) (60) (30) 0 B alance sheet rat io s
Others (70) (98) (2) 0 0 Current ratio (X) 6.7 6.7 7.1 8.7 9.6
F inancing cash f lo w 1,323 (201) (62) (30) 0 Quick ratio (X) 6.1 6.3 6.6 8.2 9.1
Cash ratio (X) 5.1 5.1 4.8 6.1 7.0
N et change in cash 1,267 (171) (307) 400 528 Trade & bill receivables days 137 131 131 131 131
Cash at beginning of the year 87 1,354 1,212 905 1,305 Trade & bill payable days 319 311 292 292 292
Effect from foreign exchange 0 30 0 0 0 Inventory turnover days 316 188 183 183 183
C ash at the end o f the year 1,354 1,212 905 1,305 1,833 Total debt to equity ratio (%) 9 4 1 0 0
Net debt to equity ratio (%) Net cash Net cash Net cash Net cash Net cash
Note 2: adjusted by CGIS research
2019E2016A 2017E 2018E
Note 1: for right to use all the relevant knowhow and patents relating to yimitasvir phosphate
and fo llow-up direct anti-viral agent compounds from Sunshine Lake Pharma. Co., Ltd.
(廣東東陽光藥業有限公司) which is a related party o f the Group.Total consideration is RM B700m.
2015A2019E2015A 2016A 2017E 2018E
35
3SBio [1530.HK]
HOLD (Unchanged)
Close: HK$16.94 (Jan 04, 2018)
Target Price: HK$17.1 (+0.9%)
Price Performance
Market Cap US$5500.6m
Shares Outstanding 2,532.3m
Auditor E&Y
Free Float 41.9%
52W range HK$7.28-16.94
3M average daily T/O US$10.3m
Major Shareholding CS Sunshine Investment
(28.3%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research
China Healthcare Sector
Fundamentally, Yisaipu’s growth, TPIAO, EPIAO+SEPO, the insulin business and the resubmission
of Trastuzumab are largely on track. Given its weekly preparation GLP-1 Bydureon has just been
approved by the CFDA, we think the Company deserves to trade at a higher valuation. We raise our
target price of HK$14.73 (27x 2018E PER) to HK$17.1 (30x 2018 PER, complies with expected
26.4% EPS CAGR in 2016-2019E, i.e.1.1x PEG, close to +1sd historical average of ~29x). Maintain
HOLD. We will turn more positive if 1) the new insulin sales team boosts insulin sales; 2) the
Trastuzumab resubmission is completed in Q1 2018; and 3) we see evidence of execution on deliv-
ering Yisaipu and TPIAO’s guided growth in 2018.
Investment thesis
Yisaipu’s growth on track: Yisaipu is used for rheumatoid arthritis (RA). Given 1) the completion of
the sales team change; 2) normal channel inventory (for both distributors and hospitals); 3) provinc-
es beginning to execute the new version NRDL in Sept (Yisaipu included in 2017 NRDL Class B,
reimbursement ratio varies from 75%-85%); and 4) the Yisaipu prefilled syringe expected to apply
for manufacturing approval in early 2018, we maintain our forecast number for Yisaipu and expect it
to deliver mid-single-digit top-line growth in 2017E and 20% top-line growth in 2018E.
TPIAO’s growth potential expected to continue: We expect TPIAO sales to grow 20-25% YoY to
~RMB1.17bn (or 24% of 2018E total revenue) in 2018E on the basis of 1) sales to lower-tier hospi-
tals, as currently 70% of sales are concentrated in ~100 Class III hospitals; and 2) execution of the
NRDL.
EPIAO+SEPO: Overall, we expect EPIAO+SEPO to deliver 5% revenue growth in 2018E, with EPI-
AO delivering single-digit revenue growth and >30% top-line growth of SEPO in its low-end erythro-
poietin market in 2018E. The biggest risk for EPIAO+SEPO growth is the likely more severe ASP
cut pressure (we estimate 5-10% of EPIAO+SEPO in 2018E) due to intense competition.
Diabetes segment growth prospective remains intact: Overall, management’s strategy for insu-
lin segment growth is to expand its sales team to capture the incremental diabetes market rather
than compete with MNCs and local players for existing market share because usually diabetes pa-
tients’ stickiness or loyalty is high due to the chronic nature of the disease. Specifically, Humulin (a
2nd generation insulin) started to consolidate on July 1, 2017. On the revenue side, management
reiterated that Humulin (2016 revenue: ~RMB800m) has a CAGR of ~10% through channel expan-
sion into more lower-tier cities. GLP-1 Byetta’s reported sales of RMB85m in 1H2017, and we ex-
pect 30% revenue CAGR in the next few years since 1) Byetta and Novo Nordisk’s Victoza are the
only two approved GLP-1 drugs in China; 2) Byetta’s patent in China expires in 2020; and 3) this is
the early stage of the product life-cycle in China as Byetta started selling in emerging markets only
in 2013. Overall, we expect the Diabetes segment (including potential Bydureon) to contribute
21.6% of revenue in 2018E.
Trastuzumab re-submission on track: Trastuzumab is used mainly for HER2 for expressed breast
cancer. Regarding the 341 Phase III clinical data, management is confident in the data quality and
reiterated that it had re-submitted the new drug application (NDA) to the CFDA in Q1 2018. We
believe the successful submission of Trastuzumab is a short-term catalyst.
Existing portfolio facing a slowdown. Maintain HOLD.
