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Attractive sector outlook; initiate on six; Zhejiang NHU Conv. Buy
Initiate on the sector with an Attractive coverage view
We believe the outlook for China’s evolving pharmaceutical industry is
bright, driven by: (1) rising healthcare expenditure; (2) an aging population;
(3) rapid economic growth; and (4) increasing insurance coverage. We
expect China’s healthcare expenditure to grow at 23% CAGR over 2005-
2010E and 13% CAGR over 2010E-2015E, after 14% CAGR over 2000-2005.
Moving up the value chain should sharpen competitiveness
With better intellectual property protection and increased R&D activity, we
expect China’s pharma companies to gradually shift from a service and
imitation-based strategy to an innovative product-driven strategy. This
should help improve overall margins as ASPs for new products are less
prone to government price controls. In our view, companies with a rich R&D
pipeline—mostly from external acquisition—will become more competitive.
Stocks in focus: Buy Zhejiang, Simcere; Sell China Pharma
Our top pick is Zhejiang NHU (002001.SZ; Buy, on our Conviction List)
over our 12-month investment horizon for its currently inexpensive valuation
and substantial 2008E earnings growth. Our 12-month target price of
Rmb59.7, offers 64% potential upside. We think Simcere (SCR; Buy) is most
likely to become a long-term leader, based on its sustainable business
model, favorable product mix and strong financial flexibility. Our 12-month
target price of US$16.2, offers 35% potential upside. Both NHU and Simcere
offer strong growth at a reasonable price, trading at 2009E PEG (over 2008E-
2010E growth) of 0.4X and 0.3X, respectively. We rate China Pharmaceutical
Group (1093.HK) Sell due to our concerns over price erosion of its key bulk
pharmaceutical products. Our 12-month target price of HK$2.5, offers 21%
potential downside. We also initiate on Guangzhou Pharma (0874.HK),
Shineway (2877.HK) and Sino Biopharma (1177.HK) — all rated Neutral as,
in our view, they are fairly valued and lack apparent catalysts.
Regulatory uncertainty represent the main industry risks
Inconsistencies between local and national regulations could mean uneven
enforcement, resulting in different possible implications for different
companies. Regulatory changes to drug manufacturing standards and
drug approval process could slow down new product launches from drug
manufacturers. Redirecting drug sales away from hospitals and towards
pharmacies could pressure marketing and distribution models.
Summary of ratings: China Pharmaceutical Stocks
Pricing Price 12-m Potential Implied P/E
Company Name Rating Currency 8/8/2008 Target Up/Downside 2009E
Price (%) (×)
NHU Buy* Rmb 36.50 59.7 63.6 12.0
Simcere Buy US$ 11.98 16.2 35.2 13.5
Shineway Neutral HK$ 5.59 6.1 9.1 9.9
Guangzhou Pharma Neutral HK$ 4.80 5.3 10.4 9.1
Sino Biopharma Neutral HK$ 1.40 1.6 14.3 11.0
China Pharma Sell HK$ 3.15 2.5 -20.6 12.0
* This stock is on our regional Conviction List.
Our coverage group vs. global peers
China Pharma
Shineway
GZ Pharma
Simcere
Sino Biopharm
NHU
Indian Pharma
European
Pharma
US Pharma
US Specialty
Pharma US Generics
6
8
10
12
14
16
18
-4 0 4 8 12 16 20 24 28 32
08E-10E EPS 2y CAGR (%) 09E P/E
(
X)
Source: Company data, Gao Hua Securities Research
estimates, Goldman Sachs Research estimates.
Wei Du, Ph.D
+86(10)6627-3318 | wei.du@ghsl.cn Beijing Gao Hua Securities Company Limited
The Goldman
Table of contents
Attractive valuation, plus strong fundamentals & growth potential 2
Top picks among our group of six; valuation methodology 3
Industry is dominated by generics; multi-layered drug supply chain 7
Industry drivers: Rising healthcare spend and sector consolidation 10
Policy uncertainties remain as major industry risks 12
Zhejiang NHU (Buy, Conviction list): Compelling valuation 13
Simcere Pharmaceutical (Buy): Distribution for growth 18
Guangzhou Pharma (Neutral): Steady so far, but obscure prospects 22
Shineway Pharmaceutical (Neutral): Weak distribution 26
Sino Biopharmaceutical (Neutral): Poor forward visibility 30
China Pharma (Sell): Price overshadowed by overcapacity 34
Appendix 39
Disclosures 40
Attractive valuation, plus strong fundamentals & growth potential
Although we expect China’s pharmaceutical sector to continue to experience
regulatory and pricing pressure, we think the current inexpensive valuations of the
sector are underappreciated given our view of the sector’s strong fundamentals and
long-term growth potential driven by: (1) rising healthcare expenditure in China; (2)
stable margins and cash flow trends; and (3) resilience to economic shocks, such as oil
price hikes.
We believe being successful in the long-term in China’s pharma space will be determined
by maintaining a sustainable business model (notably cost efficiency and product quality),
a niche market focus, strong marketing, plus effective sales channels. Our analytical
framework is based on a matrix of drivers determining the long-term profitability of
pharma companies (see Exhibit 2). Given low historical R&D investment in the sector and
ongoing demand for inexpensive drugs in China, we think internal R&D’s contribution to
overall success is limited in the near future; and we expect future growth to be driven by
new products stemming from acquisitions.
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