Pharmaceutical Industry - Chinese healthcare industry rebounds!

Chinese healthcare industry rebounds!
In the first half of year 2007, Chinese healthcare industry performance
bounced back. In the first five months, industry revenue reached 214.6 billion
RMB, with a YoY increase of 21.05%. 5-month net profit was 18.4 billion RMB,
with a YoY increase of 35.54%. Profit before tax margin also increased 0.84%
to 8.58%. This increase is mainly due to lower sales and profit in year 2006.
Drug companies’ outlook got a bit brighter as large scale price capping would
not take place within the next two years by National Development and Reform
Commission (NDRC). More resources and market share are accruing to bigger
and higher quality companies; smaller players are getting out of the market.
This restructuring will continue in the future and will benefit bigger players like
C&O.
Chinese healthcare industry includes chemical pharmaceuticals, traditional
Chinese medicine, drug related raw chemicals, biological and biochemical
pharmaceuticals and other sub industries (medical devices, hygiene related
materials and products, herbal medicine etc). Since chemical drug sector and
TCM sector were hit most by Chinese government regulations, the rebounding
of these two sectors is most obvious. According to growth data, we can see
that the TCM sector has recovered to its year 2005 performance while the
chemical drug sector still hasn’t fully recovered to its 2005 level. We also
observe that the biological and biochemical pharmaceuticals sector continue to
maintain high growth.
Recent policy effect on S share pharmas.
New drug registration method in effect from Oct 1, 2007. This new method will
generally slow down the process of new drug application and increase the
entry barrier for new drugs entering the market. The new registration method
also encourages the introduction of completely new drugs (e.g. new neverbefore
used drug formulations) into the market. This new method has much
more stringent requirements for the safety of new drugs, and discourages
those companies that simply change the drug delivery system or formulation.
Some drugs in Sihuan, C&O, and AsiaPharm pipeline are completely new
drugs. This new regulation can partially protect these companies’ current
business by preventing new comers and favoring existing companies’ new
products.
NDRC does not plan to do large-scale price capping within the next two years.
It appears that the government is trying to build an inspection framework and
prefers to give some time for the market to adjust itself. This is generally good
for drug companies.
The adjustment for export tax refund will affect certain companies, which
manufacture drug related raw materials (but not for antibiotics and vitamins).
This policy does not affect S share pharmas as none of these companies’ main
revenue sources derive from raw material export.
Singapore/Pharmaceutical/Sector
PHILLIP SECURITIES
RESEARCH
Equities
(MICA (P) 186/06/2007)
Zuo Li
􀀋 65-6531 1249
FAX 65-6536 4435
􀀍 zuoli@phillip.com.sg
Price Chart – Sihuan
52-w eek price chart
0.4
0.5
0.6
0.7
0.8
0.9
1
3/22/2007
4/5/2007
4/19/2007
5/3/2007
5/17/2007
5/31/2007
6/14/2007
6/28/2007
7/12/2007
Price Chart – C&O
52-week price chart
0.2
0.25
0.3
0.35
0.4
0.45
0.5
0.55
0.6
7/25/2006
9/5/2006
10/17/2006
11/28/2006
1/9/2007
2/20/2007
4/3/2007
5/15/2007
6/26/2007
Price Chart – AsiaPharm
52-week price chart
0.5
0.55
0.6
0.65
0.7
0.75
0.8
0.85
0.9
7/25/2006
9/5/2006
10/17/2006
11/28/2006
1/9/2007
2/20/2007
4/3/2007
5/15/2007
6/26/2007
Pharmaceutical Industry 26 July 2007
Phillip Securities Research
2
Prospects for the Chinese healthcare industry.
We expect the healthcare industry to continue its growth momentum,
especially international trade. Huge rural market, aging population,
urbanization, and raising awareness of healthcare will help the growth of
Chinese healthcare industry. We expect an industry production/sales growth of
18%.
The healthcare system reform is on going. It will change the current drug
consumption status, which is excessively concentrated in urban hospitals.
Currently, Chinese national healthcare insurance scheme only covers 30% of
urban and 25% of rural areas. Since the goal of Chinese healthcare reform is
to build a universally available primary healthcare system, the demand for
healthcare will keep growing but profit margins of the healthcare industry are
likely to get thinner.
We expect to see more resources and market share accruing to bigger and
higher quality players; industry structure will get optimized as smaller players
are getting out of the market.
Valuation.
Traditionally, healthcare has been one of the most attractive sectors for
Chinese investors, for its high margins and growth story, even though this
sector faces heavy government regulations. In the A share secondary market,
before the recent market correction, the healthcare industry PE was 55x, and
after the correction, the PE is still close to 49x, the highest among all sectors.
As for H shares, the median heath-care sector historical PE is above 25x, and
the forward PE around 20x. For S share drug companies, the historical twelvemonth
PE range is from 12-22x, and the forward twelve-month PE for those
companies under our coverage are 13-14x.
After acquisition, the size of C&O and AsiaPharm are comparable with H
shares healthcare companies (in term of net profit). Even if we give S share
companies a discount for their relatively smaller sizes and short operation
history, they should be trading at a higher PE, which we think should be around
forward 18x. Given Sihuan’s high growth, it also deserves a higher PE, which
we would expect 20-25x forward PE (those H and A share healthcare
companies which have above 50% growth trade at around 50x PE). We have a
neutral view about Reyoung, since we expect it to have a flat growth (currently
trading around 13.7x historical PE). We are also neutral about Star Pharm
even though it is trading under a lower historical PE 11.7x primarily due to its
small size, its growth quality and its acquired R&D quality.