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(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMB m) 1,673 2,797 3,837 4,957 5,733
Net profit (RMB m) 526 713 915 1,212 1,430
Net margin (%) 31.5 25.5 23.9 24.4 25.0
EPS (RMB) 0.233 0.282 0.361 0.479 0.565
YoY change 55.1 21.0 28.0 32.4 18.0
Core EPS (RMB) 0.249 0.280 0.361 0.479 0.565
YoY change 66.4 12.5 29.2 32.4 18.0
PER (x) 64.6 53.4 41.7 31.5 26.7
PBR (x) 6.0 5.6 5.0 4.3 3.7
ROE(%) 17.1 11.6 13.1 15.1 15.3EV/EBITDA (x) 38.4 22.7 16.4 12.8 11.1
36
Key financials
Source: Company data, CGIS Research estimates
Balance Sheet Profit and Loss
Year ended Dec 31 Year ended Dec 31
(RMBm) (RMBm)
Cash & cash equivalents 1,900 1,040 636 1,373 1,293 Yisaipu - 786 999 1,199 1,439
Inventories 134 262 456 661 728 TPIAO 605 765 933 1,213 1,517
Trade & note receivables 550 786 1,074 1,388 2,580 EPIAO 684 677 691 705 719
Others 179 153 153 153 153 SEPO 44 96 153 214 278
Current assets 2,763 2,241 2,320 3,575 4,755 Byetta - - 180 234 304
PP&E 450 1,763 1,683 1,594 1,498 Bydureon - - - 15 30
Intangible assets 498 2,289 2,594 2,559 2,524 Zhejiang Wansheng 103 223 268 281 295
Goodwill 561 4,126 4,126 4,126 4,126 Humulin - - 350 820 861
Others 2,359 621 612 604 597 Others 238 250 263 276 290
Non-current assets 3,867 8,798 9,015 8,883 8,745 Revenue 1,673 2,797 3,837 4,957 5,733
Cost of goods sold (242) (402) (721) (1,077) (1,223)
Total assets 6,630 11,039 11,334 12,459 13,499 Gross profit 1,431 2,395 3,116 3,880 4,509
Other gains / (losses) 8 59 35 81 93
Trade and bills payables 34 59 108 162 122 Selling expense (586) (1,017) (1,381) (1,760) (2,035)
Other payables 310 502 580 625 658 Admin & other expenses (301) (301) (276) (347) (401)
ST borrowings 405 518 500 500 500 R&D expenses (111) (243) (307) (352) (418)
Others 23 64 64 64 64 Operating profit 441 893 1,187 1,503 1,748
Current liabilities 773 1,144 1,252 1,351 1,344 Net interest income / (expense) 7 (124) (87) (53) (39)
Share of results of JV & associates 4 (12) (9) (8) (7)
LT borrowings 0 2,541 1,800 1,600 1,200 Non-operating items 136 93 0 0 0
Others 222 588 588 588 588 Pretax income 588 850 1,091 1,442 1,703
Long-term liabilities 222 3,129 2,388 2,188 1,788 Income taxes (62) (136) (164) (216) (255)
Non-controlling interests (0) 2 12 14 17
Total liabilities 995 4,272 3,640 3,539 3,132 Net profit 526 713 915 1,212 1,430
Core net profit 561 706 915 1,212 1,430
Shareholders' equity 5,624 6,522 7,438 8,650 10,080
Minority interests 11 244 256 270 287 EBITDA 519 1,054 1,441 1,766 2,020
Total equity 5,635 6,766 7,694 8,920 10,367 Basic EPS (RMB) 0.233 0.282 0.361 0.479 0.565
Fully diluted EPS (RMB) 0.229 0.278 0.356 0.471 0.556
Basic core EPS (RMB) 0.249 0.280 0.361 0.479 0.565
Fully diluted core EPS (RMB) 0.244 0.275 0.356 0.471 0.556
Dividend (RMB) 0.000 0.000 0.000 0.000 1.000
Cash Flow
Year ended Dec 31 2015A 2016A 2017E 2018E 2019E Key Ratios
(RMBm) Year ended Dec 31 2015A 2016A 2017E 2018E 2019E
Profit before tax 588 850 1,091 1,442 1,703 Growth (% YoY)
Depreciation & amortization 77 161 255 263 272 Sales 48.0 67.2 37.2 29.2 15.6
Change in working cap. (59) 492 (355) (420) (1,265) Operating profit 23.6 102.3 32.9 26.7 16.3
Income tax paid (66) (122) (164) (216) (255) EBITDA 32.8 103.2 36.8 22.5 14.4
Others (85) (377) 96 61 46 Core net profit 93.4 25.9 29.6 32.4 18.0
Operating cash flow 455 1,004 922 1,130 499 Basic EPS 55.1 21.0 28.0 32.4 18.0
Core basic EPS 66.4 12.5 29.2 32.4 18.0
CAPEX (896) (5,186) (480) (140) (140) Profitability (%)
Change in other assets (2,352) 805 10 35 33 Gross margin 85.5 85.6 81.2 78.3 78.7
Investment cash flow (3,248) (4,381) (470) (105) (107) Operating margin 26.4 31.9 30.9 30.3 30.5
EBITDA margin 31.0 37.7 37.6 35.6 35.2
Issuance of shares 3,954 0 0 0 0 Core net profit margin 33.5 25.2 23.9 24.4 25.0
Net change in debt (282) 2,654 (759) (200) (400) ROA 12.5 8.0 8.2 10.2 11.0
Others 197 56 (97) (88) (71) ROE 17.1 11.6 13.1 15.1 15.3
Financing cash flow 3,868 2,710 (856) (288) (471) Balance sheet ratios
Current ratio (X) 3.6 2.0 1.9 2.6 3.5
Net change in cash 1,075 (667) (404) 737 (79) Quick ratio (X) 2.5 0.6 0.2 0.8 0.7
Cash at beginning of the year 108 1,299 678 274 1,011 Cash ratio (X) 1.7 0.6 0.2 0.8 0.7
Effect from foreign exchange 116 45 0 0 0 Trade & bill receivables days 100 89 57 88 64
Cash at the end of the year 1,299 678 274 1,011 931 Trade & bill payable days 40 32 33 38 40
Inventory turnover days 177 180 182 189 207
Total debt to equity ratio (%) 7 47 31 24 17
2019E2018E2015A 2016A 2017E2018E2015A 2016A 2017E 2019E
37
China Medical System [867.HK]
HOLD (Unchanged)
Close: HK$18.98 (Jan 04, 2018)
Target Price: HK$16.76 (-11.7%)
Price Performance
Market Cap US$6037.9m
Shares Outstanding 2,487.2m
Auditor Deloitte
Free Float 53.3%
52W range HK$12.08-18.98
3M average daily T/O US$7.9m
Major Shareholding Lam Kong (46.49%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research estimate
China Healthcare Sector CMS stopped Plendil’s revenue downtrend at terminal and achieved strong growth for
key products. Overall, we appreciate the Company’s better-than-expected execution.
