<p>Summary and investment case<br/>TCM and western medicine both have their strong points. In China it is<br/>generally believed that TCM has the advantage in the treatment of chronic and<br/>intractable diseases, such cardio-cerebral vascular diseases, strengthening the<br/>immune system and in relieving symptoms for people who feel unwell but have<br/>no identifiable disease. Western medicine is considered to be better for the<br/>treatment of medical emergencies and severe illnesses.<br/>China has historically used policy guidance to support the TCM industry. The<br/>new round of reforms to the medical system the government is currently<br/>pursuing is likely to have a direct impact on the overall pharmaceutical industry,<br/>in our view. We believe the expansion of the scope of medical insurance should<br/>increase the affordability of drugs, and the reform of medical service institutions<br/>should stimulate spending on health care services by citizens, gradually<br/>improving the environment for drug industry development. We expect TCM to<br/>play an increasingly important role in community health service centres and<br/>rural medical institutions given its perceived advantages in preventive care and<br/>health maintenance.<br/>The government is enthusiastically promoting TCM in community health<br/>service centres and rural medical institutions. However, it is important to<br/>remember that at present, most TCM products are sold in pharmacies; that is,<br/>through OTC channels. The question is whether TCM companies can take<br/>advantage of these favourable government policies. The ability of firms to<br/>develop these new markets—community health service centres and rural<br/>medical institutions—will be tested.<br/>Rising raw material prices have put margin pressure on the TCM industry, and<br/>whether or not firms have the ability to pass on increases will be key. We<br/>believe there are two main directions of development for TCM companies: (1) to<br/>leverage their brands and use pharmacy chains as their major sales channels to<br/>gradually expand into the consumer goods market and obtain greater pricing<br/>power; and (2) to rely on technological and technical advantages, using hospitals<br/>as their main sales channels and modern TCM products as the direction of<br/>development, to maintain high profit margins by continuously launching new<br/>products and new formats.<br/>In the long term we see two major investment themes for the TCM industry: (1)<br/>against a background of rising ingredient prices, companies that have the ability<br/>to raise prices; and (2) against a background of medical reform, companies that<br/>stand to benefit from that reform.<br/>We believe that among TCM companies holding traditional brands, Shandong<br/>Dong-e E-jiao (DEEJ) and Yunnan Baiyao (YB) have relatively strong pricesetting<br/>ability, which is based on good marketing ability and brand management.<br/>Guangzhou Pharmaceutical’s (GZP) herbal tea operations also have relatively<br/>strong price-setting capacity, in our view.</p><p>Among modern TCM firms, Tianjin Tasly Pharmaceutical (Tasly), which uses<br/>hospitals as one of its main sales channels, is currently focusing on developing<br/>in the community health service centre and rural medical institution markets.<br/>This kind of firm is more likely to be able to profit from the trend for increased<br/>drug usage at basic medical service institutions brought about by medical reform.<br/>However, since we anticipate a lag before TCM companies benefit from medical<br/>reform, we believe it will be important to follow developments in this area.</p><p>Contents page<br/>Summary and investment case 3<br/>Industry analysis 8<br/>Industry risks 22<br/>Valuation and comparables 24<br/>Company pages 33<br/>— Shandong Dong-E E-Jiao.....................................................................................34<br/>— Investment case .............................................................................................35<br/>— Company risks ...............................................................................................42<br/>— Financials .......................................................................................................43<br/>— Price target derivation ....................................................................................47<br/>— Company background ....................................................................................48<br/>— Guangzhou Pharmaceutical .................................................................................51<br/>— Investment case .............................................................................................52<br/>— Company risks ...............................................................................................59<br/>— Financials .......................................................................................................60<br/>— Price target derivation ....................................................................................65<br/>— Company background ....................................................................................66<br/>— Guangzhou Pharmaceutical - A ...........................................................................69<br/>— Investment case .............................................................................................70<br/>— Company risks ...............................................................................................77<br/>— Financials .......................................................................................................78<br/>— Price target derivation ....................................................................................83<br/>— Company background ....................................................................................84<br/>— Tianjin Tasly Pharmaceuticals (G) .......................................................................87<br/>— Beijing Tongrentang (G) .......................................................................................94<br/>— Tong Ren Tang Technologies ............................................................................100<br/>— Yunnan Baiyao Group (G) ..................................................................................106</p><p></p><p>
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