However, in the medium term, we still think the existing products face slowdown risks
due to industry-wide ASP cuts, maturity and a high base. Also, Plendil’s expected single
-digit growth makes it hard to support the overall expected high-teen growth of CMS.
Overall, we think CMS’s overall expected high-teen EPS growth outlook on the basis of
its good execution of existing products makes its current valuation premium to its peers
fair (23.3/19.8/17x 2017/18/19E PER), but a more significant re-rating will depend on the
introduction of visible compelling new products to provide a new growth driver. There-
fore, we maintain our forecast numbers. The Company is currently trading at 25/21/18x
2017/18/19E PER, given its lack of new growth drivers for the foreseeable future. We
believe upgrading room for the Company is limited, given its expected EPS CAGR of
17% in 2017-2019, i.e. already 1.2x PEG. We raise our Target Price from HK$13.62 to
HK$16.76 (18x 2018 PER) as we roll over our base year to 2018. Maintain HOLD.
Investment Highlights
Existing products face a slowdown: Going forward, we maintain a positive view
on its existing products, but given industry-wide tender ASP cuts, maturity, and the
large revenue base of the products themselves, we expect to see a gradually slow-
er revenue growth pace from ~18% in 2018E to 15% in 2019E and further down to
14% in 2020E.
Plendil: The market focus was placed on Plendil (for hypertension) after its 20-year
exclusive distribution rights were acquired from AstraZeneca (AZ) in 2016 for
US$310m. What is worth noticing is that CMS stopped Plendil’s revenue downtrend
at terminal thanks to the Company’s strong academic marketing capability, which
we believe reinforced market confidence and cleared some of its growth visibility
uncertainties. The Company plans to expand Plendil’s hospital coverage (Plendil’s
current sales focus is mainly on ~1,000 key hospitals and CMS wants to expand
this to 5,000-6,000) and has allocated more salespeople to Plendil to revive its
growth. Overall, we expect single-digit growth for Plendil in next few years and ~28-
30% net profit margin (comparable to CMS’s overall net margin).
Wait for further catalysts; Maintain HOLD
0
500
1000
1500
2000
10
12
14
16
18
20
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMB m) 3,553 4,901 6,004 7,092 8,135
Net profit (RMBm) 996 1,376 1,673 1,966 2,302
Core net profit (RMB m)* 997 1,396 1,673 1,966 2,302
Core net margin (%) 28.1 28.5 27.6 27.4 28.0
Core EPS (RMB) 0.404 0.561 0.666 0.782 0.916
% Change 14.8 38.7 18.7 17.5 17.0
PER (x) 41.3 29.8 25.1 21.3 18.2
PBR (x) 7.8 6.7 5.7 4.9 4.2
ROE (%) 18.6 22.3 22.6 22.8 22.8
EV/EBITDA (x) 36.4 25.6 20.9 17.9 15.2
* adjusted by CGIS research
38
Key financials
Source: CGIS Research estimates
B alance Sheet P ro f it and Lo ss
A s at D ec 31 Year as o f D ec 31
(R M B m) (R M B m)
Cash & cash equivalents 509 482 408 982 2,050 Direct model 2,854 4,264 5,256 6,230 7,162
Inventories 385 509 625 743 854 Agency model 293 359 443 525 604
Accounts receivable 1,164 1,682 1,759 2,057 2,319 Others 406 278 306 336 370
Others 57 877 877 877 877 R evenue 3,553 4,901 6,004 7,092 8,135
C urrent assets 2,115 3,551 3,669 4,658 6,100 Cost o f goods so ld (1,507) (1,989) (2,498) (2,971) (3,414)
Property, plant and equipment 326 362 415 465 509 Gro ss pro f it 2,046 2,912 3,506 4,121 4,721
Intangible assets 1,026 2,886 2,870 2,842 2,801 Other gains / (losses) 22 (42) 58 67 73
Others 2,931 2,993 3,038 3,092 3,156 M arketing expenses (814) (1,174) (1,441) (1,723) (1,952)
N o n-current assets 4,283 6,241 6,323 6,398 6,466 Admin expenses (193) (222) (300) (355) (407)
Operat ing pro f it 1,061 1,474 1,823 2,110 2,435
T o tal assets 6,398 9,792 9,992 11,057 12,565 Net interest income / (expense) (14) (23) (60) (39) (12)
JV, associate and others 17 49 46 56 66
Accounts payable 393 579 602 715 822 Pretax income 1,064 1,500 1,809 2,126 2,489
ST borrowings 464 1,612 1,828 1,538 1,499 Income taxes (68) (123) (145) (170) (199)
Others 47 1,205 122 122 122 Non-contro lling interests 1 2 (9) (10) (12)
C urrent liabilit ies 903 3,396 2,551 2,376 2,443 N et pro f it 996 1,376 1,673 1,966 2,302
Non-recurring items (1) (20) 0 0 0
Long-term debts 0 0 0 1 2 C o re net pro f it 997 1,396 1,673 1,966 2,302
Others 142 128 129 134 130 EBIT 1,061 1,491 1,840 2,130 2,459
Lo ng-term liabilit ies 142 128 129 134 130 EBITDA 1,138 1,667 2,082 2,389 2,737
T o tal liabilit ies 1,045 3,524 2,680 2,510 2,573 EPS (RM B) 0.404 0.553 0.666 0.782 0.916
C o re EP S (R M B ) 0.404 0.561 0.666 0.782 0.916
Shareholders' equity 5,296 6,209 7,244 8,470 9,903 DPS (RM B) 0.1603 0.2216 0.2663 0.3129 0.3663
M inority interests 56 58 67 77 89 Payout 39.7% 40.1% 40.0% 40.0% 40.0%
T o tal equity 5,352 6,268 7,311 8,547 9,992
C ash F lo w Key R at io s
Year ended D ec 31 Year to D ec 31 2015A 2016A 2017E 2018E 2019E
(R M B m) Gro wth (% Yo Y)
Profit before tax 1,064 1,500 1,809 2,126 2,489 Sales 20.7 37.9 22.5 18.1 14.7
Depr & amortization 78 176 242 259 277 EBIT 15.5 40.5 21.7 15.7 15.4
Change in working cap. (424) (456) (170) (302) (266) EBITDA 18.5 46.4 23.3 14.7 14.5
Income tax paid (107) (124) (143) (165) (203) Core net profit 17.3 39.9 18.7 17.5 17.0
Others 4 (28) 15 (15) (52) Core EPS 14.8 38.7 18.7 17.5 17.0
Operat ing cash f lo w 615 1,068 1,753 1,903 2,245
P ro f itability (%)
Capex (529) (1,228) (280) (280) (280) Gross margin 57.6 59.4 58.4 58.1 58.0
Change in other assets (323) (233) (1,068) 24 32 EBIT margin 29.9 30.4 30.2 29.6 29.8
Investment cash f lo w (853) (1,461) (1,348) (256) (248) EBITDA margin 32.1 34.0 34.2 33.3 33.2
Core net profit margin 28.1 28.5 27.6 27.4 28.0
Net change in debt (58) 1,148 215 (289) (40) ROA 15.6 14.2 16.6 17.6 18.1
Others 278 (504) (695) (783) (889) ROE 18.6 22.3 22.6 22.8 22.8
F inancing cash f lo w 220 644 (480) (1,072) (929) B alance sheet rat io s
Current ratio (X) 2.3 1.0 1.4 2.0 2.5
N et change in cash (18) 251 (75) 575 1,068 Quick ratio (X) 1.9 0.9 1.2 1.6 2.1
Cash Beg. 244 229 482 408 982 Cash ratio (X) 0.6 0.1 0.2 0.4 0.8
Effect o f foreign exchange rate changes 4 2 0 0 0 Trade & bill receivables days 105 106 105 98 98
Cash End. 229 482 408 982 2,050 Trade & bill payable days 78 89 86 81 82
Inventory turnover days 70 82 83 84 85
Total debt to equity ratio (%) 8.8 26.0 25.2 18.2 15.1
Net debt / (cash) to equity (%) (0.8) 18.2 19.6 6.6 (5.6)
2019E2015A 2016A 2017E
2015A 2016A 2017E
2018E2018E
2018E
2015A 2016A 2017E2019E
2019E
39
The United Laboratories [3933.HK]
HOLD
(Unchanged)
Close: HK$6.51 (Jan 04, 2018)
Target Price: HK$6.21 (-4.6%)
Price Performance
Market Cap US$1354.6m
Shares Outstanding 1,626.9m
Auditor Deloitte
Free Float 36.55%
52W range HK$4.58-6.96
3M average daily T/O US$3.7m
Major Shareholding Ms Ning Kwai Chun
(66.1%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research estimate
China Healthcare Sector
TUL’s 2nd generation insulin is expected to recover from its 1H2017 slowdown in
2H2017 as a result of peak shipments to the channel in winter. The 6-APA (i.e. interme-
diate segment) price is expected to remain high because of stringent environmental reg-
ulations, but it will be hard for it to move higher as it is likely to induce more capacity if it
goes higher than RMB250/kg. We therefore maintain our Target Price of HK$6.21 on the
sum-of-the-parts valuation (equivalent to 17/14/12x 2017/18/19x PER). Overall, we think
the current share price reflects 6-APA’s positives. Given the possibility that insulin sales
will slow down, we do not see significant upside room. Maintain HOLD.
Investment Highlights
6-APA ASP hike positives in 2H2017: In July, the 6-APA price surged to ~RMB180/kg
since stringent environmental regulations limited the supply of some other players. At this
price level, we estimate that 6-APA (i.e. intermediate segment) will deliver ~RMB280m
segment profit in 2H2017 (assuming the utilization rate remains at 95%, TUL’s average
cost is about RMB120/kg, and 67% of the 6-APA it produces is sold externally). In
1H2017, segment profit was only RMB14.8m, as the 6-APA price was just at the breake-
ven level at RMB125.5/kg. So overall, we expect the intermediate segment to contribute
~RMB295m segment profit in 2017 (30% of our 2017E full-year estimate). Going for-
ward, despite stringent environment regulations, we think it will be hard for the price of 6-
APA to move higher, as it likely to induce more capacity if it moves higher than RMB250/
kg. Therefore, the current share price may have limited upside room).
2nd generation insulin slowing down: Recall that 2nd generation insulin’s shipment vol-
ume in 1H2017 (5.6m units) up only 14.4% YoY, slowed down from ~50% YoY in 2016.
Overall, we expect 2017 full-year volume to be 13m in terminal units. Given TUL’s cur-
rent sales progress of ~1.05m units/month in June and July and expected higher sales in
winter and sales network expansion into lower-tier hospitals, we expect 2H2017 total
terminal sales of 7.4m to be achievable. On this basis, we expect 2nd generation insu-
lin’s 2017 revenue to reach RMB570m, up 23% YoY, which is much lower than Company
revenue guidance of 50% YoY earlier this year. Overall, insulin (2nd & 3rd generation) is
expected to contribute segment profit of ~RMB106m, 10.7% of our 2017 full-year esti-
mated segment profit. In 2018, we expect insulin to deliver 25% volume growth but with a
5% ASP cut to ~RMB690m in revenue and ~RMB130m in segment profit (i.e. ~12.5% of
our 2018E full year estimated segment profit).
Stabilized 6APA; 3rd
generation insulin will take time to generate
profit; maintain HOLD
0
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140
160
4
4.5
5
5.5
6
6.5
7
7.5
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMBm) 7,694 6,043 7,325 7,887 8,370
Reported net profit (RMBm) 110 (266) 524 603 705
Core net profit (RMBm) 434 60 505 603 705
Core net margin (%) 5.6 1.0 6.9 7.6 8.4
Core EPS (RMB) 0.267 0.037 0.310 0.371 0.434
% Change 155 (86.2) 744.1 19.5 17.0
PER (x) 24.4 177.2 21.0 17.6 15.0
PBR (x) 1.58 1.63 1.48 1.35 1.22
Core ROE(%) 6.3 1.1 9.2 9.8 10.2
EV/EBITDA (x) 9.1 12.7 6.0 5.3 4.4
40
Key financials
Source: Company, CGIS Research estimates
B alance Sheet P ro f it and Lo ss
A s at D ec 31 Year ended D ec 31
R M B m R M B m
Cash & cash equivalents 1,115 1,696 2,378 2,979 4,330 Intermediates 1,680 1,228 1,846 1,852 1,768
P ledged bank deposits 922 906 904 948 Bulk medicines 3,272 2,457 2,877 3,145 3,386
Inventories 1,415 917 1,375 1,511 1,632 Finished products 2,742 2,359 2,603 2,890 3,217
Accounts receivable 2,195 1,866 2,420 2,683 2,849 R evenue 7,694 6,043 7,325 7,887 8,370
Others 1,036 77 78 80 81 Cost o f goods so ld (4,733) (3,890) (4,434) (4,721) (4,945)
C urrent assets 5,761 5,478 7,158 8,156 9,840 Gro ss pro f it 2,961 2,153 2,891 3,166 3,425
Property, plant and equipment 9,264 7,017 6,855 6,571 6,164 Other income 96 84 95 113
Investment properties 1,483 1,080 1,101 1,123 1,146 M arketing expenses (1,290) (1,057) (1,172) (1,278) (1,356)
Intangible assets 96 137 171 205 240 R&D expenses (73) (74) (95) (103) (109)
Others 805 551 555 560 564 Admin expenses (864) (608) (674) (726) (770)
N o n-current assets 11,647 8,785 8,682 8,459 8,114 Other expense (83) (87) (89) (91)
T o tal assets 17,408 14,263 15,840 16,615 17,954 Operat ing pro f it 734 427 947 1,066 1,212
Other gains / (losses) 0 (112) 0 0 0
Accounts payable 3,295 2,840 3,251 3,276 3,514 Finance cost (350) (233) (295) (294) (308)
ST borrowings 4,110 3,092 3,626 3,615 3,790 Other non-operating items 0 (214) 19 0 0
Others 1,053 467 476 486 495 Pretax income 235 (132) 672 773 904
C urrent liabilit ies 8,458 6,399 7,353 7,377 7,800 Income taxes (125) (134) (148) (170) (199)
Long-term debts 913 946 906 904 948 N et pro f it 110 (266) 524 603 705
Others 1,319 1,807 1,843 1,880 1,917
Lo ng-term liabilit ies 2,231 2,753 2,749 2,784 2,865 C o re net pro f it 434 60 505 603 705
EBITDA 1,406 812 1,716 1,855 2,035
T o tal liabilit ies 10,689 9,152 10,103 10,160 10,665
EPS (RM B) 0.068 -0.164 0.322 0.371 0.434
Shareholders' equity 6,719 5,111 5,737 6,455 7,289 C o re EP S (R M B ) 0.267 0.037 0.310 0.371 0.434
T o tal equity 6,719 5,111 5,737 6,455 7,289 DPS (HK$) 0.000 0.000 0.000 0.000 0.000
C ash F lo w Key R at io s
Year ended D ec 31 2015A 2016A 2017E 2018E 2019E Year ended D ec 31 2015A 2016A 2017E 2018E 2019E
R M B m Gro wth (% Yo Y)
Profit before tax 235 (132) 672 773 904 Sales (4.2) (8.2) 18.8 5.6 4.1
Depr & amortization 821 702 740 777 811 Operating profit (21.3) (45.1) 121.8 12.6 13.7
Change in working cap. 431 75 (603) (362) (32) EBITDA (0.8) (32.5) 111.3 8.1 9.7
Income tax paid (166) (134) (148) (170) (199) Core net profit 154.9 (83.9) 744.1 19.5 17.0
Others 488 666 281 275 277 Core EPS 154.9 (83.9) 744.1 19.5 17.0
Operat ing cash f lo w 1,810 1,177 942 1,293 1,761 P ro f itability (%)
Gross margin 38.5 35.6 39.5 40.1 40.9
Capex (723) (397) (436) (356) (272) Operating margin 11.8 7.1 12.9 13.5 14.5
Others 348 (97) 23 15 (19) EBITDA margin 18.3 13.4 23.4 23.5 24.3
Investment cash f lo w (375) (494) (414) (341) (291) Core net profit margin 5.6 1.0 6.9 7.6 8.4
ROA 2.4 0.4 3.3 3.7 4.0
Net change in debt (733) (360) 414 (105) 129 ROE (core) 6.3 1.1 9.2 9.8 10.2
Others (545) 489 (295) (294) (308) B alance sheet rat io s
F inancing cash f lo w (1,278) 129 119 (398) (179) Current ratio (X) 0.7 0.9 1.0 1.1 1.3
Quick ratio (X) 0.3 0.4 0.5 0.6 0.7
N et change in cash 156 813 648 554 1,291 Cash ratio (X) 0.2 0.3 0.3 0.4 0.6
Cash at beginning of the year 672 954 1,730 2,426 3,039 Trade & bill receivables days 108.7 102.4 95.9 104.9 107.4
Effect from foreign exchange (45) (70) 0 0 0 Trade & bill payable days 90.6 89.5 76.7 88.1 89.4
C ash at the end o f the year 783 1,696 2,378 2,979 4,330 Inventory turnover days 109.2 99.8 95.1 112.6 117.1
Total debt to equity ratio (%) 0.76 0.90 0.89 0.79 0.73
2019E2015A 2016A 2017E 2018E2018E 2015A 2016A 2017E2019E
41
SSY Group [2005.HK]
HOLD
(Downgrade from BUY)
Close: HK$5.11 (Jan 04, 2018)
Target Price: HK$4.46 (-12.7%)
Price Performance
Market Cap US$1876.9m
Shares Outstanding 2,829.6m
Auditor PWC
Free Float 34.3%
52W range HK$2.42-5.2
3M average daily T/O US$3.1m
Major Shareholding Mr. Qu Jiguang
(35.41%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
[email protected] Sources: Company, CGIS Research
China Healthcare Sector Going forward, with stabilization of the ASP of its IV product and expected execution of
new tenders won in 2H16 and 2017, we believe the volume growth target in 2017 is
achievable. Together with expected continuing operating leverage improvement, we see
~16% EPS CAGR potential in 2016-2019E. SSY’s share price has risen 78% since we
upgraded the Company to BUY in March 2017, but we think the current 24/20.6/18.9x
2017/18/19E PER fully reflects its growth story outlook, so we downgrade it to HOLD
with unchanged projection numbers and a Target Price of HK4.46 (18x 2018 PER).
Investment Highlights
Gaining high-end IV market share: After IV industry consolidation in the past few
years, the IV industry is expected to grow at a ~5-6% CAGR in 2016-2020 because
of rigid demand. Also, high-end products (non-PVC soft bags and upright soft bags)
have seen stable or moderately increased ASPs and margins as evidenced by
SSY’s solid 9M2017 results. Therefore, we believe the worst is over for the IV indus-
try, and on existing fundamentals, we reiterate that the Company’s future growth will
come mainly from improving operating leverage and stronger sales of high-margin
soft bags.
Kelun: Kelun has a 17% stake in SSY. Previously, Kelun increased its stake in SSY
at ~HK$3.0 or below. We wonder whether it wishes to accumulate more shares at
the current price level.
Valuation: Given ~16% EPS CAGR potential in 2016-2019E by operating leverage
improvement, we believe the current 23.9/20.5/18.9x 2017/18/19E PER (equivalent
to 1.3x PEG) fully reflects its growth story outlook. We thus believe further upside for
the Company’s shares is limited and downgrade our recommendation.
Growth story remains intact, rich valuation, downgrade to HOLD
0
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60
80
100
0
1
2
3
4
5
6
4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (HK$ m) 2,222 2,361 2,626 2,791 2,908
Core net profit (HK$ m) 403 490 605 704 766
Core net margin (%) 18.2 20.7 23.0 25.2 26.3
Core EPS (HK$) 0.138 0.173 0.213 0.248 0.270
% Change -17.1 25.0 23.1 16.4 8.8
PER (x) 36.9 29.5 24.0 20.6 18.9
PBR (x) 6.0 5.3 4.6 3.9 3.4
ROE(%) 14.3 19.3 20.8 20.8 19.6
EV/EBITDA (x) 20.9 17.4 15.0 13.0 11.7
42
Key financials
Source: Company, CGIS Research estimates
B alance Sheet P ro f it and Lo ss
A s at D ec 31 Year ended D ec 31
(H K$ m) (H K$ m)
Cash & cash equivalents 339 447 633 684 1,050 Glass bottles 226 225 261 287 307
Inventories 283 278 297 303 308 PP bottles 502 501 535 559 559
Accounts receivable 935 857 1,103 1,061 1,105 Non-PVC soft bags 1,128 1,131 1,188 1,287 1,365
Others 76 97 97 97 97 Upright soft bags 151 207 348 370 393
C urrent assets 1,633 1,680 2,129 2,144 2,560 Others 215 298 293 289 284
Property, plant and equipment 2,694 2,393 2,455 2,500 2,526 R evenue 2,222 2,361 2,626 2,791 2,908
Intangible assets 381 419 451 483 514 Cost o f goods so ld (1,172) (1,144) (1,219) (1,244) (1,266)
Others 300 253 247 242 236 Gro ss pro f it 1,050 1,217 1,407 1,547 1,641
N o n-current assets 3,375 3,065 3,154 3,224 3,276 M arketing expenses (281) (373) (392) (411) (428)
Admin & other expenses (278) (268) (270) (283) (295)
T o tal assets 5,008 4,744 5,283 5,368 5,836 Operat ing pro f it 491 576 746 854 919
Other gains / (losses) 50 65 12 12 12
Accounts payable 270 174 293 187 190 Gain/(losses) from JV (2) (2) - - -
ST borrowings 688 633 362 515 519 Gain on disposal o f investment in JV - 1 - - -
Others 477 289 404 409 385 Net interest income / (expense) (62) (52) (46) (37) (30)
C urrent liabilit ies 1,434 1,096 1,058 1,110 1,093 Pretax income 478 588 712 829 902
Long-term debts 1,125 935 1,068 587 526 Income taxes (75) (98) (107) (124) (135)
Others 29 29 29 29 29 Discontinued business 0 0 0 0 0
Lo ng-term liabilit ies 1,179 964 1,097 616 555 Non-contro lling interests 0 1 1 1 1
N et pro f it 403 490 605 704 766
T o tal liabilit ies 2,613 2,060 2,156 1,726 1,649
C o re net pro f it 403 490 605 704 766
Shareholders' equity 2,395 2,676 3,118 3,632 4,178
M inority interests 1 8 8 9 9 EBIT 540 638 757 865 930
T o tal equity 2,395 2,684 3,127 3,641 4,187 EBITDA 756 885 1,008 1,135 1,218
EPS (HK$) 0.138 0.173 0.213 0.248 0.270
C o re EP S (H K$ ) 0.138 0.173 0.213 0.248 0.270
DPS (HK$) 0.025 0.055 0.064 0.074 0.081
C ash F lo w Key R at io s
Year ended D ec 31 2015A 2016E 2017E 2018E 2019E Year ended D ec 31 2015A 2016A 2017E 2018E 2019E
(H K$ m) Gro wth (% Yo Y)
Profit before tax 478 588 712 829 902 Sales 6.2 6.3 11.2 6.3 4.2
Depr & amortization 216 247 251 270 288 Operating profit (12.9) 18.3 18.3 14.3 7.6
Change in working cap. 170 (216) (30) (65) (70) EBITDA (3.3) 17.1 13.8 12.6 7.4
Income tax paid (75) (98) (107) (124) (135) Core net profit (17.9) 21.3 23.6 16.4 8.8
Others (227) (183) (3) (3) (5) Core EPS (17.1) 25.0 23.1 16.4 8.8
Operat ing cash f lo w 563 338 823 906 979 P ro f itability (%)
Gross margin 47.2 51.6 53.6 55.4 56.4
Capex (396) (347) (340) (340) (340) Operating margin 24.4 27.1 28.9 31.0 32.0
Change in other assets 131 444 3 3 5 EBITDA margin 34.0 37.5 38.4 40.7 41.9
Investment cash f lo w (265) 97 (337) (337) (335) Core net profit margin 18.2 20.7 23.0 25.2 26.3
ROA 8.2 10.0 12.1 13.2 13.7
Net change in debt 940 (253) (138) (329) (57) ROE 14.3 19.3 20.8 20.8 19.6
Others (1,216) (74) (163) (190) (221) B alance sheet rat io s
F inancing cash f lo w (276) (327) (301) (518) (278) Current ratio (X) 1.1 1.5 2.0 1.9 2.3
Quick ratio (X) 0.2 0.4 0.6 0.6 1.0
N et change in cash 22 108 186 51 366 Cash ratio (X) 0.2 0.4 0.6 0.6 1.0
Cash at beginning of the year 325 339 447 633 684 Trade & bill receivables days 99.3 101.3 98.5 102.1 98.2
Effect from foreign exchange (8) 0 0 0 0 Trade & bill payable days 86.5 71.0 68.8 70.0 54.0
C ash at the end o f the year 339 447 633 684 1,050 Inventory turnover days 87.5 89.5 86.0 87.9 88.0
Total debt to equity ratio (%) 75.7 58.4 45.7 30.3 24.9
2019E2018E2018E 2015A 2016A 2017E2019E2015A 2016A 2017E
43
Luye Pharm [2186.HK]
HOLD (Upgrade from SELL)
Close: HK$6.45 (Jan 04, 2018)
Target Price: HK$6.3 (-2.3%)
Price Performance
Market Cap US$2739.8m
Shares Outstanding 3,321.1m
Auditor E&Y
Free Float 54.3%
52W range HK$3.96-6.51
3M average daily T/O US$13.9m
Major Shareholding Chairman Liu Dian Bo
(45.68%)
Sources: Company, Bloomberg
Harry He—Analyst
(852) 3698-6320
Wong Chi Man, CFA—Head of Research
(852) 3698-6317
Sources: Company, CGIS Research estimates
China Healthcare Sector
Lipusu is expected to return to growth in 2H2017, as it will no longer control shipments
(controlled in 1H2017 for NRDL price negotiations). Also, it secured RMB3.8bn in bonds to
finance further M&A (it currently has M&A projects in the works). Based on the Company’s
good historical track record, we believe any M&A news flow may be a catalyst. We raise our
2017/18E numbers by 4.2/5.5% and roll over our base year from 2017 to 2018. With Lipusu’s
growth prospects getting clearer, we no longer give the Company a valuation discount
(previously a 35% discount to its peers’ average of 17x). Therefore, we set our Target Price at
HK$6.3 (17x 2018E PER, comparable to the industry average), and adjust EPS growth by
~12% in 2017-2019E (1.4x PEG). Upgrade to HOLD.
Investment Highl ights
Lipusu’s shipments getting back to normal: Recall that Lipusu (for cancer) accounted
for ~60% of the Company’s 1H2017 total segment profit. Historically, IMS data (referring
to terminal sales) is a relatively good indicator of the Company’s reported Lipusu revenue
(i.e. shipments), as Lipusu’s covered 700-800 hospitals are mainly Class III hospitals and
overlap with IMS sampling points. In 1H2017, Lipusu reported ~5% growth vs. IMS’s
~20% YoY growth, as Luye controlled Lipusu shipments mainly because it was concerned
that NRDL negotiations would result in a sharp price cut. In 2H2017, with completion of
the NRDL, we expect Lipusu to recover its reported shipment growth in line with that of
IMS terminal data, as there is need to re-fill channel inventory after controlling shipments
since current shipments are back to normal. Overall, we expect Lipusu to deliver >20%
growth in 2017E, comparable to IMS data YTD, which reported +21.93% terminal growth
for 10M2017. Going forward, as Paclitaxel-albumin from Hengrui and CSPC will take time
to compete with Lipusu, we expect the Lipusu to continue high-teen growth in 2018.
Potential M&A expected to fuel future growth: The Company reserved a potential
RMB3.8bn debt-financing facility (short-term commercial paper: RMB1.8bn + medium-
term financing notes: RMB2bn) on Dec 19, 2017 for M&A. Only when there is actual pro-
gress on M&A will the facilities be used. Based on the historical M&A track record of the
Company, we believe this is encouraging news for investors.
Ex-Acino business recovery evidence: Based on the announcement on Dec 19, 2017,
Yantai Luye (a subsidiary of Luye Pharm, mostly representing the ex-Acino China busi-
ness performance of the Company) reported 3Q2017 net profit was up ~22% YoY to
RMB170m on an apple-to-apple basis (excluding one-off items of RMB39m impairment
and RMB32m third-party fees in 1H2017 and Acino amortisation of ~RMB28m, which
started in 1H2017), beating the market and our 2017E full-year expectation of single-digit
growth. This is strong evidence that Lipusu’s shipments are back to normal and that Li-
pusu’s growth outlook has become clear again after previous NRDL inclusion uncertain-
ties and a mismatch with IMS data.
Evidence of recovery, upgrade to HOLD.
0
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100
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200
250
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350
3
3.5
4
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4/1/2017 4/7/2017 4/1/2018
(HK$ million)(HK$)
Turnover (RHS) Price (LHS)
Y/E Dec 31 2015A 2016A 2017E 2018E 2019E
Turnover (RMB m) 2,563 2,918 3,908 4,469 4,911
Core net profit (RMB m) 755 869 958 1,083 1,197
Core net margin 29.4% 29.8% 24.5% 24.2% 24.4%
Core EPS (RMB) 0.227 0.262 0.288 0.326 0.360
YoY 7.4% 15.2% 10.2% 13.1% 10.5%
PER (x) 24.1 20.9 19.0 16.8 15.2
PBR (x) 2.6 2.0 1.9 1.8 1.6
Adjusted ROE 14.3% 14.4% 13.9% 13.8% 13.3%
EV/EBITDA (x) 17.7 17.8 13.2 10.4 8.7
44
Key financials
Source: Company, CGIS Research estimates
P&L (RMBm) 2015A 2016A 2017E 2018E 2019E Cash flow (RMBm) 2015A 2016E 2017E 2018E 2019E
Revenue 2,563 2,918 3,892 4,360 4,709 Pretax profit 898 975 1,032 1,230 1,329
Oncology 1,395 1,570 1,821 2,003 2,163 D&A 110 135 274 301 328
Cardiovascular System 621 652 639 690 738 Change in working capital (417) (453) (23) (185) (220)
Alimentary Tract and Metabolism 468 554 776 970 1,067 Income tax paid (111) (81) (150) (178) (193)
Other Products 78 141 156 171 188 Others (86) (49) (19) (22) (28)
Overseas Business n.a 0 500 525 551 Operating cash flow 395 527 1,114 1,146 1,216
COGS (476) (535) (875) (983) (1,062)
Gross profit 2,087 2,383 3,017 3,376 3,646 Capex (204) (611) (300) (300) (300)
Selling and distribution expenses (964) (1,122) (1,393) (1,526) (1,648) Purchase of intangible assets (4) (759) (50) (50) (50)
Administrative expenses (185) (267) (428) (436) (471) Acquisition of subsidiaries 0 0 0 0 0
Other expenses (190) (199) (292) (327) (353) Others 448 (509) 118 120 127
EBIT 748 795 904 1,087 1,174 Investing cash flow 240 (1,879) (232) (230) (223)
D&A 110 135 274 301 328
EBITDA 858 930 1,178 1,389 1,502 Proceed from/(repayment of) borrowings 197 1,122 (800) (500) (200)
Finance costs (16) (30) (21) (10) (4) Proceed from equity 0 0 0 0 0
Share of profit of an associate 0 1 1 2 2 Dividend paid 0 0 0 0 0
Other income and gains 165 209 148 150 157 Others (146) (216) 0 0 0
Pretax profit 898 975 1,032 1,230 1,329 Financing cash flow 51 906 (800) (500) (200)
Tax (133) (81) (150) (178) (193)
After tax profit 765 894 882 1,051 1,136 Net change in cash 686 (446) 82 416 793
MI 10 2 2 2 2
Reported net profit 755 892 880 1,049 1,134
Adjusted net profit 755 869 953 1,049 1,134
Reported EPS (RMB) 0.227 0.268 0.265 0.316 0.341
Adjusted EPS (RMB) 0.227 0.262 0.287 0.316 0.341
DPS(RMB) 0.000 0.067 0.086 0.095 0.102
Payout 0.0% 25.6% 30.0% 30.0% 30.0%
Balance sheet (RMBm) 2015A 2016A 2017E 2018E 2019E 2015A 2016A 2017E 2018E 2019E
Balance Sheet (as of end-Dec)
Property, plant and equipment 1,196 1,702 1,829 1,933 2,015 Growth rate
Goodwill 347 996 996 996 996 Revenue 0.8% 13.8% 33.4% 12.0% 8.0%
Other intangible assets 126 856 804 749 689 EBIT 12.3% 6.2% 13.7% 20.3% 8.0%
Available-for-sale investments 312 370 371 373 375 EBITDA 11.2% 8.4% 26.6% 17.9% 8.2%
Total non current assets 1,981 3,923 4,000 4,051 4,075 Recurring net profit 19.1% 15.2% 9.6% 10.1% 8.1%
Recurring EPS 7.4% 15.2% 9.6% 10.1% 8.1%
Inventories 286 453 410 560 488 Operating ratios
Trade and notes receivables 1,193 1,415 1,784 1,800 2,071 Gross margin 81.4% 81.7% 77.5% 77.4% 77.4%
Pledged short-term deposits 267 482 482 482 482 EBIT margin 29.2% 27.2% 23.2% 24.9% 24.9%
Cash and cash equivalents 3,206 2,747 2,830 3,246 4,038 EBITDA margin 33.5% 31.9% 30.3% 31.8% 31.9%
Due from related parties 120 185 64 71 77 Recurring net margin 29.4% 29.8% 24.5% 24.1% 24.1%
Total current assets 5,071 5,282 5,570 6,158 7,156 Adjusted ROE 14.3% 14.4% 13.9% 13.4% 12.7%
Total assets 7,053 9,206 9,570 10,209 11,231 Adjusted ROA 11.5% 10.7% 10.2% 10.6% 10.6%
Interest coverage (EBITDA) 55 31 55 138 383
LT borrowings 0 0 0 0 0 Net debt/equity Net cash Net cash Net cash Net cash Net cash
Deferred revenue 207 269 269 269 269 Current ratio 4.9 2.2 3.0 4.3 5.4
Total non-current liabilities 208 269 269 269 269 Quick ratio 4.6 2.0 2.8 3.9 5.0
Days inventories 206 586 180 180 180
Trade and notes payables 83 116 148 149 171 Days receivables 150 320 150 150 150
ST borrowings 502 1,624 824 324 124 Days payables 55 158 55 55 55
Due to related parties 460 635 886 973 1,036
Total current liabilities 1,045 2,375 1,857 1,445 1,331
Issued capital 427 427 427 427 427
Reserves 5,237 6,001 6,881 7,930 9,064
MI 136 133 135 138 140
Total equity 5,800 6,562 7,444 8,495 9,631
Total equity and liabilities 7,053 9,206 9,570 10,209 11,231
45
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BUY share price will increase by >20% within 12 months in absolute terms :
SELL share price will decrease by >20% within 12 months in absolute terms :
HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :