EQUITY RESEARCH INITIATION OF COVERAGE
November 15, 2012 CHINA/HEALTHCARE Stock Rating: Sinopharm Group Co Ltd PERFORM 12-18 mo. Price Target NA Dominant Leader in a Growing/Consolidating 1099.HK - HKSE HK$24.90 Industry; Initiating with Perform
3-5 Yr. EPS Gr. Rate 21% SUMMARY 52-Wk Range HK$27.45-HK$16.76 We are initiating coverage of Sinopharm (1099.HK) with a Perform rating. China's Shares Outstanding 2,403.0M pharma distribution is growing rapidly and consolidating gradually from a competitive Float 828.0M to an oligopolistic industry. Sinopharm, China's largest pharmaceutical distributor, Market Capitalization HK$59,825.4M represents the best investment vehicle to gain exposure, in our view. In recent years, Avg. Daily Trading Volume 2,452,955 it has gained market share, and we believe it will continue to do so with strong Dividend/Div Yield HK$0.19/0.76% government backing, ample capital and economies of scale. Although most pharma wholesalers experience margin erosion, Sinopharm's margins have been relatively Book Value HK$6.73 stable. We believe it can grow revenue/net income at 21.5%/21.4% CAGRs during Fiscal Year Ends Dec 2011-17. However, its fair valuation keeps us on the sideline initially. We would look 2012E ROE 9.0 % to become more constructive as valuation becomes more attractive. LT Debt HK$5,229.0M Preferred NM KEY POINTS Common Equity HK$21,528M ■ Absolute Dominance. China's No. 1 pharma distributor, Sinopharm has more Convertible Available No than 10% market share in an industry that's growing at a double-digit rate and, interestingly, consolidating at the same time, backed by government support. We Revenue(CNY/ 1H 2H Year Mult. view Sinopharm as the future top oligopoly player in the space. mil) 2011A 48.0B 54.2B 102.2B ■ Expect Above-industry Growth. Management targets growing revenue 2012E 66.6BA 64.6B 131.2B 300-500bps above the industry's. We estimate Sinopharm's revenue will rise at 2013E 81.4B 79.9B 161.3B a 21.5% CAGR during 2011-17, on: 1) increasing direct sales, 2) expanding its 2014E -- -- 195.1B distribution network, 3) developing retail pharmacies, and 4) using M&A. 2015E -- -- 234.2B ■ EPS So Far, Margins Remain Stable. Chinese pharma distributors' margins, higher 1H 2H Year Mult. Diluted than global peers', are declining as regulations tighten. Industry margins could 2011A 0.34 0.32 0.66 become similar to global peers' at some point. So far, Sinopharm's gross margin 2012E 0.40A 0.39 0.79 has been stable, on more direct sales and better product mix. 2013E 0.54 0.46 1.00 ■ Valuation. Sinopharm trades at 25x/20x our 2012-13E EPS of 2014E -- -- 1.24 HKD0.97(RMB0.79) and HKD1.24(RMB1.00), respectively. DCF analysis gives 2015E -- -- 1.48 Revenue and diluted EPS figures are in CNY. P/E us a fair value in the mid-20s HKD, which keeps us on the sideline; however, multiples based on HK$ are: 2011A-30x; 2012E-25x; we would become more constructive if Sinopharm can consistently deliver stable 2013E-20x; 2014E-16x. margins, given industry challenges. This research report is intended for use only by institutions to which the subject security or securities may be sold pursuant to an exemption from state securities registration in the state in which the institution is located. Stock Price Performance Company Description Sinopharm Group is China’s largest pharmaceutical distributor. Its network covers 178 prefecture-level cities in 30 provinces in China. It also has 1,801 retail drugstores.
Oppenheimer & Co. Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment Ingrid Yin, Ph.D. Melody Li decision. See "Important Disclosures and Certifications" section at the end of this report for important disclosures, including potential conflicts of interest. See 212-667-7194 212-667-7409 [email protected] [email protected] "Price Target Calculation" and "Key Risks to Price Target" sections at the end of this report, where applicable.
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Table of Contents
Investment Thesis ...... 2 Company Overview ...... 3 China Pharmaceutical Distribution Industry Overview ...... 6 A Fragmented Market Undergoing Consolidation ...... 6 Simplify Structure by Eliminating Bottom Layer ...... 7 Double-Digit Growth Rate to Stay ...... 8 Distributors Must Focus to Survive ...... 11 History as a Mirror: Margin Trend of Global Pharma Distributors ...... 16 Regulations Pressure China’s Pharmaceutical Distributors ...... 18 Value-added Services Is Still at Early-Stage in China ...... 20 Industry Consolidation ...... 21 Competitive Landscape ...... 23 M&A Environment ...... 28 Sinopharm: Competitive Advantages ...... 32 1.Extensive Distribution Network ...... 32 2.Leading Logistics Capabilities ...... 33 3.Providing Value-added Services ...... 34 4.Diversified Product Offerings ...... 36 Growth Strategies ...... 37 1.Increase Direct Sales to Hospitals ...... 37 2.Expand Distribution Network ...... 38 3.Grow Retail Pharmacy Business ...... 38 4.Grow Through M&A ...... 39 Valuation...... 41 Investment Risks ...... 44 Financial Analysis ...... 45 Management ...... 55 Financial Statements ...... 56
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Investment Thesis
We Are Initiating Coverage of Sinopharm Group (1099.HK) with a Perform Rating. Sinopharm is China‟s largest pharmaceutical distributor with 10.8% market share (see Exhibit 3). Its competitive advantages help it continue to gain share in this consolidating industry, which we foresee as transforming into an oligopolistic one. Although overall, China‟s pharma distribution industry is facing declining margins, so far Sinopharm has been able to maintain or even improve margins by adjusting sales channel mix and improving operation efficiencies. However, we view the current valuation as fair and begin coverage on the sideline, waiting until valuation becomes more attractive.
Absolutely Dominant Player. With the largest pharmaceutical distribution network in China, Sinopharm likely will continue to gain market share, benefiting from industry consolidation. We expect Sinopharm‟s market share to grow from 10.8% in 2011 to 14.4% in 2017 (see Exhibit 53), through organic growth and M&A activities. Long-term, we believe Sinopharm will be the top oligopoly player with significant market share.
So Far, Margins Remain Stable. Chinese pharma distributors enjoy better margins than global counterparts‟. However, recently, Chinese distributors‟ gross margins have started experiencing pressure, from drug price cuts and mark-up reductions. In the long term, we believe industry gross margin will continue a gradual decline to a global average level. So far, Sinopharm has been able to maintain a stable gross margin at 8.0-8.4% (see Exhibit 72), driven by increasing direct sales to hospitals and adjusting its product portfolio.
We Expect Sinopharm to Grow Revenue/Net Income at a 21.5%/21.4% 2011-2017 CAGR. Sinopharm can grow revenue by: 1) increasing direct sales to hospitals; 2) expanding its distribution network; 3) further developing its retail pharmacy business; and 4) engaging in M&A activities. With improving operating efficiency, we think it can achieve net income growth of 21.4% during 2011-2017.
Valuation. Sinopharm is trading at 25x and 20x our 2012 and 2013 EPS estimates of HKD0.97 (RMB0.79) and HKD1.24 (RMB1.00), respectively, 67% above global peers and in-line with domestic peers‟ 21x PE multiple for 2013 (using consensus estimates for peers). Applying a DCF analysis, we derived a fair value range in the mid-20s in HKD terms. Believing the valuation quite rich, we will begin coverage on the sideline and would become more constructive if Sinopharm consistently delivers stable margins.
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Company Overview
Sinopharm (1099.HK) is China‟s largest pharmaceutical distributor, owning the nation‟s most extensive pharmaceutical distribution network. Its 50 distribution centers cover 30 provinces and 178 cities and service 9,993 hospitals including 1,312 top-tier hospitals. It also has more than 57,000 small customers (un-graded hospitals, community service centers/stations, and healthcare centers), more than 45,000 retail customers, and more than 5,700 pharmaceutical distributing customers as of 2011. In addition, it operates 1,801 retail drugstores with 1,637 (91%) directly owned and 164 (9%) franchised. Its distribution business accounted for 94% of revenue while retail and other business contributed 6% (Exhibit 1). Of its 1H12 revenue, 54% came from direct sales to hospital while 34% was generated by sales to sub-distributors (Exhibit 2). Sinopharm has been increasing its market share from 7.1% in 2006 to 10.8% in 2011 (Exhibit 3).
Exhibit 1. Revenue Breakdown,1H12 Exhibit 2. Sales Breakdown by Channels,1H12
Retail Other 3% 3%
Indirect Sales 34% Hospital Sales Distribution 54% 94% Direct Retail Sales Sales to Basic 5% Healthcare Institutions 7%
Source: Company Reports, Oppenheimer & Co. Inc. Research Source: Company Reports, Oppenheimer & Co. Inc. Research Note: Other business represents production and sale of pharmaceutical products, chemical
reagents and laboratory supplies. Exhibit 3. Sinopharm’s Market Share by Sales 12.0% 10.8% 9.8% 10.0% 9.3%
8.1% 8.0% 7.7% 7.1%
6.0%
4.0%
2.0%
0.0% 2006 2007 2008 2009 2010 2011
Source: Company Reports, MOFCOM, Oppenheimer & Co. Inc. Research
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History and Parent Companies
Sinopharm was established in January 2003 as a joint venture by China National Pharmaceutical Group Corp (CNPGC) and Fosun Investment, with investment capital of RMB 1.637B. Fosun Investment transferred its equity interest in Sinopharm to Fosun Pharma in 2004. CNPGC and Fosun Pharma currently hold 33.5% and 32.1% equity interests in Sinopharm, respectively (Exhibit 4). Sinopharm IPO‟ed in Hong Kong on September 23rd, 2009.
Exhibit 4. Sinopharm’s Corporate Structure Fosun Pharma China National Pharmaceutical 100% Group Corp. Qishen Company (CNPGC)
51% 49%
The National Sinopharm Social Security Public Industrial Fund Shareholders Investment Co. Ltd. (NSSF)
0.11% 65.41% 2.61% 31.97%
Sinopharm Group Co. Ltd. (1099.HK)
Source: Company Reports, Oppenheimer & Co. Inc. Research
CNPGC
CNPGC, founded in 1998, is a medical and healthcare group directly managed by the state-owned Assets Supervision and Administration Commission of the State Council (SASAC). Its core business includes distribution and retail sales of pharmaceuticals, and R&D of healthcare related products. In 2011, CNPGC‟s sales exceeded RMB120B ($19.2B). Currently, CNPGC has 10 wholly owned or holding subsidiaries, and 5 publicly listed companies (Exhibit 5) including Sinopharm (1099.HK), China National Medicines Co. (600511.CN), Beijing Tiantan Biological Products Co. (600161. CN), Shyndec Pharmaceutical Co. (600420. CN) and China National Accord (000028.CN).
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Exhibit 5. CNPGC’s Corporate Structure China National Pharmaceutical Group Corp. (CNPGC)
44.01% China National Medicines (600511-CN, Mkt Cap: $1.1B) China State Institute of Pharmaceutical Industry (CSIPI) Sinopharm Group (1099-HK, Mkt Cap: $7.6B) China Sinopharm International Corp. China National Accord (000028-CN, Mkt Cap: $1.5) Reed Sinopharm Exhibitions 38.33% Co., Ltd
China National Scientific Instruments & Materials Corp. (CSIMC) 95% 53% Beijing Tiantan Biological China National Biotec Group Products (CNBG) China National Corporation (600161-CN, Mkt Cap: $1.1B) of Traditional & Herbal Medicine
Sinopharm United Engineering Crop.
Sinopharm United Engineering Corp. 41.62% Shyndec Pharmaceutical Sinopharm Group Finance (600420-CN, Mkt Cap: $557M) Co.
Private Yangzhou VACBIO Biological Engineering Co., Ltd. Public
Source: Company Data, Oppenheimer & Co. Inc. Research
Fosun Pharma
Fosun Pharma is a leading healthcare company in China. Its business includes manufacturing, distributing, and retail sales of pharmaceuticals, diagnostic products and medical devices, and healthcare services. Its 2011 revenue was RMB6.4B. Fosun Pharma has listed on the Shanghai Stock Exchange under ticker 600196 since 1998. Recently, it IPO‟ed on the Hong Kong Stock Exchange on October 30, 2012.
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China Pharmaceutical Distribution Industry Overview
A Fragmented Market Undergoing Consolidation
The pharmaceutical distribution industry in China is very fragmented: there are total of 13,853 pharmaceutical wholesale distributors. The top 3 players, namely CNPGC, Shanghai Pharma and China Resources Pharma, have only 22.8% of total market share as of 2011, compared with their counterparts‟ 95% in the US, 70% in Europe and 77% in Japan (Exhibits 6 and 7). Most wholesalers are small local players dispersed throughout sub-provincial level cities. We estimate there are ~60 tier 1 distributors (Exhibit 8), with 1-2 in each province/municipality/autonomous region. We expect the ongoing consolidation in the industry to allow market share to concentrate in top 3 players and gradually move toward the level similar to developed countries‟.
Exhibit 6. Market Share of Top 3 Pharma Distributors in China, US, Europe and Japan
95%
77% 70%
23%
China US Europe Japan Source: Company Reports, Oppenheimer & Co. Inc. Estimates
Exhibit 7. Market Shares of Top 3 Pharma Distributors, China vs. US
China US
Others, 5%
Shanghai Pharm, Sinopharm, 5.2% 13.2%
China Resources Pharma, 4.4% AmerisourceBergen, McKesson, 36% 26%
Others, 77.2%
Cardinal Health, 33%
Source: MOFCOM, Company Reports, Oppenheimer & Co. Inc. Research
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Exhibit 8. Pharmaceutical Distribution Channel in China
Manufacturers
Tier 1 Distributors
Tier 2 Distributors
Tier 3 Distributors To Be Eliminated
Hospitals Drug Stores
>70% ~20%
Patients
Source: Oppenheimer & Co. Inc. Research
Simplify Structure by Eliminating Bottom Layer
In China, pharmaceutical products are sold/distributed from drug manufacturers through one or more tiers of distributors (Exhibit 8). The complicated distribution channels and mark-up structures at each level are causing unreasonably high drug prices. The reason behind the multiple layers of distribution is that in China, more than 70% of drugs are dispensed by hospitals, which become centers of important decision-making. Local relationships with hospitals have created unnecessary extra layers in the distribution value chain. The situation is totally different in the US, where 71% of Rx drugs are sold through retail channels (Exhibit 9). In order to reduce patients‟ out-of-pocket drug spending, the Chinese government aims to simplify and “shrink” the distribution channel to reduce the mark-up between ex-factory price and hospital purchase price. Lowest-tier distributors that mainly rely on earning mark-up by reselling pharmaceuticals to local hospitals are facing an increasingly difficult business environment. In the structural transformation process, large distributors such as Sinopharm are gaining market share.
Exhibit 9. Drug Sales by Channels, China vs. US China US
Basic Healthcare Institutions 13% Retail Drugstores Hospitals/Clinics 25% 29%
Retail Hospitals Channels 62% 71%
Source: IMS, Oppenheimer & Co. Inc. Research Note: US drug sales refer to sales of prescription drugs
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Double-Digit Growth Rate to Stay
China‟s pharmaceutical industry sales grew at a 23% CAGR during 2005-2011 from RMB437.3B (US$54B) to RMB1.53 trillion (US$238B) (Exhibit 10). Highly correlated with pharmaceutical sales, pharma distribution industry revenue has been growing at double digits for the last seven years (Exhibit 11). Although regulation changes such as NDRC price cuts and centralized provincial tenders have put pressure on the industry since healthcare reform launched in 2009, volume has driven the sales value to increase at a 21% CAGR from RMB300B (USD$37B) in 2005 to RMB943B(US$147B) in 2011 (Exhibit 11), according to MOFCOM (Ministry of Commerce of China). We expect the industry to grow at 20% CAGR through 2015, supported by unmet medical need due to the aging population, rising affordability and expansion of healthcare insurance coverage.
Exhibit 10. China’s Pharmaceutical Industry Exhibit 11. China’s Pharmaceutical Sales Distribution Industry Sales RMB Bn RMB Bn 1,800 1000 2005-2011 CAGR: 21% 942.6 30% 1,600 900 2005-2011 CAGR: 23% 24.6% 1,400 25% 800 21.0% 708.4 19.8% 1,200 700 23.0% 16.7% 20% 600 568.4 1,000 500 469.9 15% 800 12.0% 402.6 400 336 300 10% 600 300 200 400 5% 100 200 0 0% 0 2005 2006 2007 2008 2009 2010 2011 2005 2006 2007 2008 2009 2010 2011 Sales Value of China's Drug Distribution Industry YoY Change Source: National Bureau of Statistics, Oppenheimer & Co. Research Source: MOFCOM, Oppenheimer & Co. Research Note: 2011 Year-over-year growth rate excluding non-comparable factors is 23%, according to MOFCOM.
1. Aging Population
China‟s population is aging fast. The number of people over the age of 65 in China reached 119 million, representing 8.9% of total population, in 2010. That number is expected to reach 172 million in 2020 and 336 million, or 24% of the total population, by 2040 (Exhibit 12). The rapidly aging population will drive the growth of hospital visits, hence boosting demand for pharmaceuticals and healthcare products.
Exhibit 12. China’s Population is Aging Rapidly Million 400 30% 350 25% 300 20% 250 200 15% 150 10% 100 5% 50 0 0% 2000 2010 2020E 2030E 2040E 2050E
Population Aged 65+ % of Total Population
Source: National Population and Family Planning Commission, Oppenheimer & Co. Inc. Research
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2. Increasing Affordability
The economic boom in the last 15 years has pushed up income levels in China. Income per capita in urban and rural China grew at 12.8% and 9.9% CAGRs during 2000-2010 (Exhibit 13). During the same period, medical expenditures per capita in China grew at 10.6% and 14% in urban areas and suburban areas, respectively (Exhibit 14). Even though the economy recently cooled off to less than 8% growth this year, the typical salary increase in China is still above 10% annually. Rising disposable income should continue to boost volume increases of pharmaceutical products, thus supporting pharmaceutical distribution industry growth.
Exhibit 13. Income Per Capita in China Exhibit 14. Healthcare Expenditure Per Capita RMB RMB 25,000 2000-2010 CAGR 1,000 2000-2010 CAGR Urban: 12.8% 900 Rural: 9.9% Urban: 10.6% 20,000 800 Rural: 14.0% 700 15,000 600 500 10,000 400 300 5,000 200 100 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Rural Household Urban Household Urban Rural
Source: National Statistics Bureau, Oppenheimer & Co. Inc. Research Source: National Statistics Bureau, Oppenheimer & Co. Inc. Research
3. Near-Universal Healthcare Insurance Coverage
In China, healthcare spending as a percentage of GDP is still behind that in developed countries (Exhibits 15 and 16). China kicked off a 3-year healthcare reform program in 2009, aiming to increase government spending on healthcare and improve healthcare access, especially for the grassroots population.
Exhibit 15. Per Capita Healthcare Expenditure Exhibit 16. Public Health Expenditure as % of as % of GDP, 2010 Total Healthcare Spending 83.9 17.9 82.5 77.8 77.1
59 11.9 11.6 53.6 53.1 47 9.6 9.5 9
6.9 29.2 5.1 4.1
US France Germany UK Japan Brazil Korea China India UK Japan France Germany Korea China US Brazil India
Per Capita Healthcare Spending as % of GDP Public Health Expenditure as % of Total
Source: World Bank, Oppenheimer & Co. Inc. Research Source: World Bank, Oppenheimer & Co. Inc. Research
Government healthcare expenditures increased significantly during 2009-2011: by 45%, 20% and 34% year over year, respectively (Exhibit 17). Healthcare outlays also grew 23.5% yoy YTD as of August 2012. Meanwhile, basic healthcare insurance coverage increased from merely 25% of the population in 2005 to 97% in 2011 (Exhibit 18). Social security spending on healthcare has grown at a 5-year CAGR of 27% to RMB443B in 2011 (Exhibit 19). The Chinese government plans to increase the annual medical insurance subsidy per person from RMB240 in 2012 to RMB360 in 2015 (Exhibit 20). As a result, patient traffic in China is rising rapidly, with outpatient and inpatient volume
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jumping by 11% and 13%, respectively, in 2011 (Exhibits 21 and 22). The growth rates accelerated to 15% and 19% during January-July, 2012.
In August 2012, the Chinese government announced it will expand medical insurance for serious diseases, to reimburse at least 50% on top of the existing coverage under basic healthcare insurance. Near-universal healthcare insurance, a rising reimbursement ratio, and increasing government expenditure should continue to serve as medium - to long- term growth drivers for the pharmaceutical distribution industry.
Exhibit 17. China’s Government Healthcare Exhibit 19. Medical Expenditure of the Social Expenditure Security Fund
RMB Bn YoY Change RMB Billion 700 60% 500 450 600 50.7% 50% 400 2000-2011 CAGR: 38% 500 44.9% 33.8% 350 38.5% 40% 400 300 23.5% 30% 250 300 27.3% 22.5% 200 21.3% 20.3% 20% 200 16.3% 150 11.5% 100 100 9.8% 10% 50 0 0% 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: MOHRSS, Oppenheimer & Co. Research Source: MoH, Oppenheimer & Co. Inc. Research
Exhibit 18. Basic Medical Insurance Coverage Exhibit 20. Government Subsidy for in China Healthcare Insurance Program Million RMB/person 360 900 100% 800 90% 700 80% 240 600 70% 60% 500 200 50% 400 40% 300 30% 120 200 20% 100 60 10% 40 0 0% 2005 2006 2007 2008 2009 2010 2011 Population covered by Urban Basic Medical Insurance 2008 2009 2010 2011 2012 2015 Goal Population covered by New Rural Co-op Basic Medical Insurance Coverage Ratio Source: MoH, Oppenheimer & Co. Inc. Research
Source: MoH, Oppenheimer & Co. Inc. Research
Exhibit 21. Outpatient Volume at Hospitals Exhibit 22. Inpatient Volume at Hospitals yoy yoy Million Million change change 2,500 18% 120 25% 15% 16% 100 19% 2,000 14% 20% 80 11% 12% 17% 1,500 11% 15% 15% 10% 14% 13% 60 12% 9% 8% 1,000 8% 10% 9% 6% 6% 6% 40 4% 5% 500 20 2% 0 0% 0 0% 2005 2006 2007 2008 2009 2010 20111-7, 2012 2005 2006 2007 2008 2009 2010 2011 1-7, 2012
Source: MoH, Oppenheimer & Co. Research Source: MoH, Oppenheimer & Co. Research
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Distributors Must Diversify to Survive
Distributors in China have to be very adaptive to market trend changes in order to survive in a tough environment. They have to constantly adjust their strategies regarding what kind of products to distribute, what sales channel to use, and what geographic regions to focus on to stay ahead of competitors and gain market share. 1. Western Drugs vs. Traditional Chinese Medicine The majority of pharmaceuticals consumed in China are Western chemical and biological products, representing 76% of industry sales (Exhibit 23). Traditional Chinese medical (TCM) accounted for 18%, still a very important category due to historical reasons and Chinese government support. Medical devices and reagents are much smaller, only 5% of the total; we believe this segment has more growth potential with better margins.
Exhibit 23. Distribution Industry Sales by Product Type, 2011
Medical Reagents Devices and 1% Instruments Others 3% 2%
TCM and TCM raw materials 18%
Western Drugs and Biological Products 76%
Source: MOFCOM, Oppenheimer & Co. Research 2. Direct vs. Indirect Of pharmaceuticals in China, 56% are sold by distributors directly to hospitals/healthcare institutions and retail drug stores (Exhibit 24), and the other 44% are sold to sub- distributors, especially in regions where top-tier distributors cannot penetrate easily. The current percentages are similar to the 2010 level. Compared with the industry average, large players usually have heavy direct sales because of broad distribution networks and strong relationships with hospitals. For example, direct and indirect revenue were 66% and 34% at Sinopharm, respectively. At Shanghai Pharma, in 2011, hospital sales contributed 61.4% of distribution business. Cachet Pharma (嘉士堂), a No. 58-ranked wholesaler in 2011, has hospital sales only 46% of total revenue, below the industry average of 56%.
Exhibit 24. Distribution Industry Sales by Channels
Sales to Sub- distributors Direct Sales 44% 56%
Source: MOFCOM, Oppenheimer & Co. Research
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3. Coastal vs. Interior Regions
Due to significant wealth disparity, residents of China‟s coastal regions in the east, north and south consume significantly more pharmaceutical products than those living in the western interior. These three regions accounted for 80.4% of industry sales in 2011 (Exhibit 25) as they historically have experienced faster economic growth and therefore better affordability. Recently, growth in the traditionally “backward” southwest, northwest and northeast regions has exceeded that of the nation average in 2011 (Exhibit 25). The growth rates for these three regions were 76%, 27% and 28% yoy respectively, vs. 17% for the coastal area. In our view, those interior regions could serve as future drivers for the industry with healthcare insurance coverage expansion, which has significantly improved patients‟ affordability there.
Exhibit 25. China’s Pharmaceutical Distribution Sales by Regions Sales (RMB Bn) Sales Breakdown Regions 2010 2011 YoY Change 2010 2011 YoY Change East 339 396 16.9% 44.2% 42.0% -2.2% North 156 182 16.9% 20.3% 19.3% -1.0% South 151 180 19.3% 19.7% 19.1% -0.6% Sub-total 645 758 17.4% 84.2% 80.4% -3.8% Southwest 62 109 76.1% 8.1% 11.6% 3.5% Northwest 22 28 27.2% 2.9% 3.0% 0.1% Northeast 37 47 28.1% 4.8% 5.0% 0.2% Sub-total 121 185 52.6% 15.8% 19.6% 3.8% Source: MOFCOM, Oppenheimer & Co. Research
4. Urban vs. Rural
Recent healthcare insurance coverage expansion and increased healthcare subsidies have benefited rural populations more than urban populations. Before the 2009 healthcare reform, rural residents had very low or even no healthcare insurance coverage. Now they can afford to seek basic healthcare diagnosis and treatments. Medical consumption per capita in rural areas grew 34% in 2011 and 22.6% in 1H12 compared with 12% and 4.4% in urban cities during the same period (Exhibit 26). Drug sales in other regions outside top-3 tier cities grew by 25%/20% in 2010/2011, faster than national rates of 20% and 17% (Exhibit 27 and 28). We expect the trend to continue in the next few years.
Exhibit 26. Growth Rates of Medical Consumption Per Capita
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10%
Rural Urban
Source: National Bureau of Statistics, Oppenheimer & Co. Research
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Exhibit 27. Drug Sales Growth by City Tiers 30% 25% 25% 22% 21% 20% 19% 20% 18% 17% 17% 17%17%
15% 13% 13% 2010
10% 2011
5%
0% China 1st Tier 2nd Tier 3rd Tier 3 regions Others Cities Cities Cities
Note: IMS Health, Oppenheimer & Co. Inc. Research
Exhibit 28. Drug Sales Breakdown by City Tiers
48% 49%
6% 6% 6% 6%
20% 21%
20% 18%
2010 2011
1st Tier Cities 2nd Tier Cities 3rd Tier Cities 3 regions Others
Note: IMS Health, Oppenheimer & Co. Inc. Research 1st Tier Cities: Beijing, Shanghai, Guangzhou 2nd Tier Cities: 11 cities, Hangzhou, Tianjing, Wuhan, Nanjing, Shenzhen 3rd Tier Cities: 7 cities, Changzhou, Ningbo, Taiyuan, Dalian, Qingdao 3 Regions: Pearl River Delta, FuXiaQuan, SuXi; Others： Rest of China
5. SOE vs. Private
State-owned enterprises (SOEs), businesses either wholly or partially owned by the government, take significant market share in China‟s pharmaceutical distribution industry. In 2011, 60% of sales of large-scale pharmaceutical distributors, meaning wholesale distributors with more than RMB50M in sales and retail players with more than RMB20M in sales, were generated by SOEs (Exhibit 29). Although the ratio declined slightly from 62% in 2010, SOEs still dominate the market. Among the top 10 pharmaceutical distributors, only Jointown (No.4) and Sichuan Kelun (No.9) are non-SOEs.
SOEs generally have more resources such as capital, local government and business relationships, natural advantages for them to conduct business in China. In addition, current policies favor large players, as the government aims to consolidate the industry. Thus, we do not expect market shares of SOEs to come down significantly in the medium term, and expect players such as Sinopharm, with national-level government backing, to continue to have an edge over those distributors with local government backing and private players.
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Exhibit 29. Sales Breakdown by Enterprise Type
2010 2011
Private Other Private Other Company 0% Company 1% 6% Foreign Foreign 8% Company Company 11% 9%
Shareholding Shareholding State-owned State-owned Company Company or State- or State- 21% 23% holding holding Companies Companies 62% 60%
Source: MOFCOM, Oppenheimer & Co. Research Note: large scale pharmaceutical distributors include wholesale distributors with >RMB50M sales and retail players with >20M sales.
6. Retail Drugstores vs. Healthcare Institutions
Unlike in the US, retail drugstores are not as important a drug dispensing outlet as in China. Only 25% of drugs are distributed through retail stores compared with 71% in US (Exhibit 9). Retail drugstores sales have been growing at a 17% CAGR from RMB79B in 2005 to RMB203B in 2011 (Exhibit 30). There are a total of 2,607 retail chain drugstore enterprises in China as of 2011, running total 423,788 retail drug stores, including 146,703 chain drug stores and 277,085 independent stores (Exhibit 31). The total number of retail drugstores grew by 6% in 2011. In the long run, the government intends to transfer drug distribution from healthcare institutions to drugstores, imitating developed countries‟ model. However, numerous hurdles exist as many interested parties are involved. Meanwhile, big distributors have to invest in this segment, preparing for a potential shift in the future.
Exhibit 30. Retail Drugstores Sales Exhibit 31. Number of Retail Drugstores RMB Bn 250 300,000 277,085 261,996 2005-2011 CAGR: 17% 252,631 203.8 236,232 250,000 223,861 200 185.3 198,076 153.1 200,000 150 129.5 146,703 150,000 129,346 135,762 137,073 110.0 121,579 121,070 91.6 100 79.0 100,000
50 50,000
0 0 2006 2007 2008 2009 2010 2011 2005 2006 2007 2008 2009 2010 2011 # of Chain Drugstores # of Independent Drugstores Source: SFDA Southern China Economic Research Center, Oppenheimer Source: SFDA, Oppenheimer & Co. Research & Co. Research
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Exhibit 32. 2011 China’s Top 10 Retail Drugstores 2011 Sales YoY Market Share Ranking Company Name (RMB Bn) (USD M) Change by Sales 1 国药控股国大药房连锁 Sinopharm Holding Guoda Drugstore 3.72 59.1 14% 2.0% 2 重庆桐君阁药房连锁 Chongqing Tongjunge Pharmacy Chainstore 3.69 58.6 10% 2.0% 3 广东大参林连锁药店 Guangdong Dashenlin Chain Drugstore 3.67 58.3 20% 1.9% 4 中国海王星辰连锁药店 China Nepstar Chain Drugstore 3.62 57.5 6% 1.9% 5 老百姓大药房连锁股份 LBX Pharmacy 3.57 56.7 13% 1.9% 6 湖北同济堂药房 Hubei Ready Medicine 2.88 45.7 21% 1.5% 7 成大方圆医药连锁 Chengda Fangyuan Pharmarcy Chains 2.60 41.3 10% 1.4% 8 云南鸿翔一心堂药业 Yunnan Hongxiang Yixintang 2.58 41.1 9% 1.4% 9 上海华氏大药房 Shanghai Huashi Pharmacy 2.50 39.7 25% 1.3% 10 重庆和平药房连锁 Chongqing Peace Chain-drugstore 1.93 30.6 -24% 1.0% Source: MOFCOM, Oppenheimer & Co. Inc. Research
Exhibit 33. Market Share of China’s Retail Drugstores, 2011 2% 2% 2% 2% 2% Sinopharm Holding Guoda Drugstore 2% 1% Chongqing Tongjunge Pharmacy Chainstore 1% 1% 1% Guangdong Dashenlin Chain Drugstore China Nepstar Chain Drugstore LBX Pharmacy Hubei Ready Medicine Chengda Fangyuan Pharmarcy Chains Yunnan Hongxiang Yixintang Shanghai Huashi Pharmacy 84% Chongqing Peace Chain-drugstore Other
Source: MOFCOM, Oppenheimer & Co. Inc. Research
Exhibit 34. 2011 China’s Top 10 Retail Drugstores by Store Numbers # of Eligible for Healthcare # of Directly Ranking Company Name Franchise Total # of Stores Insurance Owned Stores Reimbursement
1 中国海王星辰连锁药店 China Nepstar Chain Drugstore 2883 0 2883 - 2 国药控股国大药房 Sinopharm Holding Guoda Drugstore 2000 0 2000 360-450 3 重庆和平药房连锁 Chongqing Peace Chain-drugstore 1800 720 2520 - 4 哈尔滨宝丰医药连锁 Harbin Baofeng Pharmaceutical Chain 1604 0 1604 1512 5 云南鸿翔一心堂药业 Yunnan Hongxiang Yixintang 1505 0 1505 993 6 重庆桐君阁大药房连锁 Chongqing Tongjunge Pharmacy Chainstore 1172 6454 7626 1645 7 广东大参林连锁药店 Guangdong Dashenlin Chain Drugstore 1100 0 1100 - 8 云南健之佳健康连锁店 Yunnan Jianzhijia Chain Health Drug Store 800 0 800 430 9 成大方圆医药连锁 Chengda Fangyuan Pharmarcy Chains 658 170 828 631 10 江西黄庆仁栈华氏大药房 Jiangxi Huang Qing Ren Zhan Hua Shi Pharmacy 616 0 616 - 老百姓大药房连锁股份 11 LBX Pharmacy 600 0 600 - Source: MOFCOM, Oppenheimer & Co. Inc. Research
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History as a Mirror: Margin Trends of Global Pharma Distributors
We believe Chinese pharma distributors are enjoying better margin profiles than most global counterparts‟ (Exhibits 73, 78, and 80): 2011 average gross margin, operating margin, and net margin of Chinese peers (excluding Guangzhou Pharma and Huadong Medicine which have a high contribution from manufacturing business) were 6.7%, 2.5%, and 1.6%, respectively, vs. 4.2%, 1.7%, and 1.0% for US peers, and 7.5%, 0.7%, and 0.5% for Japanese peers, respectively. We have studied historical margin trends of global pharmaceutical distributors, which convince us that it‟s inevitable that China distributors‟ current gross margin will come down in the future, although it might take decades before it reaches the global level. US
The US pharmaceutical distribution industry experienced consolidation during 1978-1995: the number of pharmaceutical wholesalers dropped from 147 firms to 53, and market share of the largest six firms increased from 35% in 1977 to 77% in 1995. More than 100 buyouts have taken place since 1980s. Currently the top 3 players, Cardinal Health, McKesson, and AmerisourceBergen, together hold ~95% market share. Technology upgrades of IT systems, better inventory management, nationwide delivery capabilities, efficiencies and cost reductions are driving the industry to further consolidate.
In the process, average gross margins of the top 3 players have been declining (Exhibit 35), from 9.75% in 1990 to only 4.1% in 2011. Operating margin declined from 2.8% to 1.63%. Net margin has also narrowed from 1.40% to 0.93% over the same period. Revenue CAGRs of MCK and CAH during 1990-2011 were 13.5% and 24.7%, respectively, faster than their respective net income CAGRs of 12.3% and 19.2%. ABC managed to increase net income at CAGR of 22.3% during 1995-2011, faster than its revenue CAGR of 19.5%.
Exhibit 35. Margin Trend of Top 3 US Pharma Distributors
18
16
14
12
10
8
6
4
2
0
-2 Gross Margin Operating margin Net margin Source: Factset, Oppenheimer & Co. Inc. Research Note: Data availability: MCK: 1980-2012, CAH: 1982, 1984-2012, ABC: 1994-2011
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Europe
European distributors have also experienced consolidation during the last few decades as well. The market share of top 3 players, Alliance Boots, Phoenix and Celesio, has increased from 47% in 2004 to the current 70%. Consolidation in the EU was accelerated by intensive cost containment policies imposed by governments. Players have survived by improving efficiency, increasing logistic capabilities and cutting costs. Celesio‟s revenue grew at a 12.5% CAGR during 1990-2011 with negative net income growth. Gross margin, operating margin and net margin declined from 8.2%, 2.6%, and 1.5% in 1990 to 4.8%, 0.8% and 0% in 2011, respectively (Exhibit 36).
Exhibit 36. Historical Margin Trend of Celesio
% 12
10
8
6
4
2
0
-2
Gross Margin EBIT Margin Net Margin Source: Factset, Oppenheimer & Co. Inc. Research
Japan
Similarly, Japan‟s pharma distribution industry has experienced consolidation in recent decades, mainly due to a drastic local drug price-cut policy in the early 1990‟s. Before consolidation, small distributors served customers within a limited geographic area and had sales rights with only a select number of manufacturers. During the consolidation, local distributors were acquired by those with nationwide coverage and broader sales rights. The number of pharmaceutical wholesale distributors dropped from 434 in 1987 to 128 in 2007. The market share of the top 10 players increased from 37.1% in 1996, to 61.7% in 2004. By 2010, the top four participants, namely Medipal, Alfresa, Suzuken, and Toho, accounted for 89.4% market share.
The gross margin of Japan‟s top 4 pharmaceutical wholesalers has been on a declining path (Exhibit 37): from an average 13% in 1994 to currently 7.5%. Net margin contracted from 1.11% to only 0.53% in 2011, despite revenue growth at a high single-digit to low double-digit pace. Sales of primary-care drugs, the main source of distributors‟ revenue, are shrinking significantly in Japan. Therefore, major players expect further gross margin erosion. They are reducing costs to survive in a low-margin business environment, at the same time, gaining market share by offering low-cost and high-quality logistics solutions to customers.
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Exhibit 37. Margin Trend of Top 4 Japan Pharma Distributors
% 14 12 10 8 6 4 2 0
Gross Margin Operating Margin Net Margin
Source: Factset, Oppenheimer & Co. Inc. Research
Regulations Pressure China’s Pharmaceutical Distributors Chinese pharmaceutical distributors are subject to the supervision of the Ministry of Commerce (MoC) and the State Food and Drug Administration (SFDA). MoC is responsible for setting plans, policies and standards regarding industry development, promoting industry structure adjustment, guiding industry reform, and promoting the development of modern logistics. SFDA is responsible for the approval, registration, and supervision of pharmaceutical distributors, setting product quality and safety standards, and inspection. Wholesalers and retail pharmacies need to get the local SFDA‟s approval for operational permit and Good Supply Practice (GSP) designation. China‟s National Development and Reform Commission (NDRC) is responsible for drug pricing and the mark-up ceiling in distribution channels, and both impact the pharmaceutical distribution industry. Ministry of Health, together with SFDA and NDRC, regulates drug tenders. Below we listed some recent important regulation changes impacting the industry. Centralized Drug Tenders In 2009, the Chinese government announced “Guideline of Further Standardization of Pharmaceuticals Procurement by Healthcare Institutions” (“进一步规范医疗机构药品集中 采购工作的意见”), requesting that all domestic pharmaceutical manufacturers must attend drug tenders, and in the case of imported products, main distributors have to do it. Prior to that, distributors could bid on behalf of domestic manufacturers. After winning the bids, manufacturers can either distribute the product on their own or through distributors. The policy limits that distribution task can be only assigned once, compared with previously multiple times, for one product although multiple tier-1 distributors could be appointed in certain region. The bidding prices of the pharmaceuticals already include distribution fees, and distributors are not allowed to collect extra fees from hospitals and healthcare institutions. The policy reduces the number/layers of distributors by shortening the supply chain of pharmaceutical distribution and favors large players in winning exclusive distribution rights. Drug Price Cuts NDRC has announced six retail price ceiling cuts since 2009 (Exhibit 38). Price cuts are usually absorbed by both distributors and manufacturers, which will negatively affect wholesalers‟ profitability, although some manufacturers will reimburse them partial price difference.
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Exhibit 38. NDRC Price Cuts 2005-2012
Types of Average Annoucement Implementation Drug Category Products Reduction of Date Date Affected Retail Price
9/28/2005 10/10/2005 Cefuroxime and others 22 40% 6/1/2006 6/12/2006 Adriamycin and other oncology drugs 68 23% 8/22/2006 8/28/2006 Antimicrobial agents, including Penicillins 99 30% Anti-tumor Chinese Patent Medicines including 11/14/2006 11/20/2006 32 15% Cinobutacini Injection 1/25/2007 1/26/2007 Various 354 20% 2/28/2007 3/15/2007 Chinese Patent Medicines 278 15% 4/9/2007 4/16/2007 Chinese Patent Medicines 188 16% 5/9/2007 5/15/2007 Western Medicines 260 19%
10/2/2009 10/22/2009 EDL Drugs 307 12% 11/30/2010 12/12/2010 Ceftriaxone and others 174 19% 3/7/2011 3/28/2011 Antimicrobial drugs and circulatory system drugs 162 21% 8/5/2011 9/1/2011 Hormone, endocrinology and nervous system drugs 82 14%
3/30/2012 5/1/2012 Alimentary drugs 53 17% 9/18/2012 10/8/2012 Oncology, immunology and hematology drugs 95 17% Source: NDRC, Oppenheimer & Co. Research
Exhibit 39. Major Policies Related to Pharma Distribution Industry Document Date of Release Key Comments English Chinese Encourage pharmaceutical distribution industry consolidation through M&A. Major Goals: 2011-2015 Plan for China's Have 1-3 large national pharmaceutical distributors with >RMB100B sales; 2011-2015 5/2011 Pharmaceutical Distribution Have 20 regional distributors with >RMB10B sales; 全国药品流通行业发展规划纲要 Industry Top 100 distributors to account for >85% market share; Chain drugstores to have >60% market share; Chain drugstores to account for >2/3 of total retail drugstores. Suggest mark-up ceilings for drugs at both wholesale level (from pharmaceutical manufacturers to hospitals) and retail level (from hospitals to patients). Pharmaceutical Distribution 药品流通环节价格管理暂行办法 Lower maximum mark-up from previous 40% to current 30%, and set stricter 1/2012 Channel Mark-up Measure (意见稿) control on ex-factory mark-up. (Draft) Request manufacturers to report the highest, lowest and average ex-factory price of last year to NDRC
Raise entry-barrier and industry standards. Practices of Pharmaceutical Request pharmaceutical distributors and retailers to build quality management 药品经营质量管理规范 4/2012 Distribution and Retail system. (修订草案) (Revised Draft) Request pharmaceutical distributors/retailers to promptly report/deal with drug quality issue. Source: Ministry of Commerce, NDRC, SFDA, Oppenheimer & Co. Research
A Draft of Pharmaceutical Distribution Channel Mark-Up Measure (药品流通环节价格管理 暂行办法征求意见稿) was published in January 2012 (Exhibit 39 and 40). It suggested mark-up ceilings for drugs at both wholesale (from manufacturers to hospitals) and retail levels (from hospitals to patients). The new measure lowers maximum mark-up from the previous 40% to the current 30%, and set stricter controls on ex-factory mark-up. It also requests that manufacturers report the highest, lowest and average ex-factory prices from the previous year to the NDRC. The policy was originally scheduled to be finalized in July 2012. However, it was delayed, and we expect the final version to be released soon.
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Exhibit 40. Proposed and Previous Mark-up Ceilings 2011 Draft Version Ex-Factory (Imported) Mark-up Ceiling at Mark-up Ceiling at Retail Price (RMB) Wholesale Level Level 1 <10 30% 25% 2 10-40 20%+RMB1 15%+RMB1 5 40-200 15%+RMB3 10%+RMB3 4 200-800 10%+RMB18 8%+RMB5 5 800-2,000 8%+RMB34 RMB69 6 >2,000 RMB194 RMB69
2010 Draft Version
Ex-Factory (Imported) Price (RMB) Mark-up at Retail Level
1 <5 40% 2 5-20 30%+RMB0.5 5 20-100 25%+RMB1.5 4 100-500 20%+RMB6.5 5 500-1000 15%+RMB31.5 6 1,000-10,000 8%+RMB101.5 7 >10,000 RMB901.5
2000 Official Version
Ex-Factory (Imported) Price (RMB) Mark-up at Retail Level 1 <5 50% 2 5.01-6.25 RMB2.5 5 6.26-10 40% 4 10.01-12.50 RMB4 5 12.51-50.00 32% 6 50.01-57.14 RMB16 7 57.15-100 28% 8 100.01-112.00 RMB28 9 112.01-500 25% 10 >500 15%+RMB50 Source: NDRC and Oppenheimer & Co. Inc. Research
Value-added Services Is Still at Early Stage in China
For years, global pharma distribution players have been seeking ways to differentiate and increase profit (Exhibit 41). In US, AmerisourceBergen provides specialized medical distribution, while McKesson focuses more on distribution solutions and healthcare technology solutions. Other than pharmaceuticals, Cardinal Health also distributes surgical products. Medipal distributes cosmetics and daily necessities in addition to healthcare products. In Europe, different from other global players, Celesio shifted its strategy focus back on core business in 2011, after it invested heavily in diversification as expectations were not met due to both internal and external reasons, including the European financial crisis. Meanwhile, Celesio plans to further expand its network in emerging markets such as Latin America and Brazil.
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Exhibit 41. Major Global Pharma Distributors
Business Model Diversification
Diversified Services
Medipal
Cardinal Health Celesio
McKesson Value-added Service
AmerisourceBergen Sinopharm Drug Distribution
Geographic Local Regional Int‟l Coverage
Source: Booz & Co., Oppenheimer & Co. Inc. Research
Chinese pharmaceutical distributors have started to modify their business model by adding value-added services although development is still at an early stage. Large players are transforming from pure distributors into pharmaceutical distribution solution providers. For example, Sinopharm worked with the 309th Military Hospital to provide a solution which could track drugs from procurement to dispensing. Nanjing Pharma pioneered a hospital-pharmacy-trusteeship model (医院药房托管). Through this model, a hospital will assign a drug distributor to operate the hospital pharmacy, without changing the ownership of the pharmacy. This format then transitioned to pharmacy services (药事服务), which provide full solutions to hospital pharmacies.
Government is supportive of improving overall system efficiencies by introducing advanced logistics systems and information systems. Ministry of Commerce launched a demonstration project of pharmaceutical logistics service extension in Beijing in June 2011. Beijing Pharmaceutical Co. (a subsidiary of China Resources Pharma) helped Tiantan Hospital redesign the pharmacy flow structure and introduced an IT system. The project successfully improved the operational efficiency of Tiantan Hospital‟s pharmacy: 60% of pharmacists can focus on clinical pharmacy services, inventory capacity increased by 20% and inventory turnover improved by 20%. The collaboration is viewed as a service outsourcing model, through which hospitals can lower costs and improve service quality while distributors can earn service fees.
At the current stage, value-added service for hospitals is a way to help retain customers; however, it does not generate revenue for either Sinopharm or Nanjing Pharma (see p. 26), the No. 5 pharma distributor in China and a pioneer in providing pharmacy services to hospitals. Nanjing Pharma has even experienced profit declines and net losses in recent years, partially attributable to those value-added services. However, as scale grows and as the business model matures, we expect those services to become profitable.
Industry Consolidation
China‟s drug distribution industry is consolidating, backed by government policy support (Exhibit 42). Government clearly expressed in the “2011-2015 Development Outline for Drug Distribution Industry” (Exhibit 39) that it will support three nationwide leaders with
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annual sales of more than RMB100B, and 20 regional leaders with sales of more than RMB10B. Government is also targeting the top 100 players to account for 85% of industry sales by 2015, vs. only 73% in 2011. For retail, the government aims that chain drugstores to dispense two-thirds of the pharmaceutical products and the top 100 players to have 60%-plus market share by 2015. The policy also emphasizes the need for overall capabilities improvement, such as logistics equipment, IT systems, and other value-added services.
We expect the industry to consolidate quickly through 2015 and small players to be acquired or eliminated. As the bellwether with a strong SOE background, SinoPharm would largely benefit from the government‟s policy and can further expand its operating scale through M&A.
Exhibit 42. China’s Pharma Distribution Industry Is Consolidating % of Total % of Total Top 3 Top20 Top 10 Top 100 Top 11-20 40% 85%
35% 80%
75% 30% 70% 25% 65% 20% 60% 15% 55% 10% 50%
5% 45%
0% 40% 2003 2004 2005 2006 2007 2008 2009 2010 2011 Top 3 Top 10 Top 11-20 Top 100 Top 20 Source: CAPC, Company Reports, Oppenheimer & Co. Inc. Research
The retail drugstore industry has been consolidating as well. According to MOFCOM, the top five players accounted for 26% market share by sales, up from 24% a year ago while the top ten players hold a combined 44% share, vs. 41% in 2010. In total, the top 20 players accounted for a 61% share of industry sales, up from 58% in 2010. As policy headwinds on retail drugstores continue, we expect consolidation to accelerate in upcoming years. Sinopharm, Guoda, Guangdong Dasenlin, and LBX Pharmacy gained shares in 2011 while Nepster lost market share. The market share of Chongqing Tongjunge remained stable at 1.81% in 2011, while Sinopharm Guoda‟s share doubled from 0.9% in 2006 to 1.82% in 2011 (Exhibit 43).
Large players have been actively expanding their drugstore network by acquiring either independent stores or regional chain drugstores. Long-term, as hospital drug prescription and dispensing are gradually separated, we expect drugstore industry growth to re- accelerate.
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Exhibit 43. Market Share of Top 5 Retail Drugstores Players 3.0%
2.5%
Sinopharm Holding Guoda 2.0% Chongqing Tongjunge Guangdong Dashenlin 1.5% China Nepstar LBX Pharmacy
1.0%
0.5% 2006 2007 2008 2009 2010 2011 Source: China Drugstore Magazine, Company Reports, Oppenheimer & Co. Inc. Research
Competitive Landscape
In China, pharmaceutical distributors compete very intensely in a very fragmented market for distribution rights for manufacturers and hospitals. The top 10 pharma distributors control 34% market share, according to 2011 data (Exhibits 44 and 45). CNPGC, Sinopharm‟s parent company, is the industry leader, with more than twice the market share of the No.2 player, Shanghai Pharma. The top four distributors, CNPGC, Shanghai Pharma, China Resources Pharm, and Jointown, have nationwide networks, while Nanjing Pharm, Guangzhou Pharma, Chongqing Medicine, Huadong Medicine, Sichuan Kelun Medicine & Trade, and Zhejiang Int‟l are more regional. Each company has its differentiated business model and geographical focus (Exhibits 46 and 49).
Exhibit 44. 2011 China’s Top 10 Pharma Wholesale Distributors, 2011 Market 2011 Sales National/ Ranking Company Name YoY Change Share by Regional (RMB Bn) (USD Bn) Sales 1 中国医药集团总公司 China National Pharmaceutical Group (CNPGC) 125 19.8 42% 13.2% National 2 上海医药(集团)股份有限公司 Shanghai Pharmaceuticals Holding 49 7.8 48% 5.2% National 3 华润医药控股有限公司 China Resources Pharmaceutical 41 6.5 27% 4.4% National 4 九州通医药集团有限公司 Jointown Pharmaceutical Group 25 3.9 17% 2.6% National 5 南京医药股份有限公司 Nanjing Pharmaceutical 20 3.2 32% 2.1% Regional 6 广州医药有限公司 Guangzhou Pharmaceutical 18 2.8 21% 1.9% Regional 7 重庆医药(集团)股份有限公司 Chongqing Medicine Group 13 2.1 21% 1.4% Regional 8 华东医药股份有限公司 Huadong Medicine 11 1.8 24% 1.2% Regional 9 四川科伦医药贸易有限公司 Sichuan Kelun Medicine & Trade 10 1.5 12% 1.0% Regional 10 浙江英特药业有限责任公司 Zhejiang Int'l Group 9 1.4 32% 0.9% Regional Source: MOFCOM, Oppenheimer & Co. Inc. Research
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Exhibit 45. Market Share of China’s Pharmaceutical Distributors, 2011
CNPGC
Shanghai Pharma 13% China Resources Pharma
5% Jointown Pharma
5% Nanjing Pharma 3% Guangzhou Pharma Corp. 2% 2% Chongqing Medicine 1% Huadong Medicine 66% 1% Sichuan Kelun Medicine & 1% Trade 1% Zhejiang Int'l Others
Source: MOFCOM, Oppenheimer & Co. Inc. Research
Sinopharm, owning 10.8% market share, derives 96% of revenue from its distribution business. It has the broadest geographic coverage in the industry, with coverage of 30 provinces and municipalities. It‟s the first mover to massively expand into central and western areas while other players are still focusing on top tier cities and coastal regions (Exhibit 46). Sinopharm currently covers 178 (55%) out of total 333 prefecture-level cities (above tier 3). Its revenue/net profit grew by 34%/69% CAGR during 2006-2011, significantly faster than the industry average. It focuses on hospital direct sales (54% of 1H12 sales) for its higher gross margin and large market potential. It distributes a broad range of pharmaceuticals produced by top multinational corporations (MNCs) and domestic manufacturers.
Exhibit 46. Distribution Network Coverage of Top 10 Pharma Distributors in China Guangzhou Shanghai China Nanjing Chongqing Huadong Sichuan Zhejiang Regions Sinopharm Jointown Pharma Pharma Resources Pharma Med Med Kelun Med Int'l Corp. 2nd tier ** ** ** ** * * Central 3rd tier ** ** ** ** * County-level ** ^ ** ** * 1st tier ** ** ** ** ** ** ** (Shanghai) East 2nd tier ** ** ** ** ** * ** ** 3rd tier ** ** ** ** ** ** ** County-level ** ** ** ** ** ** ** 1st tier ** ** ** ** (Beijing) North 2nd tier ** ** ** ** 3rd tier ** ** ** ** County-level ** ^ ** ** 1st tier (Guangzhou, ** ** ** ** ** Shenzhen) South 2nd tier ** ^^ ** ** ** 3rd tier ** ^^ * ** ** County-level ** - - ** ** 2nd tier ** ** * * * * ** ** Southwest 3rd tier ** ^^ * * * * ** ** County-level ** - * * * ** ** 2nd tier ** ^^ ** * * Northwest 3rd tier ** ^^ ** * * County-level ** - ** * * 2nd tier ** * ** * * Northeast 3rd tier ** * ** * * County-level ** - ** * * Source: Company Data, Oppenheimer & Co. Inc. Research Note: ** strong coverage; * medium coverage; ^^ strong coverage by sub-distributors; ^ medium coverage by sub-distributors.
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Shanghai Pharma has a strong presence in the Yangtze River Delta, with 72.5% of distribution revenue derived from that region in 1H12 (Exhibit 47). Of revenues, 20.5% and 7% were from northern and eastern China. It acquired Guangzhou Z.S.Y Pharma (广州中 山医药) and CITIC Pharma (中信医药) to expand to southern and northern regions. Shanghai Pharma distributes more high-end products with more than 50% revenue generated from selling imported medicines or those manufactured by MNCs‟ China subsidiaries. Shanghai Pharma also targets hospitals directly, which was 59.8% of its 1H12 distribution revenue. It manufactures pharmaceuticals, 14% of FY11 revenue, with 58 key products contributing 55% of its manufacturing revenue. Its total revenue grew at a 26% CAGR from 2008 to RMB38.7B in 2011. Distribution grew faster at a 31.6% CAGR compared with 7.4% for the manufacturing segment. Net profit grew at a 35% CAGR during the same period due to better operating margins despite declining gross margins.
Exhibit 47. Shanghai Pharma Revenue Breakdown by Regions
South 7.0%
North 20.5%
East 72.5%
Source: Company Reports, Oppenheimer & Co. Inc. Research
China Resources Pharma moved up in the ranks after acquiring Beijing Pharma, a leading distributor of healthcare products in northern China. It has a nationwide network, covering 28 provinces with 13,000 end-customers. It also has more than 1,200 retail chain drugstores. China Resource Pharma Group has three domestically listed, well-known pharmaceutical subsidiaries: Huarun Sanjiu (000999-CN), Hurun Shuanghe (000062-CN) and Dong-E E-Jiao (000423-CN). These three subsidiaries generated RMB14.6B in 2011, while China Resources Pharma‟s drug distribution business had RMB41B in revenue. China Resources‟ revenue and net profit were US$8.8B (HK$67.9B) and US$628M (HK$4.87B), respectively, in 2011 with the highest net margin in the industry: 7%.
Jointown is the only company without an SOE background among the top six players. Before 2010, it mainly targeted low-tier markets, namely hospitals below tier 2, grassroots healthcare institutions, retail drugstores and sub-distributors. More than 41% of its drugs are OTC compared with Sinopharm and Shanghai Pharma‟s focus on prescription drugs. It conducted a low margin and low accounts-receivable strategy. After listing in the domestic market in 2010, Jointown began to enter mid- to upper-tier hospitals. However, given the existing strong presence of other large distributors, it was slowly winning business at big hospitals. Sales to tier 2 and above hospitals of RMB1.3B in 2011, although up 47% yoy, represented only 5.5% of distribution revenue. Of Jointown‟s sales, 98% derive from its distribution business. Revenue and net profit grew at 15% and 23% CAGRs, respectively, during 2008-2011 to RMB24.8B and RMB376M.
Nanjing Pharma is the leading distributor in Jiangsu Province with 98% of revenue derived from distribution. It pioneered in outsourcing pharmacy services to hospitals and collaborates with 277 hospitals, including 8 top-tier, 47 second-tier, and 222 third-tier. However, the outsourcing business has not helped its profitability yet. Although its revenue grew at a 14.5% CAGR during 2008-2011 to RMB17.1B, Nanjing Pharma has
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experienced operating and net profit declines since 2008. Due to lower gross margin and higher operation cost, it hasn‟t reported a profit since 2010. In 2012, Alliance Boots announced that it would invest $91M (RMB560M) for a 12% equity interest in the company. Final timeline for the deal is contingent upon government approval. Nanjing Pharma aims to leverage MNCs‟ capital and experience to improve its operational management, logistics capability and IT systems.
Exhibit 48. Corporate Structure of Guangzhou Pharma Corp. GZ Pharma Holding 广州医药集团有限公司（广药集团）
35.58% 48.2%
Guangzhou GZ Pharma Co. Other non-public listed Baiyunshan (874-HK; 600332-SHE) subsidiaries (000522-SHE) 广州药业股份有限公司
98.48% Guangzhou Bai Di (Subsidiary of GP Co.)
50% 48.05% 50% Guangzhou Nuo Guangzhou Wang GZ Pharma Corp. Cheng Bio-Tech Co. Lao Ji 广州医药有限公司 Pharmaceutical Co.
50% 48.05% 50% Guangzhou Jiahe Hong Kong Tung Hing Alliance Boots Bio-tech Co. Pharmaceuticals 广州市嘉合生物技术有 香港同兴 药业 限公司
JV Companies
JV Partners Source: Company Reports, Oppenheimer & Co. Inc. Research
Guangzhou Pharma Corp., ranking No. 6, has 100% hospital coverage in Guangdong Province, and its customers include more than 5,700 healthcare institutions, more than 7,000 retail drugstores, and more than 3,100 sub-distributors across the country. It became a JV company controlled by Alliance Boots and Guangzhou Pharma Co. (874-HK) in 2008 (Exhibit 48). Although its geographic presence is still limited to southern China and the Pearl River triangle, Guangzhou is expanding to other provinces via M&A. Its revenue grew by a 17% CAGR from RMB9.9B in 2008 to RMB15.8B in 2011, and net profit grew at a 15.3% CAGR over the same time.
MNCs. International distributors have started to pay more attention to China‟s pharmaceutical market as it‟s on a path to become one of the largest pharma markets in the world. International distributors typically enter China through JVs and acquisitions. Alliance Boots, the largest pharmaceutical distributor in Europe and now 45% owned by Walgreens, established a JV with Guangzhou Pharma in 2008 and acquired a 12% equity interest in Nanjing Pharma in 2012. Recently, Alliance Boots aims to be a China‟s pharmaceutical distribution industry consolidator, with plans to further expand through M&A and steps into retail pharmacies. Cardinal Health, after acquiring two regional distributors in Sichuan and Wuxi, acquired Zuellig Pharma, a leading healthcare distributor doing business under the Yong Yu brand, in 2010. In June 2012, Cardinal Health acquired Zhejiang Dasheng, another regional player. Yong Yu and Dasheng together had a 0.94% market share in 2011. Cardinal is now a top 10 player.
27 Sinopharm GroupExhibit Co Ltd 49. Comparison Table of Top 10 Pharma Distributors in China Total 2011 Distribution Market # of Sub- Ranking Companies Description Revenue Revenue Regional Exposure Major Growth Strategies Comments Share distributors RMB M It's China's largest pharmaceutical distributor with most Increase direct hospitals sales; extensive network coverage. It distributes both imported Largest distribution network among peers; Provide value-added services to customers; We expect it to gain shares by further and domestic manufactured pharmaceutical products to Covers 178 cities in 30 provinces; Expand distribution network and further penetrating existing markets and 1 Sinopharm Group hospitals, grassroots healthcare institutions, retail 102 99 10.8% Covers 9,993 (74% of total) hospitals and 1,312 (94% of total) >5,700 penetrate mid-and-low tier cities; expanding to new geographic regions, drugstores and sub-distributors. It has 1,801 retail chain top-tier hospitals; Grow retail pharmacy business; through both organic growth and M&A. drugstores. Distribution and retail segments accounted for Hospital direct sales accounted for 54% of 1H12 sales. Grow though M&A. 94% and 3% of 2011 sales respectively. It's China's second largest pharmaceutical distributor with National network; Covers >7,600 hospitals and medical Expand nationwide network coverage; strong network coverage in Eastern China. 52% of institutions, including >229 (64% of total) Class III, 879 (56% of We expect it to gain shares by further Optimize product portfolio and consolidate Shanghai distribution revenue is from imported products/MNCs total) Class II hospitals in Eastern China; strengthening its network coverage in manufacturing resources; 2 Pharmaceuticals brands. It has 1,700 chain drugstores. It also engaged in 55 49 5.2% 75% of FY11 distribution sales is from Eastern China while >3,354 regions besides Eastern China Enhance cross-segment and operational Holding R&D and manufacturing of pharma products. Distribution, 16.4% and 5.3% are from Northern and Southern China; through both organic and inorganic integration; retail and manufacturing accounted for 82%, 14% and 4% Hospital direct sales accounted for 61% of FY11 distribution growth. Grow though M&A. of 2011 sales respectively. sales. It's China's leading pharmaceutical company and is We expect it to gain shares by further National network; Covers 28 provinces; Expand distribution network coverage; dedicated to R&D, manufacturing and distribution of penetrating existing markets and China Resources Gained strong presence in Northern China through acquisition Gain share by providing value-added services; 3 pharmaceutical products. It provides nationwide wholesale, 55 41 4.4% NA expanding nationwide coverage Pharmaceutical of Beijing Pharmaceuticals in 2010. Integrate cross-segment business; logistics, retail and supply chain value-added services. It through both organic and inorganic Grow though M&A. has ~1,200 retail chain drugstores. growth. Expand distribution network to top-tier hospitals We expect its share to be stable or It's a leading distributor of pharmaceutical and healthcare and increase hospital direct sales; lower as it's still in the process of National network; Covers 1,881 ≥ tier 2 hospitals and 25,994 Jointown products in China with strong network coverage of mid and Gain market share by providing value-added shifting target market from low-end basic healthcare institutions; 4 Pharmaceutical lower tier markets. >41% of products it distributes are OTC 25 25 2.6% >8,600 services; (grassroots healthcare institutions and Has >8,600 sub-distributors and >37,000 other customers Group drugs. It has 776 retail drugstores. Distribution business Optimize product portfolio to improve margins; retail drugstores) to high-end market including retail drugstores. accounted for 98% of its 2011 sales. Grow retail drugstores business; (hospital direct sales). Major M&A Grow through M&A. could accelerate its growth. We expect its share to be stable or It's a leading pharmaceutical distributor in Eastern China, lower given its regional presence, especially in Jiangsu province. 98% of its revenue derived Enhance value-added services; although investment by Alliance Coots Nanjing from distribution business while 1.3% was from Regional network; Covers >750 hospitals, including 250 top Grow retail drugstores business; could help improve its operation 5 Pharmaceutical manufacturing business in 2011. It has ~400 retail 17 17 2.1% NA tier hospitals and 500 tier 2 hospitals. Strengthen cost control and improve margin management, and service and Co. drugstores. Alliance Boots invested $91M for 12% equity profile. logistics capabilities in the long-term. interest of the company in 2012. Major M&A could accelerate its growth. It's a leading pharmaceutical distributor in Southern China, especially in Guangdong province. It's engaged in the Regional network; 100% hospital coverage in Guangdong Grow hospital direct sales; We expect its share to be stable or Guangzhou wholesale and retail of pharmaceutical products and province; Expand distribution network; lower given its regional presence. 6 Pharmaceutical medical apparatus. It has 2 retail chain drugstores brands: 16 16 1.9% Customers includes >5,700 healthcare institutions, >7,000 >3,100 Develop e-commerce business; Major M&A could accelerate its Corp. Guangzhou Jianmin and Dazhong Yiyao. It became a 50:50 retail drugstores, and >3,100 sub-distributors across the Grow through M&A. growth. JV company in 2008, controlled by Guangzhou Pharma Co. country. and Alliance Boots. We expect its share to be stable or It's the largest pharmaceutical distributor in Western China. Chongqing Regional network; Strong coverage in Chongqing; Distribution lower given its regional network 7 It's engaged in wholesale distribution, retail pharmacy, and 15 13 1.4% >200 Expand nationwide network coverage. Medicine Group network extends to 31 provinces. coverage. Major M&A could accelerate manufacturing business. its growth. Expand distribution network coverage; It's a leading pharmaceutical distributor in Jiangsu province. Enhance logistics service capabilities; We expect its share to be stable or It‟s also engaged in manufacturing of pharmaceutical Regional network; Established collaboration relationship with Enrich product portfolio with more imported lower given its regional network 8 Huadong Medicine products and API. 83% and 17% of its 2011 sales were 11 11 1.2% 72 >30 hospitals in Zhejiang province. products; coverage. Major M&A could accelerate derived from distribution and manufacturing business Grow through M&A. its growth. respectively.
It's a leading pharmaceutical distributor in Sichuan province. Further expand network coverage within Sichuan It distributes TCM and western pharmaceutical products, Regional network; Strong coverage of mid-to-low tier markets province; We expect its share to be stable or Sichuan Kelun API, medical devices and other healthcare products. It has in Sichuan province; Diversify product portfolio; lower given its regional network 9 10 10 1.0% >100 Medicine & Trade >13,000 retail drugstores in Sichuan province. It's a Has >100 sub-distributors and covers thousands of hospitals. Develop hospital direct sales; coverage. Major M&A could accelerate subsidiary of Sichuan Kelun Pharmaceuticals, one of Enhance services capabilities; its growth. China's largest manufacturers of IV solutions. Grow through M&A. Further expand coverage and penetrate lower- We expect its share to be stable or It's a leading pharmaceutical distributor in Zhejiang Regional network in Zhejiang province; tier market; Zhejiang Int'l lower given its regional network 10 province. It distributes western and TCM pharmaceuticals 9 9 0.9% Covers all hospitals at county-level or above in Zhejiang; NA Diversify product portfolio, especially in biologic Group coverage. Major M&A could accelerate products and medical devices. Has >18,000 end-customers. products, medical devices and TCM; its growth. Grow through M&A. Source: Company Data, MOFCOM, Oppenheimer & Co. Inc. Research
28 Sinopharm Group Co Ltd
M&A Environment
M&A activities in China‟s pharmaceutical distribution industry were intense during 2010- 2011. All large players acquired companies to gain share and access to new geographic regions. Acquisitions occurred in both the wholesale distribution and retail pharmacy segments. However, the M&A pace slowed in 2012 (Exhibits 50 and 51): the number of acquisitions during 1H12 was much less than those in 2010 and 2011. Sinopharm spent less on acquisitions in 1H12 (RMB804M vs. RMB1.4B and RMB3.3B in 2010 and 2011) (Exhibit 67). Among other players, the major acquisitions of 1H12 were the acquisition of Zhejiang Xinxin Pharma by Shanghai Pharma, the acquisition of Anhui Yuanchu Chain Drugstore by Jointown, and the purchase of Da Sheng Pharma by Cardinal Health (Exhibit 50).
In our view, major reasons for the slowing down of M&A are:
1) The price of M&A targets has been rising due to active M&A in prior years: typical P/E multiples for acquisitions were ~8x in 1H10 and then rose to 12-15x in 2H10 and 2011.
2) Integration of previously acquired companies takes time, so acquirers slowed the M&A pace to focus on integration.
3) M&A funds have gotten scarcer due to ongoing organic expansion projects, such as system upgrades and distribution centers‟ build-out.
4) Operating costs tend to rise after acquisitions due to the differences between local policies and the central government‟s goal of industry consolidation.
We expect industry consolidation to continue in the upcoming years; however, acquisitions are expected to be smaller, and targets will be more concentrated in mid- to-lower tier cities.
29 Sinopharm Group Co Ltd
Exhibit 50. Major Pharma Distribution M&A since 2010 Target Amount Acquired Region Time Valuation English Chinese (RMB M) Interest
Shanghai Pharma Shanghai Industrial Pharmaceutical 上海实业医药 Eastern Jan-10 1,946 100% - Ningbo Pharmaceutical 宁波医药 Southeastern Apr-10 38 13% - Qingdao Growful Pharmaceutical 青岛国风药业 Eastern Apr-10 150 26% - Guangzhou Z.S.Y. Pharmaceutical 广州中山医药 Southern Jun-10 141 51% 0.16x FY09 sales Fujian Pharmaceutical 福建省医药公司 Southern Jul-10 79 49% 0.14x FW sales Beijing Aixin Weiye Medicine 北京上药爱心伟业医药 Northern Nov-10 206 52% - Shanghai Yutiancheng Pharmaceutical 上海余天成医药 Shanghai Dec-10 70 51% - Zhejiang Taizhou Pharmaceutical 浙江台州医药 Southeastern Dec-10 150 53% - China HealthSystem Ltd. (Citic Pharma) 中信医药实业 Northern Jan-11 3,568 100% 0.42x FY11 Sales Shanghai Zhongxie Pharmaceutical 众协药业 Eastern May-11 119 100% 0.15x FY10 sales Wuxi Shanhe Group Pharmaceutical Logistics 无锡山禾医药 Eastern Jul-11 344 80% 0.43x sales Shanghai Asia Pioneer Huakang Pharmaceutical 上海新先锋华康医药 Eastern Sep-11 356 100% 0.4x BV Guangzhou Zhongnan Pharmaceutical 广州中南药业 Southern 2011 - - - Foshan Daxiang Pharmaceutical 佛山大翔医药 Southern 2011 - - - Zhuhai Kangtuo Pharmaceutical 珠海康拓医药 Southern 2011 - - - Shantou Wande Pharmaceutical 汕头市万德医药 Southern 2011 - - - Hangzhou Quandetang Pharmacy 杭州全德堂药房 Eastern 2011 - - - Zhejiang Xinxin Pharmaceutical 浙江新欣医药 Eastern Mar-12 103 67% - China Resources Jinan Zhongxin Pharmaceutical 济南中信药业 Eastern Nov-10 - - - Henan Aisheng Pharmaceutical Logistics 河南爱生医药物流 Central Dec-10 - - - Beijing Pharmaceutical 北京医药 Northern Jun-11 - 51% - Beijing Purenhong Pharmaceutical 北京普仁鸿医药销售 Beijing Jun-11 250 25% 0.82x FY09 sales Shenzhen Huayi Runsheng Pharmaceutical Drugstores in 14 0.23x FY10 sales 深圳华益润生医药投资有限公司 Jul-11 73 100% Investment provinces 14.2x FY10 PE Suzhou Lian Pharmaceutical 苏州礼安医药有限公司 Eastern Nov-11 1,000 65% - China Resources Guangdong 华润广东医药 South Sep-12 - - - (Collaboration with Guangdong Zhongjian Pharma) (与广东中健医药共同组建) Guangzhou Pharma Holding Shaanxi Kangjiang Pharmaceutical 陕西康健医药 Northwestern Nov-10 - - - Changsha Hengsheng Pharmaceutical 长沙恒生医药 South Central Nov-10 - - - Shanxi Kangxingyuan Pharmaceutical 山西康兴源药业 Northern Mar-11 - - - Henan Nanyang Guanbao Pharmaceutical 河南南阳冠宝药业 Central Aug-11 - - - Fujian Jieda Pharmaceutical 福建广药洁达医药 Southern - - - - Hainan Chenfei Pharmaceutical 海南晨菲医药 Southern - - - - Jointown Sichuan Beili Pharmaceutical 四川省倍立医药有限责任公司 Southwestern Jan-10 24 75% Suining Western Huayuan Pharmaceutical 遂宁市西部华源医药有限公司 Southwestern Jun-10 17 55% - Sichuan Jointown Kechuang Pharmaceutical 四川九州通科创医药有限公司 Southwestern 2010 - 51% Nanjing Jointown Logistics Tech 南京九州通物流技术 Eastern Jan-11 14 100% - Shandong Jointown Pharmaceutical 山东九州通医药 Central May-11 25 100% - Henan Xinglin Good Pharmacist Chain Drugstore 河南杏林好药师大药房连锁 Central Jun-11 19 90% - Wuhu Jointown Pharmaceutical 芜湖九州通医药销售 Eastern Jun-11 9 70% - Shanxi Jointown Pharmaceutical 山西九州通医药 Northern Aug-11 36 90% - Beijing Good Pharmacist Chain Drugstore 北京好药师大药房连锁 Beijing Sep-11 1 51% - Qingdao Jointown Pharmaceutical 青岛九州通医药 Central Nov-11 51 72% - Guangdong Jointown Pharmaceutical 广东九州通医药 Southern Dec-11 34 79% - Anhui Yuanchu Chain Drugstore 安徽元初药房连锁 Eastern Jan-12 46 65% - Hubei Lishizhen Int'l Medicine Trade Port 湖北李时珍国际医药港药业有限公司 Central 1H12 25 83% North China Pharma Int'l Trading 华北制药国际贸易有限公司 Northern Oct-12 62 49% (JV with North China Pharmaceutical Group Corp.) Nanjing Pharma Henan Jinbaokang 河南金保康药事服务 Central Jan-10 28 100% - Nanjing Xingma 南京兴马商贸 Eastern 2010 34 100% - Jiangsu Kangbao 江苏康宝制药 Eastern Jan-11 NA 53% - Xinjiang Nanjing Tongrentang 新疆南京同仁堂健康药业 Northwestern Jun-11 10 51% - Sichuan Yatong 四川省雅通药业 Sourthwestern Jun-11 21 100% - Xinjiang Production and Construction Corps 新疆生产建设兵团医药零售连锁 Northwestern May-11 1 94% - Pharmaceutical Retail Cardinal Health Zuellig Pharma 永裕(中国)医药 National Nov-10 $470M 100% 0.47x sales Southwestern Sichuan Hewei 四川和维医药咨询有限公司 Aug-11 RMB25M 100% - (Sichuan) Wuxi Xishan 无锡锡山药业 Eastern (Jiangsu) Dec-11 - > 80% - Da Sheng Pharma 浙江大生医药 Eastern (Zhejiang) Jun-12 - 100% - Alliance Boots RMB560M Investment in Nanjing Pharma 南京医药 Regional Sep-12 12% 35x EV/EBITDA ($91M) Source: Company Reports, Industry News Sources, Oppenheimer & Co. Inc. Research
30 Sinopharm Group Co Ltd
Exhibit 51. Major Manufacturing M&A by China’s Pharma Distributors since 2010 Target Amount Acquired Region Time Valuation English Chinese (RMB M) Interest
Shanghai Pharma
Shanghai Fudan-Zhangjiang Bio-Pharmaceutical 上海复旦张江生物医药 Eastern Jan-10 36 9% -
Shanghai Zhongxi Pharmaceutical 上海中西药业 Eastern Feb-10 - - - Shanghai New Asiatic Pharmaceutical 上海新亚药业 Eastern Sep-11 1,132 97% 8.8x FY11 PE Changzhou Kony Pharmaceutical 常州康丽制药 Eastern 1H12 210 70% - Changzhou Wuxin Pharmaceutical 常州武新制药 Eastern 1H12 - - - Nantong Zhongbao Pharmaceutical 南通中宝药业 Eastern 1H12 - - -
China Resources Huarun Pian Zai Huang Pharmaceutical RMB1B by 华润片仔癀药业 Southern Nov-11 51% - (JV with Zhangzhou Pian Zai Huang) 2 parties
Jointown Hubei Jingui TCM Electuary Co. 湖北金贵中药饮片有限公司 Central Apr-11 13 100% - Hubei Xianglian Pharma 湖北香连药业有限责任公司 Central Jan-11 28 30% - Hubei Jointown TCM Development 湖北九州通中药产业发展有限公司 Central Mar-11 60 60% - (JV with Jing Brand) Enshi Jointown TCM Development 恩施九州通中药发展有限公司 Central Aug-11 17 85% - Nanjing Pharma Nanjing Tongrentang 南京同仁堂药业 Eastern 2011 45 100% - Hefei Lejia Laopu TCM 合肥乐家老铺中药饮片 Eastern 2011 3 100% Nanjing Tongrentang Huangshan Pharmaceutical 南京同仁堂黄山精制药业 Eastern 2011 11 100% - Source: Company Reports, Industry News Sources, Oppenheimer & Co. Inc. Research
Exhibit 52. Cash and Debt Balance of Top Public Players RMB M 16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0 Sinopharm Shanghai Jointown Nanjing Guangzhou Huadong Zhejiang Int'l Pharma Pharma Pharma Co. Medicine Cash Debt
Source: Company Reports, Factset, Oppenheimer & Co. Inc. Research
We expect Sinopharm, Shanghai Pharma and China Resources to continue gain market share from smaller players going forward. We conservatively model the market share of the top 3 players combined to increase from the current 20.4% to 27.2% in 2017(Exhibit 53). We expect the market shares of other regional players to be maintained at current levels or even to shrink going forward, due to lack of economies of scale and a slower pace of geographic expansion.
31 Sinopharm Group Co Ltd
Exhibit 53. Top Distributors’ Market Share Trend 16.0%
14.0%
12.0%
10.0% Sinopharm Shanghai Pharma 8.0% China Resources Jointown 6.0% Guangzhou Pharma Nanjing Pharma 4.0%
2.0%
0.0% 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E
Source: MOFCOM, Company Reports, Oppenheimer & Co. Inc. Estimates
Synergy Between Manufacturing and Distribution Businesses?
In China, major distributors have some manufacturing business although scale and revenue contribution vary. Shanghai Pharma and Guangzhou Pharma get more than 10% of revenue from manufacturing, vs. only 1-3% for Sinopharm, Jointown and Nanjing Pharma. Kelun Pharmaceutical sells 11% of its products to Sichuan Kelun Medicine & Trade, its distributing subsidiary.
Synergy between manufacturing and distribution business is more obvious at Shanghai Pharma: the percentage of manufacturing sales distributed by its own channel increased from 12% in 2008 to 18% in 2011 and 18.5% in 1H12. The percentage of sales to Kelun Medicine & Trade from Kelun Pharmaceutical has stayed at the ~11% level for recent years. For three public companies engaged in pharmaceutical manufacturing under China Resources, sales to its distribution companies under China Resources represent a small portion of total revenue. For distribution business at Shanghai Pharma, sales derived from its own manufacturing business represent only 3.3% of distribution revenue, and most business comes from externally sourced products.
Meanwhile, greater flexibility in coordinated sales efforts could allow more competitive product pricing. Although players with both manufacturing and distribution business aim to further realize the synergy between segments, we believe that at the current stage of industry development, the “synergy” benefit accrues more to the manufacturing business rather than to the distribution business.
32 Sinopharm Group Co Ltd
Sinopharm: Competitive Advantages
1. Extensive Distribution Network
Sinopharm„s large distribution network in China differentiates it from peers focusing on specific geographic regions. As of June 2012, Sinopharm has 50 distribution centers covering 178 cities in 30 provinces. It covers a total of 9,993 hospitals, and among those, 1,312 are tier-1 (Exhibits 54 and 55). Its hospital penetration is the highest among its competitors (Exhibit 56), 31% more than Shanghai Pharma‟s, and 5.7 times that of Jointown. Sinopharm also operates 1,801 stores as of June 2012 (Exhibit 57), ranking No.3 in the industry, 101 more than Shanghai Pharma and 801 more than China Resources. To manufacturers, Sinopharm can help their products penetrate a broader market than other distributors. Its distribution network was built over many years‟ efforts and that it would be very difficult for a new entrant or even other competitors to achieve similar scale.
Exhibit 54. Sinopharm’s Hospital Coverage
100% 91.8% 93.8% 90% 85.4%
80% 72.3% 74.0% 70% 64.2% 60% 56.8%
50% 42.2% 40% 30% 20% 10% 0% 2009 2010 2011 2012 1H
All Hospitals Tier-1 Hospitals
Source: Company Reports, Oppenheimer & Co. Inc. Research
Exhibit 55. Covered Hospital Number Comparison 12,000 9,993 10,000
8,000 7,600
5,700 6,000
4,000
1,740 2,000 750 0 Sinopharm Shanghai Guangzhou Jointown Nanjing Pharma Pharma Pharma Corp.
Source: Company Reports, Oppenheimer & Co. Inc. Research
33 Sinopharm Group Co Ltd
Exhibit 56. Hospital Coverage Comparison by Tiers
100% 93.8% 90%
80%
70%
60% 57.9%
50% 45.5% 42.2% 40% 34.6% 33.0% 30% 22.7% 22.1% 23.9% 24.0% 20% 17.9% 11.3% 10.5% 10% 3.4% 2.4% 0% Sinopharm Shanghai Pharma Guangzhou Jointown Nanjing Pharma Pharma
Total Hospital/National Total Top Tier/Total Top Tier Hospitals below top tier/Total below top tier
Source: Company Reports, Oppenheimer & Co. Inc. Estimates
Exhibit 57. Retail Drugstores Network Comparison 3,500
3,000 2,883 2,520 2,500
2,000 1,801 1,700 1,500 1,000 1,000 776 500 500
0 Nepstar Chongqing Peace Sinopharm Shanghai Pharma China Resources Jointown Nanjing Pharma Chain-drugstore Pharma
Source: Company Reports, Oppenheimer & Co. Inc. Research
2. Leading Logistics Capabilities
Sinopharm leads its peers in terms of logistics capabilities. Its logistics services consist of storage, warehousing, local transportation, and delivery. Sinopharm‟s warehouses are equipped with comprehensive warehouse management systems (WMS), radio-frequency identification (RFID) tracking systems, and climate control. Sinopharm has four national logistic hubs, namely, Beijing, Shanghai, Tianjin and Guangzhou, and provincial and local logistics centers (Exhibit 58). Each center can process 100,000 purchase orders daily. Sinopharm provides outsourced logistics services for GlaxoSmithKline and Bayer AG. Eli Lily and Bausch & Lomb are also customers. Sinopharm currently has a total of 50 distribution centers, the most in the industry (Shanghai Pharma: 30; Jointown: 34). Those centers are in 30 provinces, covering 178 cities. Sinopharm aims to cover 4 national logistic hubs, 7 regional, 30-40 provincial, and 60-80 city distribution centers by 2015.
34 Sinopharm Group Co Ltd
Exhibit 58. Selected Logistics Centers of Sinopharm
Beijing Tianjin
Shanghai Guangzhou
Shenyang Shanxi
Source: Company Data, Oppenheimer & Co. Inc. Research
3. Providing Value-added Services
Exhibit 59. Value-added Services Provided by Sinopharm Category Services
Import agency
Customs clearance
Supplier solutions Free trade zone warehousing
Pharmaceutical inventory management
Collection services on behalf of the suppliers
Inventory analysis report
Design and establishment of supply chain Advanced logistics services Technical support and sales assistance
Inventory tracking and management
Electronic purchase orders and confirmation
Quality inspection for imported pharmaceuticals
Packaging, repackaging and reprocessing services Other value-added services Product insurance arrangement
Product return or replacement Delivery of specialty pharmaceutical products Source: Company Data, Oppenheimer & Co. Inc. Research
Sinopharm‟s ability to provide value-added services to manufacturers and hospitals is one of its key advantages. Value-added services include information systems for ordering, inventory management, dispensing and tracking, information/data connection between hospital pharmacy and distributor, and pharmaceutical usage analysis, which helps hospital pharmacies save on labor costs, improve operational efficiency, reduce inventory, and better control drug dispensing service quality (Exhibits 59-61). Through implementing these services, Sinopharm can gain timely feedback on hospitals‟ needs and better control the supply chain, hence improve operational efficiencies and lowering costs.
35 Sinopharm Group Co Ltd
Exhibit 60. China Pharmaceutical Distribution Work Flow
Purchases from Purchases from foreign domestic suppliers suppliers
Customs control and Quality Check quality inspection
Warehousing in free trade zone
Tax and duty clearance
Warehousing
Receiving Orders
Logistics arrangement and delivery
Direct sales to Distribution to other Distribution to retailers hospitals distributors and other customers
Invoicing / collection
Source: Company Data, Oppenheimer & Co. Inc. Research
Providing value-added services has become a growing trend. Although the revenue contribution from those services is not significant, it helps Sinopharm to set it apart from competition, gain market share, save costs and build long-term customer relationships. Most small players are not capable of offering this kind of service. Sinopharm expects to see a meaningful revenue contribution in 2-3 years, once the business scales up.
36 Sinopharm Group Co Ltd
Exhibit 61. Value-added Services Benefits to suppliers • Lower cost • Optimize pharmaceutical products procurement process and customers • Better inventory management • Improve services and efficiency of drug dispensing • Better channel development • Lower operation and labor cost • Lower inventory • Enhance working capital management • Improve overall operation efficiency • Enhance quality and safety assurance
Benefits to Sinopharm • Build L-T supply/distribution relationships • Build L-T supply/distribution relationships with hospitals • Obtain exclusive distribution rights • Obtain priority distribution rights
Hospital Pharmaceutical Pharmacies Sinopharm Manufacturers Retail Drugstores
Value-added Services • Import agency and customs clearance • Inventory IT information system upgrade • Free trade zone warehousing • Product tracking • Inventory tracking and management • Inventory management and analysis • Collection services • Pharmaceutical usage analysis • Quality inspection for imported products • Product return or replacement • Packaging/repackaging services • Delivery of specialty pharmaceutical products • Cold chain logistics • Sales assistance
Source: Company Data, Oppenheimer & Co. Inc. Research
4. Diversified Product Offerings
Sinopharm offers a wide range of products, which includes more than 98,095 categories of medicines, much more than its peers (Exhibit 62). Its offerings range from branded and generic Rx drugs and OTC medicines, and healthcare products, to medical devices, reagents and laboratory supplies. Diversified offerings allow Sinopharm to become a one- stop shop for customers, and achieve leverage in government tenders and hospital drug purchases. Shanghai Pharma, the second-largest player, focuses more on high-value imported drugs, and its product portfolio includes ~18,600 categories, much less than Sinopharm.
Exhibit 62. Product Offering Comparison
99,095
40,000
18,600 14,000 8,000
Sinopharm Shanghai Jointown Nanjing Guangzhou Pharma Pharma Pharma
Number of Products Distributes
Source: Company Reports, Oppenheimer & Co. Inc. Research
37 Sinopharm Group Co Ltd
Product diversification also allows Sinopharm to adjust product mix to mitigate pricing pressure. For example, to reduce the negative impact of antibiotics‟ usage restriction, Sinopharm can adjust the product line to sell fewer antibiotics and focus on unrestricted substitutes. For a specific dosage form of drugs that are included in an NDRC price cut, Sinopharm can coordinate with drug manufacturers to use different dosage forms.
Sinopharm‟s products are of high quality. They are sourced from over 3,300 pharmaceutical companies, including both domestic companies and MNCs. Domestic pharmaceutical companies include 97 of the top 100, such as Jiangsu Hengrui, Harbin Pharma, and North China Pharma, and MNCs include 30 of the top 50 int‟l pharma players such as Pfizer, GSK, Merck, Eli Lily, Roche, AstraZeneca, Novo Nordisk, etc.
Growth Strategies 1. Increase Direct Sales to Hospitals
To better mitigate gross margin pressure from drug price cuts, Sinopharm has been actively adjusting sales mix by channels. Direct sales to hospitals, of which gross margin is 1-1.5% higher than other channels, have grown rapidly in recent years: they grew 57% yoy in 2011 and 45% yoy in 1H12, much faster than overall revenue growth of 48% and 39% during the respective periods. Sales contribution from hospital direct sales increased from 49.4% in 2010 to 51.5% in 1H11 and 53.8% in 1H12 (Exhibit 63). Despite continuing pressure from drug price cuts, Sinopharm‟s gross margin improved from 8.17% in 1H11 to 8.19% in 1H12, after falling to 8.17% in 2011 from 8.43% in 2010 due to nationwide drug price declines (Exhibit 63).
Hospitals are the largest customers of pharmaceutical products, accounting for more than 70% of China‟s drug consumption. Sinopharm plans to continue to penetrate the hospital market and targets increasing the revenue contribution from hospital direct sales from its current 54% to 62%. A major concern for Sinopharm is the typically long accounts receivable (A/R) days‟ outstanding of hospital customers (80-190 days). The target for hospital direct sales‟ contribution could be higher, after public hospital reforms complete in the future.
Exhibit 63. More Direct Hospital Sales
60% 53.8% 10.0% 52.4% 51.5% 49.4% 50% 9.5% 42.1% 9.0% 8.37% 40% 37.0% 8.38% 8.43% 35.9% 8.5% 8.20% 8.17% 8.19% 33.7% 7.96% 8.17% 8.0% 30% 7.5% 7.0% 20% 6.5% 7.2% 6.0% 10% 6.3%5.5% 6.2% 4.6%3.9% 5.3% 5.3% 5.5% 0% 5.0% 2010 2011 2011 1H 2012 1H 2006 2007 2008 2009 2010 2011 2011 1H 2012 1H Hospital Sales Indirect Sales Gross Margin Sales to Basic Healthcare Institutions Direct Retail Sales
Source: Company Reports, Oppenheimer & Co. Inc. Research
38 Sinopharm Group Co Ltd
2. Expand Distribution Network
Sinopharm has expanded its distribution network over the years through both M&A and organic growth. Sinopharm‟s city coverage above the prefecture level has increased from 40% (133 cities) in 2010 to 53% (178 cities) in 1H12, with the number of distribution centers increased from 39 in 2010 to 50 as of June 2012 (Exhibit 64). Sinopharm has established a strong network layout, not only in top tier cities but also in second- and third- tier cities. Going forward, Sinopharm plans to further solidify its leading position in top tier cities and continue to penetrate the lower tier market, where pharmaceutical consumption grows faster than in the top-tier cities.
Sinopharm targets expanding from 178 to 280 above-prefecture-level cities in the next few years. The company plans to have a distribution network including 4 national logistics hubs including Beijing and Shanghai; 7 regional logistic centers including Shenyang, Tianjin and Xian; 30-40 provincial logistic centers including Haerbin, Changchun, Shijiazhuang, and Taiyuan; and 60-80 city-level logistics centers including Pingdingshan, Shangqiu, and Changde, covering all level of cities across China by 2014.
Exhibit 64. Number of Distribution Centers and Cities under Coverage
174 178
133
46 50 39
2010 2011 2012 1H
# of Distribution centers # of Cities Under Coverage
Source: Company Reports, Oppenheimer & Co. Inc. Research
3. Grow Retail Pharmacy Business
Sinopharm has been expanding in the retail pharmacy segment, through both organic and inorganic methods. The number of Sinopharm‟s retail drugstores has doubled in the past three and a half years from 947 in 2009 to 1,801 in 2012 (Exhibit 65). Sinopharm‟s retail drugstore network covers over 40 large and medium-size cities in China. Retail drugstore brands under Sinopharm include Guoda (国大药房), China Accord (一致药店), Dadesheng (大德生), Tianyitang (天益堂), Guanghua (光华大药房), and Lerentang (乐仁堂). Sinopharm plans to gradually consolidate the brands that it acquired.
Sinopharm sets different strategies for drugstores according to their locations: drugstores that are close to hospitals focus on Rx drugs and usually are eligible for healthcare insurance reimbursement; drugstores in shopping malls usually sell more healthcare products, cosmetics and consumables; drugstores located in residential communities promote OTC drugs. Currently, one-fourth to one-fifth (360-450) of Sinopharm‟s retail drugstores are eligible for reimbursement from a national insurance plan.
39 Sinopharm Group Co Ltd
Although the revenue size of this segment (2.98% of 2011 total revenue) is much smaller than distribution business (93.41% of sales), the retail pharmacy business is one of Sinopharm‟s key growth strategies, especially when favorable policies for drugstores industry emerge. Management aims to increase the number of retail drugstores to 5,000 by the end of 2015.
Sinopharm has improved the operating efficiency (Exhibit 66) and service quality of its retail pharmacy business. An ERP (enterprise resource planning) system was implemented in 2010, to the integration of financial, operational, human resources, and procurement systems.
Exhibit 65. Sinopharm Has Increased Its Number of Retail Pharmacies
1,773 1,801
1,394
947
2009 2010 2011 2012 1H
# of Retail stores
Source: Company Reports, Oppenheimer & Co. Inc. Research
Exhibit 66. Revenue and Operating Margins at Sinopharm’s Retail Pharmacies
RMB M 3,500 90% 3.5% 77.5% 80% 3,000 3.0% 70% 2,500 2.5% 60% 2,000 50% 2.0% 45.6% 1,500 40% 1.5% 30% 1,000 1.0% 23.7% 20% 14.0% 500 10% 0.5% - 1.5% 0% 0.0% 2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011 Sales of Retail Segment yoy growth Operating Margin Source: Company Reports, Oppenheimer & Co. Inc. Research
4. Grow Through M&A
Sinopharm has been an active industry consolidator (Exhibit 67). Through M&A, it has expanded its geographic footprint, especially in second- and third-tier cities. It has acquired more than 100 companies in recent years, including both private entities and SOEs. Acquisition valuation was at ~8x P/E multiples in 1H10, much more attractive than 12-15x in 2011 and ~10x in 2012. In 2010, Sinopharm reported a RMB16.6B sales increase, and RMB14.5B, or 88% of the increase, came from the newly consolidated operations. Analyzing the 38.67% sales growth in 1H12, businesses that existed before 2011 contributed 22.38% while those acquired during 2011 contributed 13.14%, and companies acquired in 1H12 contributed 3.15%. After several years of aggressive acquisitions, Sinopharm is now shifting its main focus to integration, yet it will continue to seek good M&A opportunities. Future M&A targets might be more concentrated in lower
40 Sinopharm Group Co Ltd
tier markets, and acquisition size should be much smaller than previously, according to management.
Exhibit 67. SinoPharm M&A Activities 2010-1H2012 Acquired Amount Region Acquisition Target Valuation Interests % (RMB M) 2010 1 Beijing Tianxinpuxin Bio-med Co. (Beijing) 51% - - 2 Hebei Traditional & Herbal Medicine (Hebei) 100% 27 10.4x FY09 PE North 3 Local distributors in Inner Mongolia - - - 4 Local distributors in Changzhi and Lvliang - - - 5 SinoPharm Merro (Liaoning Dalian) 70% 54 0.1x FY09 sales North Eastern 6 Jilin Longtai Pharma (Sinopharm Jilin) 70% - - 7 Likang(Shanghai) 72% - - 8 Shanghai Santa Medical & Science Co. 100% - - 9 Shanghai Huyong (Shanghai) 100% - - 10 Shanghai Peibaokang(Shanghai) - - - Eastern 11 Wenzhou BioMedical Supply(Zhejiang) 58% - - 12 JinYun Pharmaceutical (Zhejiang) - - - 13 Local distributors in AnQing and BengBu(Anhui) - - - 14 Local distributors in Fujian and Shandong - - - Central 15 Local distributors in Henan,Hubei and Hunan - - - 16 Hubei Yi Bao 51% 10 11x FY09 PE 17 Xinjiang Province New & Special National Pharmaceutical (Xinjiang) 36% 409 - North Western 18 Xinjiang Pharmaceutical 80% 736 4x FY09 PE 19 Local distributors in Gansu - - - Southern 20 Guangdong Dong Fang 100% 95 12.5x FY09 PE 21 ShenZhen Yanfeng Medicine Co. 51% 38 - 22 Sinopharm Holding Shenzhen Chinese Herbal 53% 27 - 23 Local distributors in Yunnan,Guizhou, Sichuan and Chongqing - - - Total 1,374 - 2011 1 Hunan Guoda Minshengtang Pharmacy Chain Store 51% - - 2 Sinopharm Holding Pingdingshan 60% Central 300 - 3 Henan Guoda Pharmacy Chain Store 51% 4 Sinopharm Holding Hunan Deyuan Pharmaceutical 70% - - 5 Sinopharm Holding Qingdao 100% - - 6 Sinopharm Nutraceuticals (Shanghai) 70% - - 7 Sinopharm Holding Wuxi 70% - - Eastern 8 Sinopharm Holding Changzhou 65% - - 9 Liyang Guoda People Pharmacy Store 80% - - 10 Sinopharm Holding Zaozhuang 70% - - 11 Sinopharm Holding Heilongjiang 65% - - Northeastern 12 Sinopharm Holding Jinzhou 70% - - 13 Sinopharm Holding Tianjin North Pharmaceutical 51% - - 14 Shanxi Wanmin Pharmacy Chain Store 51% - - 15 Sinopharm Holding Tangshan (Xintiandi) 70% - - Northern 16 Sinopharm Holding Handan 70% - - 17 Sinopharm Holding Le Ren Tang Pharmaceutical 60% 1,300 - 18 Lerentang Shijiazhuang Pharmacy Chain Store 60% 19 Neimenggu Guoda Jiuling Pharmacy Chain Store 70% - - 20 Sinopharm Holding Lishui 89% - - 21 Sinopharm Holding Taizhou 75% - - Southeastern 22 Sinopharm Suzhou Boai Pharmaceutical 70% - - 23 Sinopharm Holding Jinhua 90% - - 24 Foshan City Nanhai Pharmaceutical Group 100% - - 25 Sinopharm Holding Putian 60% - - 26 Sinopharm Holding Lingyun Biological Medicine 55% - - 27 Quanzhou Guoda Pharmacy Chain Store 51% - - 28 Sinopharm Holding Longyan 60% - - Southern 29 Sinopharm Holding Sanming 60% - - 30 Sinopharm Holding Zhangzhou 60% - - 31 Sinopharm Holding Nanping 60% - - 32 Sinopharm Holding Hainan Hongyi 100% - - 33 Sinopharm Holding Ningde 60% - - Southwestern 34 Sinopharm Holding Anshun 70% - - Western 35 Sinopharm Holding Qinghai 70% - - Total 3,282 - 1H2012 1 Sinopharm Holding Nantong Co.,Ltd. 80% - - 2 Shanghai Meitai Medical Instruments Co., Ltd. 70% - - 3 Sinopharm Holding Wuhu Co.,Ltd. 70% - - 4 Sinopharm Holding Liuan Co.,Ltd. 60% - - Eastern 5 Sinopharm Holding Weihai Co.,Ltd. 90% - - 6 Sinopharm Holding Jining Co.,Ltd. 70% - - 7 Zhejiang Intlmedicine Drugstore Co., Ltd. 39% 5 - 8 Sinopharm Holding Suzhou Boai Pharmaceutical Co., Ltd. 30% 12 ~2.0x historical sales 9 Shanghai Donghong Medical Co., Ltd. 45% - - 10 Sinopharm Jiankun (Beijing) Medical Co., Ltd. 51% - Northen 11 Sinopharm Holding Instrument (Beijing) Co., Ltd. 70% - - 12 Sinopharm Holding Wulanchabu Co., Ltd. 19% 2 - 13 Jiangmeng Guoda Jiyuantang Pharmacy Chain Store Co., Ltd. 65% - - Southern 14 Sinopharm Holding Zhaoqing Co., Ltd. 100% - - 15 Sinopharm Holding Jiangmeng Renren Co., Ltd. 100% 56 - Total 804 - Source: Company data, Oppenheimer & Co. Inc. Research.
41 Sinopharm Group Co Ltd
Valuation
Sinopharm is trading at 25x and 20x our 2012 and 2013 EPS estimates of HKD0.97 (RMB0.79) and HKD1.24 (RMB1.00), respectively, 67% above global peers and in line with domestic peers‟ 21x PE multiple for 2013. Applying a discounted cash flow analysis (see Exhibit 68), we derived a fair value range of HKD24-26. Believing the valuation quite rich, we will begin coverage on the sideline and look to become more constructive if Sinopharm consistently delivers stable margins.
Exhibit 68. DCF Valuation SinoPharm (1099.HK) DCF Valuation RMB M except per share data 2011A 2012E 2013E 2014E 2015E 2016E 2017E Revenue 102,225 131,175 161,300 195,147 234,230 278,891 329,380 EBIT 3,636 4,833 6,028 7,226 8,580 10,082 11,754 Taxes 725 956 1,237 1,541 1,852 2,198 2,582 After-tax EBIT 2,911 3,877 4,791 5,685 6,728 7,884 9,171
Add D&A 460 611 705 815 925 1,035 1,144 Less CAPEX 3,068 2,637 2,637 2,637 2,637 2,637 2,637 Less Change in WC 2,327 2,659 2,752 3,343 3,704 4,380 4,689 FCF (2,023) (807) 106 519 1,311 1,901 2,990
Cost of Capital 8.0%
NPV of cash flows, 2012-2017 3,898
Terminal Growth 3.5%
Terminal value 68,760 NPV of terminal value 46,797
Current net debt 2,707
Equity Value 47,987
Shares outstanding 2,403
Value per Share (RMB) 20.0 Value per Share (HKD) 24.8
Sensitivity Analysis Terminal Growth Rate 25 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 6.0% 30 35 40 49 61 81 122 6.5% 26 30 34 40 48 60 80 7.0% 23 26 29 33 39 47 58 7.5% 21 23 25 28 33 38 46 8.0% 18 20 22 25 28 32 37
WACC 8.5% 17 18 20 22 24 27 31 9.0% 15 16 18 19 21 24 27 9.5% 14 15 16 17 19 21 23 10.0% 13 14 15 16 17 19 21 Source: Company Reports, Oppenheimer & Co. Estimates
42 Sinopharm Group Co Ltd Exhibit 69. Peers Valuation Comparison Market '11-'13E '11-'13E Price Cap EPS PE Sales EPS PEG Price/Sales EV/EBITDA Company Ticker Rating Currency 11/13/12 ($M) '12E '13E '12E '13E CAGR CAGR '12E '13E '12E '13E '12E '13E US Pharmaceutical Distributors AmerisourceBergen Corp. ABC NC USD 40.28 10,226 2.76 3.13 14.6 12.9 3.6% 5.8% na 0.9 0.1 0.1 7.6 7.4 Cardinal Health Inc. CAH NC USD 39.24 13,535 3.21 3.43 12.2 11.4 -3.9% 5.9% 2.5 1.6 0.1 0.1 6.6 6.2 McKesson Corp. MCK NC USD 92.31 22,005 7.30 7.99 12.6 11.5 1.1% 19.6% 0.4 1.2 0.2 0.2 7.2 6.7 Average 13.2 11.9 0.3% 10.4% 1.5 1.3 0.1 0.1 7.1 6.8
Japanese Pharmaceutical Distributors Medipal Holdings Corp. 7459-TKS NC Yen 975.00 2,771 88 81 11.1 12.0 2.9% 28.0% 0.1 na 0.1 0.1 3.8 3.7 Suzuken Co. Ltd. 9987-TKS NC Yen 2425.00 2,751 145 188 16.7 12.9 3.0% 45.1% 0.3 0.4 0.1 0.1 3.5 4.0 Toho Holdings Co. Ltd. 8129-TKS NC Yen 1608.00 1,495 148 154 10.9 10.4 3.5% 4.0% 2.6 2.7 0.1 0.1 na na Alfresa Holdings Corp. 2784-TKS NC Yen 3535.00 2,515 275 259 12.9 13.6 3.2% 41.7% 0.1 na 0.1 0.1 1.1 1.1 Average 12.9 12.2 3.2% 29.7% 0.8 1.6 0.1 0.1 2.8 2.9
Domestic-listed Chinese Pharmaceutical Distributors Guangzhou Pharmaceutical Co. Ltd. 600332-CN NC RMB 20.20 2,610 0.50 0.66 40.8 30.6 50.7% 36.3% 1.0 0.9 2.3 1.3 18.6 17.4 Shanghai Pharmaceuticals Holding Co. Ltd. 601607-CN NC RMB 10.95 4,668 0.76 0.86 14.4 12.8 20.7% 1.0% na 1.0 0.4 0.4 8.0 7.3 China National Medicines Corp. Ltd. 600511-CN NC RMB 13.66 1,047 0.68 0.80 20.1 17.1 -17.5% -16.6% na 1.0 0.8 0.6 na na Jointow n Pharmaceutical Group Co. Ltd. 600998-CN NC RMB 12.00 2,745 0.32 0.42 37.5 28.6 na 27.1% 1.6 0.9 na na na na China National Accord Medicines Corporation Ltd A 000028-CN NC RMB 29.57 1,344 1.61 1.92 18.3 15.4 17.9% 29.4% 0.5 0.8 0.5 0.4 10.4 10.0 Nanjing Pharmaceutical Co. Ltd. 600713-CN NC RMB 5.04 559 na na na na na na na na na na na na Huadong Medicine Co. Ltd. 000963-CN NC RMB 32.64 2,255 1.13 1.44 28.9 22.7 29.5% 27.9% 1.0 0.8 0.9 0.8 15.7 12.1 Zhejiang Int'l Group Co. Ltd. 000411-CN NC RMB 7.28 243 na na na na na na na na na na na na Average 26.7 21.2 20.3% 17.5% 1.0 0.9 1.0 0.7 13.2 11.7
HK-listed Chinese Pharmaceutical Distributors Guangzhou Pharmaceutical Co Ltd 874-HK NC HKD 14.38 1,511 0.60 0.81 23.8 17.9 53.2% 37.2% 0.6 0.5 1.3 0.8 18.6 17.4 Shanghai Pharmaceuticals Holding Co. Ltd. 2607-HK NC HKD 14.78 5,149 0.94 1.06 15.7 14.0 22.2% 2.3% na 1.1 0.5 0.4 8.1 7.4 China NT Pharma Group Co. Ltd. 1011-HK NC HKD 0.78 105 (0.11) (0.05) na na -25.7% na na na 0.5 0.4 na 33.3 Average 19.8 15.9 16.5% 19.8% 0.6 0.8 0.8 0.5 13.3 19.3
Sinopharm Group Co. Ltd. 1099-HK P HKD 24.90 7,859 0.97 1.24 25.7 20.1 25.9% 23.2% 1.4 0.7 0.4 0.3 10.5 8.5 Source: Factset, Oppenheimer & Co. Inc. Estimates Note: Factset estimates for Not Covered companies. P Perform NC Not Covered
43 Sinopharm Group Co Ltd Exhibit 70. Historical Stock Price Sinopharm (HKD) Hang Seng Index 9/27/09, 1H09 3/24/10, FY09 8/25/10, 1H10 8/24/11, 1H11 3/20/12, FY11 8/23/12, 1H12 earnings earningsc earnings earnings earnings earnings
6/7/12, proposal 9/22/09, IPO 5/13/11, of RMB8B bond compeleted First issue 40 Tranche Bond, 30,000 RMB2B
35 25,000 30 20,000 25 2/25/10, announced acquisitions of 2 1/25/11, cooperative 20 drug distributors framew ork agreemtn 15,000 w ith LeRengTang 4/25/11, Pharma annoucement of 15 138M H shares placement 10,000 3/24/10, announced 5/4/11, completion 10 acquisitions of 4 drug distributors Expectation of Weak 5,000 5 1H11 earnings performance due to drug pricing pressure
0 0
4/09/2010 5/21/2010 7/02/2010 1/07/2011 4/21/2011 6/03/2011 7/15/2011 1/20/2012 6/15/2012 7/27/2012 11/1/2012 1/15/2010 2/05/2010 2/26/2010 3/19/2010 4/30/2010 6/11/2010 7/23/2010 8/13/2010 9/03/2010 9/24/2010 1/28/2011 2/18/2011 3/11/2011 4/01/2011 5/13/2011 6/24/2011 8/05/2011 8/26/2011 9/16/2011 2/10/2012 3/02/2012 3/23/2012 4/13/2012 5/04/2012 5/25/2012 7/06/2012 8/17/2012 9/07/2012 9/28/2012
11/13/2009 12/24/2009 10/15/2010 11/26/2010 10/28/2011 12/09/2011 10/23/2009 12/04/2009 11/05/2010 12/17/2010 10/07/2011 11/18/2011 12/30/2011 10/19/2012 10/24/2012 10/29/2012
Sinopharm Hang Seng Index
Source: Factset, Oppenheimer & Co. Inc. Research Note: These results cannot and should not be viewed as an indicator of future performance.
44 Sinopharm Group Co Ltd
Investment Risks Upside Risks
1. Major M&A activities could accelerate Sinopharm‟s growth in revenue. Accretive M&A could accelerate profit growth.
2. Faster-than-expected network expansion.
3. JV partnerships with MNCs or domestic companies.
4. Favorable government policy releases could benefit Sinopharm.
5. Better cash collection period from hospital customers
6. Lower financing costs could help improve profitability. Downside Risks
1. Failure or hurdles in integration of acquired entities
2. Further unfavorable regulatory changes, such as drug price cuts.
3. Failure to grow effectively through M&A activities.
4. Inflation causing higher labor and other costs, thereby hurting profitability.
5. Financing costs increase and A/R days‟ outstanding increase.
6. Heavy equity ownership by state-owned entities might cause difference in priorities versus those of public shareholders.
45 Sinopharm Group Co Ltd
Financial Analysis
Revenue
Sinopharm has almost quadrupled its revenue from RMB23.7B in 2006 to RMB 102.2B in 2011. Its distribution business grew at a 34% CAGR during 2006-2011 to RMB102B, both organically and inorganically. We expect revenue to grow at a 2011-2017 CAGR of 21.5% to RMB329.4B (Exhibit 71) with the distribution business remaining the major driver.
Exhibit 71. Revenue Growth
RMB M 2006-2011 CAGR: 350,000 Total Sales:34% 2011-2017E CAGR: 21.5% Distribution: 34% 300,000 Retail: 30% Others: 30% 250,000
200,000
150,000 2006-2011 CAGR: 34%
100,000
50,000
- 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E
Distribution Retail Other
Source: Company Reports, Oppenheimer & Co. Estimates
Margins
Despite pricing pressure due to industry regulatory changes, Sinopharm has been able to maintain a stable gross margin at the 8.0-8.4% level (Exhibit 72). In 1H12, gross margin improved 0.02% yoy to 8.19%, mainly attributable to more direct sales. Going forward, we believe Sinopharm‟s efforts on channel and product mix shift can partially offset generally lower mark-ups and drug prices imposed by regulations. We expect Sinopharm‟s gross margin to gradually decline from 8.17% in 2011 to 8.01% in 2015 and 7.85% in 2017.
46 Sinopharm Group Co Ltd
Exhibit 72. Sinopharm’s Margin Trends
8.4% 8.4% 8.4% 8.2% 8.0% 8.2%
3.6% 3.5% 3.6% 3.1% 2.5% 2.0% 1.8% 1.5% 1.7% 1.2% 1.5% 0.4%
2006 2007 2008 2009 2010 2011
Gross Margin Operating Margin Net Margin
Source: Company Reports, Oppenheimer & Co. Research According to management, gross margin of the distribution business was ~7% in 2011, comparable to Guangzhou Pharma‟s 6.7% distribution GM. and Shanghai Pharma‟s 6.9% distribution gross margin, and above Jointown‟s 5.6% and Nanjing Pharma‟s 6.6%.
Exhibit 73. Gross Margins Comparison with Major China and Foreign Peers
% Gross Margin - Domestic Players % Gross Margin - MNC Players 12 12
10 10 Mckesson Sinopharm 8 Cardinal Health 8 Shanghai Pharma AmerisourceBergen Jointown 6 6 Medipal Nanjing Pharma Suzuken Guangzhou Pharma 4 4 Toho Huadong Medicine Alfresa Zhejiang Int'l 2 2 Sinopharm
0 0 FY2007 FY2008 FY2009 FY2010 FY2011 FY2007 FY2008 FY2009 FY2010 FY2011
Source: Company Reports, Factset, Oppenheimer & Co. Inc. Research Note: Shanghai Pharma and Guangzhou Pharma‟s figures are gross margins of distribution/retail segment.
The mark-up for China pharmaceutical distributors is ~7% on average although it varies significantly across different products. Sinopharm‟s transportation, sales/marketing, financing and overhead expenses account for 0.4%, 0.4%, 0.9% and 2.6% of revenue, respectively (Exhibit 74). As a result, its pretax profit margin is 3.1%.
47 Sinopharm Group Co Ltd
Exhibit 74. Estimated Cost Structure of Sinopharm 107% 7% 7% 0.4% 100% 0.4% 0.9%
2.6%
3.1%
Ex-Factory Price Sinopharm's Price Mark-Up Gross profit Transportation Sales Financing Overhead Profit before promotion Tax
Source: Company Reports, Oppenheimer & Co. Estimates
Sinopharm has improved its operating margin from only 2.0% in 2006 to 3.88% as of 1H12 (Exhibit 72), thanks to economies of scale, upgraded logistics systems and improved operating efficiency. In the past few years, Sinopharm has maintained a very healthy and stable operating margin at around 3-4% with a 10-basis-point increase per year from 2010-2012. The G&A expense ratio has been declining (Exhibit 75), but the distribution and selling expense ratio has increased slightly. Compared with domestic and int‟l peers, Sinopharm‟s SG&A expenses ratio is at the industry average (Exhibit 76).
Exhibit 75. Sinopharm’s Operating Expenses Ratios
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0% 2006 2007 2008 2009 2010 2011 Selling and distribution costs G&A expenses Source: Company Reports, Oppenheimer & Co. Research
48 Sinopharm Group Co Ltd
Exhibit 76. SG&A Expenses Ratios Comparison 10.0%
9.0%
8.0% Sinopharm 7.0% Shanghai Pharma Jointown 6.0% McKesson 5.0% Cardinal Health AmerisourceBergen 4.0% Medipal
3.0% Suzuken Toho 2.0% Alfresa
1.0%
0.0% 2006 2007 2008 2009 2010 2011 Source: Company Reports, Oppenheimer & Co. Research
Among Sinopharm‟s three business segments, the distribution segment‟s operating margin is in the middle, although it improved from 1.81% in 2005 to 3.58% in 2009 but fluctuated afterwards. The “Other “business, the production and sale of pharmaceutical products, chemical reagents and laboratory supplies (3.6% of 2011 sales), has the highest operating margin. Retail drugstore (3.0% of 2011 sales) suffers the most from policy headwinds, reached an operating margin trough in 2009 and has recovered since then. Even so, Sinopharm‟s operating margin ranks highest among domestic and foreign peers, including its closest peer, Shanghai Pharma (Exhibits 78 and 79).However, we expect Sinopharm‟s corporate operating margin to gradually decline over the long term, mainly dragged down by lower gross margin, partially offset by improving operational efficiency.
Exhibit 77. Sinopharm’s Operating Margin by Segment 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2006 2007 2008 2009 2010 2011 Distribution Retail Other Source: Company Reports, Oppenheimer & Co. Research
49 Sinopharm Group Co Ltd
Exhibit 78. Operating Margins Comparison with Major China and Foreign Peers
% Operating Margin - Domestic Players % Operating Margin - MNC Players
4.0 4.0
3.5 Sinopharm 3.5 Mckesson
3.0 Shanghai Pharma 3.0 Cardinal Health
2.5 Jointown 2.5 AmerisourceBerg en 2.0 Nanjing Pharma 2.0 Medipal Suzuken 1.5 Guangzhou 1.5 Pharma Toho 1.0 1.0
0.5 0.5
0.0 0.0 FY2007 FY2008 FY2009 FY2010 FY2011 FY2007 FY2008 FY2009 FY2010 FY2011 Source: Company Reports, Factset, Oppenheimer & Co. Inc. Research Note: Shanghai Pharma and Guangzhou Pharma‟s figures are operating margins of distribution/retail segment.
Exhibit 79. Segment Operating Margin Comparison: Sinopharm vs. Shanghai Pharma % Operating Margin - Distribution Segment % Operating Margin - Retail Segment 4.0 3.0 3.5 2.5 3.0 2.0 2.5 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 2008 2009 2010 2011 2008 2009 2010 2011
Sinopharm Shanghai Pharma Guangzhou Pharma Sinopharm Shanghai Pharma
Source: Company Reports, Factset, Oppenheimer & Co. Inc. Research
Sinopharm‟s net margin declined from 2009‟s 1.8% to 1.5% in 2011(Exhibits 72 and 80), mainly due to higher financing costs. Shanghai Pharma had the highest net margin in 2011, followed by Zhejiang In‟tl, which recorded a one-time benefit. Sinopharm‟s net margin was comparable to Jointown‟s. Nanjing Pharma experienced a net loss in 2011.
Exhibit 80. Net Margins Comparison with Major China and Foreign Peers
% Net Margin - Domestic Players % Net Margin - MNC Players
3.0 3.0
2.5 Sinopharm 2.5 Mckesson
2.0 Shanghai Pharma Cardinal Health 2.0 Jointown 1.5 AmerisourceBerg Nanjing Pharma 1.5 en 1.0 Medipal Guangzhou 0.5 Pharma 1.0 Suzuken Zhejiang Int'l 0.0 Toho 0.5 -0.5 0.0 -1.0
-1.5 -0.5 FY2007 FY2008 FY2009 FY2010 FY2011 FY2007 FY2008 FY2009 FY2010 FY2011 Source: Company Reports, Factset, Oppenheimer & Co. Inc. Research Note: Shanghai Pharma‟s and Guangzhou Pharma‟s figures are OPCO estimates for distribution/retail segment.
50 Sinopharm Group Co Ltd
Financing Costs
Sinopharm‟s net financing costs increased 201% year over year to RMB818M (Exhibit 81) in 2011, due to higher bank loans and a tight credit market in China (Exhibits 82 and 83). Sinopharm also uses bill discounting and A/R factoring. With two rounds of interest rate cuts in June 2012, bank borrowing rates are trending down. In addition, Sinopharm and CNPGC formed a 20:80 finance JV in June, which could offer interest rates 5% lower than a commercial bank loan. The current scale of the JV is still small and cooperation limited. Therefore, Sinopharm doesn‟t expect an immediate significant benefit. However, we believe the JV should help the company and its subsidiaries to cut financing costs in the long run.
As of June 2012, Sinopharm has RMB11.7B cash and RMB14.5B debt, making net debt RMB2.7B (RMB1.13/share). The debt/equity ratio is 67% while the debt/asset ratio is 19%, which means Sinopharm employs healthy leverage. The company plans to issue the first tranche of a RMB8B corporate bond in late 2012, to pay back some bank loans borrowed at higher interest rates previously. The bond issue was delayed from previously planned 3Q12, due to higher than expected rates. Therefore, we expect Sinopharm‟s financing costs to remain high in 2H12 and 1H13.
Exhibit 81. Finance Cost Hike in 2011 933 818
349 266 272 242 231 257 151 133 115 90 102 76 12 18 24 26
2006 2007 2008 2009 2010 2011
Net Finance Costs Finance income Finance costs
Source: Company Reports, Oppenheimer & Co. Research
51 Sinopharm Group Co Ltd
Exhibit 82. Sinopharm’s Fund Raising History Time Fund Raising Type Details Use of Proceeds
Expand distribution network, upgrade logistic facilities, upgrade Raised HKD10.04B($1.3B) by issuing 627.5M H shares at 9/23/2009 IPO information systems and electronic commerce platform, expand HKD16($2.1)/share; net proceeds HKD9.8B ($1.3B) retail pharmacy operations, purchase imported pharma products
Propose to issue Corporate Plan to issue not >RMB5B($645M) medium-term bonds, 11/23/2010 Fund the operational activities, add liquidity, repay bank loans Bond maturity: not >5 years, interest rate: NA
Raised HKD3.4B ($437.4M) by issuing 138M H shares at Expand pharmaceutical distribution and retail network and liquidity 5/4/2011 H Share Placing HKD25($3.2)/share replenishment
Issue First Tranche of Bonds announced on 11/23/2010 of 5/13/2011 Issue Corporate Bond Fund the operational activities, repay bank loans RMB2B ($308M), maturity: 3 years, interest rate: 4.89%
Issue Second Tranche of Bonds announced on 11/23/2010 of 8/23/2011 Issue Corporate Bond Fund the operational activities, repay bank loans RMB3B($465M), maturity: 3 years, interest rate 5.53%.
Propose to issue Corporate Plan to issue up to RMB8B ($1.3B) corporate bond, Repay bank loans, improve debt structure, supplement working 6/7/2012 Bond maturity: up to 10 years, interest rate: TBD capital
Source: Company Reports, Oppenheimer & Co. Research
Exhibit 83. Sinopharm’s Debt and Interest Rates Debt (RMB M) 2010 2011 1H12 Non-Current Debt Bank borrowings 91 222 261 Bond - 4,961 4,968 Sub-total 91 5,182 5,229 Current Debt Secured bank borrowings 908 2,551 9,224 Unsecured bank borrowings 2,436 6,116 Sub-total 3,344 8,667 9,224 Total Debt 3,435 13,849 14,452
Interest Rate Weighted average effective 4.73% 5.51% 4.89% for 1st tranche RMB2B Interest rate - Bond - 5.53% for 2nd tranche RMB3B
Bank Borrowings Breakdown < 1 year 3,344 8,667 9,224 1-2 years 0 46 144 2-5 years 30 62 117 >5 years 61 114 0 Total 3,435 8,888 9,485 Source: Company Reports, Oppenheimer & Co. Research
Increasing A/R Days Are a Challenge to the Industry
Distributors‟ cash cycle is longer in China than in the US and Japan. Accounts receivable days‟ outstanding and inventory days are significantly higher than those of US peers, although lower than Japanese peers‟ (Exhibit 85). This is mostly due to the strong bargaining power that hospitals in China have because they are an important decision- maker in the drug purchasing process. Even when these hospitals are well-funded, they
52 Sinopharm Group Co Ltd
have often chosen to delay paying distributors or manufacturers. Long A/R days pose a major challenge to distributors‟ working capital management. According to MOFCOM, industry average A/R days was 131 days in 2011, with military hospitals at 176 days, following by second-tier hospitals‟ 136 days and grassroots healthcare institutions‟ 135 days (Exhibit 84). Top-tier hospitals sales have an average as long as 125 days. A/R days also vary depending on local economic situations, usually more than 3 months for the coastal regions of eastern China, 5-6 months for the central area and 8-9 months for western China.
Sinopharm‟s AR days are among the highest in industry, and they are still rising (Exhibits 85 and 87). The large revenue contribution from hospital sales is the major reason. In addition, its acquisition of subsidiaries with higher A/R days contributed to the increase. We don‟t expect this situation to improve significantly going forward, until hospitals‟ decision-making power is reduced. Sinopharm‟s inventory days of 38 days are below the industry average of 46 days (Exhibit 85). The increase in inventory days over recent years has stemmed from increased purchase of merchandise to support business expansion. Its overall cash cycle of 26 days is below the domestic average of 44 days. We expect Sinopharm can mitigate the negative impact of industrywide cash collection trends much better than its peers. Sinopharm‟s working capital turnover declined to 4.5 in 2009 from 21.4 in 2008 as its cash balance increased significantly in 2009 from IPO fundraising (Exhibit 86). The turnover improved to 6.4 in 2011 but we expect it to decline to 5.7 in 2012.
Jointown enjoys a much shorter A/R collection period than peers as it generates most sales from lower-tier markets. Its A/R days were only 13 days in 2008 and 2009; however, as it expanded its presence to tier 2 hospitals or above, its A/R days more than doubled in 2 years to 29 days in 2011 (Exhibit 85), but still drastically lower than peers‟. We expect pharma distributors with more hospital customers will continue have longer A/R days.
Exhibit 84. Account Receivables Structure of China’s Pharma Wholesale Distributors, 2011 Grassroots 1st (Top) Tier 2nd Tier Military (RMB Billion) Hospital Types Healthcare Total Hospitals Hospitals Hospitals Insitutions Sales to Public Healthcare Institutions (Ex.Tax) 72.3 30.8 5.4 11.2 119.7 Total 25.0 11.6 2.6 4.2 43.5 ≤90 days 12.7 4.9 1.3 1.8 20.7 90-180 days 7.0 3.1 0.9 1.1 12.1 A/R Structure 180-270 days 0.8 0.5 0.1 0.1 1.5 270-360 days 1.8 1.0 0.2 0.6 3.5 >1 year 2.8 2.1 0.1 0.5 5.6 Average A/R days 125 136 176 135 131 Source: MOFCOM, Oppenheimer & Co. Research
53 Sinopharm Group Co Ltd
Exhibit 85. Cash Cycle Comparison with Peers Inventory Days A/R Days A/P Days Cash Cycle Domestic Peers Sinopharm 38 79 91 26 Shanghai Pharma 51 67 70 51 Jointow n 54 29 21 54 Nanjing Pharma 31 79 53 31 Guangzhou Pharma 72 50 30 72 Huadong Medicine 43 74 63 43 Zhejiang Int'l 32 60 62 32 Average 46 63 56 44 US Peers Mckesson 30 28 47 30 Cardinal Health 27 21 41 27 AmerisourceBergen 25 17 42 25 Average 27 22 43 27 Japanese Peers Medipal 21 89 116 21 Suzuken 29 89 132 29 Toho 22 91 123 22 Alfresa 21 97 130 21 Average 23 91 125 23 Source: Company Reports, Factset, Oppenheimer & Co. Research
Exhibit 86. Sinopharm’s Working Capital and Turnover
RMB M 18,000 35
16,000 30 14,000 25 12,000 10,000 20 8,000 15 6,000 10 4,000 2,000 5 0 0 2006 2007 2008 2009 2010 2011
Working Capital Working Capital Turnover
Source: Company Reports, Factset, Oppenheimer & Co. Estimates
Exhibit 87. Sinopharm’s Cash Cycle Days 120
100
80
60
40
20
0 2006 2007 2008 2009 2010 2011
Inventory days Trade receivable days Trade payable days Cash Cycle Source: Company Data, Oppenheimer & Co. Inc. Estimates
54 Sinopharm Group Co Ltd
FCF
Sinopharm‟s operating cash flow has been growing at a 10% CAGR from 2006 to 2011, significantly below revenue and net income CAGRs of 34% and 73.4% during the same period, mainly due to intensive working-capital needs. We expect OCF to grow at a 33% CAGR from RMB1.0B in 2011 to RMB5.6B in 2017, driven by net income growth and better working-capital management (Exhibit 88). Sinopharm‟s free cash flow grew from only RMB220M in 2006 to RMB344B in 2009 but then went into negative territory in 2010. The inability to provide free cash flow has been caused by high capex spent for acquisitions. Sinopharm plans to invest less than RMB3B per year in the next 2 years, mainly for distributor center build-up, IT system upgrades, and acquisitions. We expect FCF to turn positive in 2013 (Exhibit 89).
Exhibit 88. Sinopharm’s OCF RMB M 6,000
5,000
4,000
3,000
2,000
1,000
- 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E
OCF
Source: Company Data, Oppenheimer & Co. Inc. Estimates
Exhibit 89. Sinopharm’s FCF
RMB M 4,000 3,000 2,000 1,000 0 -1,000 -2,000 -3,000 -4,000
FCF Source: Company Data, Oppenheimer & Co. Inc. Estimates
55 Sinopharm Group Co Ltd
Management
Exhibit 90. Senior Management Team of Sinopharm Name Position Biography Mr. Wei joined the Company in 2003 and has been the President since Dec. 2009 and an Executive Director since Dec. 2008. President, Mr. Wei has over 17 years of management experience in the pharmaceutical and healthcare industry. He's the Chairman of Mr. Yulin Wei General Manager, China National Accord Medicines Corp. and Sinopharm Chemical Reagent Ltd. Mr. Wei obtained MBA from Cheung Kong Executive Director Graduate School of Business.
Mr. Jiang joined the Company in 2010 as CFO. During 2002-2010, he was CFO of China National Medicines Co. Previously he was the deputy head of various departments at China Medicines Corp. He is a director of several subsidiaries of CNPGC and Mr. Jiang Xiuchang CFO Sinopharm. Mr. Jiang obtained a BS from Zhongnan University of Economics and Law and received postgraduate education at University of Int'l Business and Economics.
Vice President, Mr. Ma became VP in 2010 and has been the Secretary to the Board and one of the joint company secretaries since 2012. Secretary to the Board, He's the Director of various Sinopharm's subsidiaries. Previously, he served various senior management roles at China Mr. Wanjun Ma Joint Company National Pharmaceutical Tianjin Corp. Mr. Ma obtained BS in chemistry from Nankai University and EMBA degree from China Secretary Europe International Business School.
Mr. Li joined the company in 2010 as VP. He was the GM of China National Group Corp. of Traditional & Herbal Medicine, and the Vice Chairman of China Association of Traditional Chinese Medicine. He is the executive director of Sinopharm Logistics Mr. Guangpu Li Vice President Co. Mr. Li obtained BS in Chinese medicine from Guangzhou University of Chinese Medicine and a MBA degree from Jinan University.
Ms. Shen joined the Company in 2003 as VP. She was the Chairman of various Sinopharm's subsidiaries during 2010-2011. Prior to that, she served as the Deputy GM of China National Pharmaceutical Group Shanghai. Ms. Shen obtained MBA Ms. Linian Shen Vice President degrees from Maastricht School of Management and Shanghai Jiaotong University, and received postgraduate education at Jiangsu Province Administration Institute.
Mr. Lu joined the company in 2003 and became a VP in 2004. He's currently the Chairman of various Sinopharm's Mr. Jun Lu Vice President subsidiaries. Previously Mr. Lu served as the GM of several Sinopharm's subsidiaries. Mr. Lu obtained MBA degrees from the Maastricht School of Management and Shanghai Jiaotong University.
Mr. Wu joined the Company in 2003 as CFO and became VP in 2006. He has 18 years of experience in financial management. Mr. Wu served as the Director of various Sinopharm's subsidiaries. He was the CFO of VV Food & Beverage Mr. Anmin Wu Vice President Co.(a domestic-listed company) during 1999-2003. He obtained BS in technical economy from Hunan University and MBA degree from Shanghai Jiaotong University.
Mr. Shi joined the Company in 2003 and became VP in 2009. He's the Chairman/Director of China National Accord Medicines Corp and Executive Director of two Sinopharm's subsidiaries. He also has served as Chairman of various Sinopharm's Mr. Jinming Shi Vice President subsidiaries. Mr. Shi obtained BS in Economics from Shanghai University of Finance and Economics and EMBA degree from Sun Yat-sen University.
Mr. Liu joined the Company in 2003 and became VP in 2009. He's the Chairman of various subsidiaries of Sinopharm and has Mr. Yong Liu Vice President served as GM of various Sinopharm's subsidiaries previously. Mr. Liu obtained BS in business administration of pharmaceutical enterprises from China Pharmaceutical University and MBA degree from Fudan University.
Mr. Li joined the Company in 2010 as VP. He's currently the Chairman of various subsidiaries of Sinopharm. Previously he Mr. Zhiming Li Vice President held various senior management positions at Xinjiang Pharmaceutical Group. Mr. Li graduated from economic management discipline of the Urumuqi Branch of Xi‟an Military Academy.
Mr. Cai joined the Company as VP in 2010. Mr. Cai has served various senior management roles in China National Pharmaceutical Group Shanghai Corp. and was a doctor during 1989-1991. Mr. Cai graduated from Second Military Medicine Mr. Zhongxi Cai Vice President University, and obtained Master and Doctorate degrees in business administration from Maastricht University of the Netherlands and Southwestern University of the US respectively.
Mr. Xu became VP of the Company in 2011. He has been the Chairman/GM of Le Ren Tang Pharmaceutical Group Co. Ltd. since 2005. Previously, he held several management positions at Shijiazhuang City Medicines and Herbs Co. and Hebei Mr. Shuangjun Xu Vice President Zhongrui Medicines Co. He obtained BS in medicine from Second Military Medical University and MBA from Macau University of Science and Technology.
Source: Company Reports, Oppenheimer & Co. Inc. Research
56 Sinopharm Group Co Ltd
Financial Statements
Exhibit 91. Semi-annual Income Statement 2009 2010 2011A 2012E 2013E 2014E Income Statement (RMB millions, except per share data) 1H 2H 1H 2H 1H 2H 1H 2H E 1H E 2H E 1H E 2H E
Revenue 23,294 29,374 32,356 36,878 48,000 54,225 66,562 64,613 81,371 79,928 98,891 96,257 Distribution 21,701 27,590 30,069 34,731 44,888 50,601 62,889 60,721 77,354 75,598 94,372 91,473 Retail 656 730 877 838 1,369 1,676 1,769 1,827 1,999 2,101 2,299 2,353 Other 937 1,053 1,409 1,308 1,743 1,948 1,904 2,065 2,018 2,230 2,220 2,431 COGS (21,436) (26,825) (28,965) (34,433) (44,080) (49,790) (61,109) (59,342) (74,750) (73,425) (90,893) (88,473) Gross profit 1,858 2,549 3,390 2,445 3,920 4,435 5,453 5,270 6,621 6,504 7,997 7,784 Other income 20 35 25 53 59 110 107 133 109 109 112 112 Selling and distribution costs (521) (883) (796) (1,164) (1,317) (1,605) (1,771) (1,861) (2,059) (2,199) (2,483) (2,628) G&A (455) (710) (607) (938) (839) (1,125) (1,210) (1,289) (1,471) (1,587) (1,772) (1,896) Operating profit 902 990 2,012 397 1,822 1,814 2,580 2,253 3,200 2,827 3,854 3,372 Other gains/(losses) 104 76 33 139 69 133 (9) 100 20 20 20 20 Finance income 12 14 51 25 47 68 54 65 60 60 63 63 Finance costs (117) (140) (152) (197) (392) (542) (674) (539) (620) (620) (614) (614) Share of results of associates 33 35 43 47 45 62 65 72 72 72 76 76 Pre-tax income 934 975 1,987 411 1,592 1,535 2,016 1,951 2,732 2,359 3,399 2,916 Tax (239) (227) (287) (280) (389) (336) (487) (469) (665) (572) (831) (710) Net income 696 748 1,699 131 1,203 1,199 1,529 1,482 2,067 1,788 2,568 2,206 Minority interests (201) (276) (283) (339) (419) (423) (570) (553) (771) (666) (957) (823) Net income to shareholders 494 473 1,417 (208) 784 776 959 930 1,296 1,121 1,611 1,384 Diluted EPS(RMB) 0.30 0.23 0.63 (0.09) 0.34 0.32 0.40 0.39 0.54 0.46 0.66 0.57 Diluted EPS(HKD) 0.34 0.26 0.74 (0.11) 0.42 0.40 0.50 0.48 0.67 0.58 0.82 0.71 Diluted shares outstanding(in millions) 1,637 2,032 2,265 2,265 2,309 2,309 2,403 2,403 2,413 2,413 2,423 2,423
% of Revenue Distribution 93.2% 93.9% 92.9% 94.2% 93.5% 93.3% 94.5% 94.0% 95.1% 94.6% 95.4% 95.0% Retail 2.8% 2.5% 2.7% 2.3% 2.9% 3.1% 2.7% 2.8% 2.5% 2.6% 2.3% 2.4% Other 4.0% 3.6% 4.4% 3.5% 3.6% 3.6% 2.9% 3.2% 2.5% 2.8% 2.2% 2.5% Gross margin 8.0% 8.7% 10.5% 6.6% 8.2% 8.2% 8.2% 8.2% 8.1% 8.1% 8.1% 8.1% Selling and distribution costs 2.2% 3.0% 2.5% 3.2% 2.7% 3.0% 2.7% 2.9% 2.5% 2.8% 2.5% 2.7% G&A expenses 2.0% 2.4% 1.9% 2.5% 1.7% 2.1% 1.8% 2.0% 1.8% 2.0% 1.8% 2.0% Operating margin 3.9% 3.4% 6.2% 1.1% 3.8% 3.3% 3.9% 3.5% 3.9% 3.5% 3.9% 3.5% Pre-tax margin 4.0% 3.3% 6.1% 1.1% 3.3% 2.8% 3.0% 3.0% 3.4% 3.0% 3.4% 3.0% Effective Tax Rate 26.5% 24.1% 14.8% 77.0% 25.2% 22.8% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% Net margin 3.0% 2.5% 5.3% 0.4% 2.5% 2.2% 2.3% 2.3% 2.5% 2.2% 2.6% 2.3% Net margin (attributable to shareholders) 2.1% 1.6% 4.4% -0.6% 1.6% 1.4% 1.4% 1.4% 1.6% 1.4% 1.6% 1.4%
YoY Change Revenue 38.9% 25.5% 48.4% 47.0% 38.7% 19.2% 22.2% 23.7% 21.5% 20.4% Distribution 38.6% 25.9% 49.3% 45.7% 40.1% 20.0% 23.0% 24.5% 22.0% 21.0% Retail 33.6% 14.8% 56.1% 99.9% 29.2% 9.0% 13.0% 15.0% 15.0% 12.0% Other 50.5% 24.2% 23.7% 48.9% 9.3% 6.0% 6.0% 8.0% 10.0% 9.0% COGS 35.1% 28.4% 52.2% 44.6% 38.6% 19.2% 22.3% 23.7% 21.6% 20.5% Gross profit 82.4% -4.1% 15.6% 81.3% 39.1% 18.8% 21.4% 23.4% 20.8% 19.7% Other income 23.3% 52.8% 139.2% 108.6% 81.5% 21.1% 2.0% -18.4% 3.0% 3.0% Selling and distribution costs 52.7% 31.8% 65.4% 38.0% 34.4% 15.9% 16.3% 18.1% 20.6% 19.6% G&A 33.2% 32.0% 38.4% 20.0% 44.1% 14.6% 21.6% 23.1% 20.5% 19.5% Operating profit(EBIT) 123.2% -59.9% -9.5% 357.3% 41.6% 24.2% 24.1% 25.5% 20.4% 19.2% Pre-tax income 112.7% -57.8% -19.8% 273.3% 26.6% 27.1% 35.5% 20.9% 24.4% 23.6% Net income 144.3% -82.5% -29.2% 816.2% 27.1% 23.6% 35.2% 20.6% 24.2% 23.4% Net income to shareholders 186.6% na -44.6% na 22.3% 19.8% 35.2% 20.6% 24.2% 23.4% Diluted EPS(RMB) 107.2% na -45.7% na 17.5% 19.9% 34.6% 20.1% 23.7% 22.9% Source: Company Data, Oppenheimer & Co. Estimates
57 Sinopharm Group Co Ltd
Exhibit 92. Annual Income Statement
Income Statement (RMB millions, except per share data) 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E
Revenue 23,737 31,110 38,192 52,668 69,234 102,225 131,175 161,300 195,147 234,230 278,891 329,380 Distribution 21,927 28,997 35,745 49,292 64,801 95,489 123,610 152,952 185,845 223,954 267,638 317,166 Retail 823 836 952 1,386 1,715 3,045 3,596 4,100 4,651 5,231 5,831 6,441 Other 986 1,277 1,495 1,990 2,718 3,691 3,969 4,248 4,651 5,045 5,422 5,773 COGS (21,747) (28,560) (35,153) (48,261) (63,398) (93,870) (120,451) (148,175) (179,366) (215,475) (256,783) (303,534) Gross profit 1,990 2,550 3,040 4,407 5,836 8,355 10,724 13,125 15,781 18,755 22,108 25,846 Other income 17 24 70 54 77 169 240 218 224 247 271 298 Selling and distribution costs (779) (945) (966) (1,404) (1,960) (2,923) (3,632) (4,258) (5,111) (6,076) (7,179) (8,413) G&A (748) (840) (970) (1,166) (1,544) (1,965) (2,499) (3,057) (3,669) (4,345) (5,118) (5,978) Operating profit 480 789 1,174 1,892 2,409 3,636 4,833 6,028 7,226 8,580 10,082 11,754 Other gains/(losses) (46) 124 93 180 171 202 91 40 40 41 42 42 Finance income 12 18 24 26 76 115 119 120 126 139 152 168 Finance costs (102) (151) (266) (257) (349) (933) (1,214) (1,240) (1,228) (1,350) (1,485) (1,634) Share of results of associates 19 40 54 68 90 107 138 144 151 166 183 201 Pre-tax income 363 820 1,079 1,909 2,398 3,128 3,967 5,092 6,315 7,576 8,974 10,531 Tax (182) (284) (259) (465) (568) (725) (956) (1,237) (1,541) (1,852) (2,198) (2,582) Net income 181 536 820 1,444 1,830 2,403 3,011 3,855 4,774 5,723 6,776 7,949 Minority interests (81) (155) (232) (477) (622) (842) (1,123) (1,437) (1,780) (2,134) (2,526) (2,963) Net income to shareholders 100 381 588 967 1,209 1,561 1,889 2,418 2,994 3,590 4,250 4,985 Diluted EPS(RMB) 0.06 0.23 0.36 0.53 0.53 0.66 0.79 1.00 1.24 1.48 1.75 2.06 Diluted EPS(HKD) 0.06 0.25 0.41 0.61 0.63 0.82 0.97 1.24 1.53 1.84 2.18 2.55 Diluted shares outstanding(in millions) 1,637 1,637 1,637 1,809 2,265 2,356 2,403 2,413 2,423 2,423 2,423 2,423
% of Revenue Distribution 92.4% 93.2% 93.6% 93.6% 93.6% 93.4% 94.2% 94.8% 95.2% 95.6% 96.0% 96.3% Retail 3.5% 2.7% 2.5% 2.6% 2.5% 3.0% 2.7% 2.5% 2.4% 2.2% 2.1% 2.0% Other 4.2% 4.1% 3.9% 3.8% 3.9% 3.6% 3.0% 2.6% 2.4% 2.2% 1.9% 1.8% Gross margin 8.4% 8.2% 8.0% 8.4% 8.4% 8.2% 8.2% 8.1% 8.1% 8.0% 7.9% 7.8% Selling and distribution costs 3.3% 3.0% 2.5% 2.7% 2.8% 2.9% 2.8% 2.6% 2.6% 2.6% 2.6% 2.6% G&A expenses 3.2% 2.7% 2.5% 2.2% 2.2% 1.9% 1.9% 1.9% 1.9% 1.9% 1.8% 1.8% Operating margin 2.0% 2.5% 3.1% 3.6% 3.5% 3.6% 3.7% 3.7% 3.7% 3.7% 3.6% 3.6% Pre-tax margin 1.5% 2.6% 2.8% 3.6% 3.5% 3.1% 3.0% 3.2% 3.2% 3.2% 3.2% 3.2% Effective Tax Rate 53.0% 36.4% 25.3% 25.3% 24.6% 24.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% Net margin 0.8% 1.7% 2.1% 2.7% 2.6% 2.4% 2.3% 2.4% 2.4% 2.4% 2.4% 2.4% Net margin (attributable to shareholders) 0.4% 1.2% 1.5% 1.8% 1.7% 1.5% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5%
YoY Change Revenue 31.1% 22.8% 37.9% 31.5% 47.7% 28.3% 23.0% 21.0% 20.0% 19.1% 18.1% Distribution 32.2% 23.3% 37.9% 31.5% 47.4% 29.4% 23.7% 21.5% 20.5% 19.5% 18.5% Retail 1.5% 14.0% 45.6% 23.7% 77.5% 18.1% 14.0% 13.5% 12.5% 11.5% 10.5% Other 29.5% 17.0% 33.1% 36.6% 35.8% 18.1% 7.0% 9.5% 8.5% 7.5% 6.5% COGS 31.3% 23.1% 37.3% 31.4% 48.1% 28.3% 23.0% 21.1% 20.1% 19.2% 18.2% Gross profit 28.2% 19.2% 45.0% 32.4% 43.2% 28.4% 22.4% 20.2% 18.8% 17.9% 16.9% Other income 41.2% 191.7% -22.2% 42.0% 118.4% 42.1% -9.3% 3.0% 10.0% 10.0% 10.0% Selling and distribution costs 21.3% 2.2% 45.4% 39.6% 49.1% 24.3% 17.2% 20.0% 18.9% 18.1% 17.2% G&A 12.3% 15.5% 20.2% 32.5% 27.2% 27.2% 22.4% 20.0% 18.4% 17.8% 16.8% Operating profit(EBIT) 64.6% 48.7% 61.2% 27.3% 51.0% 32.9% 24.7% 19.9% 18.7% 17.5% 16.6% Pre-tax income 126.3% 31.5% 77.0% 25.6% 30.4% 26.8% 28.3% 24.0% 20.0% 18.5% 17.4% Net income 197.1% 52.9% 76.2% 26.7% 31.3% 25.3% 28.0% 23.9% 19.9% 18.4% 17.3% Net income to shareholders 283.1% 54.2% 64.5% 25.0% 29.1% 21.0% 28.0% 23.9% 19.9% 18.4% 17.3% Diluted EPS(RMB) 283.1% 54.2% 48.9% -0.2% 24.1% 18.7% 27.5% 23.3% 19.9% 18.4% 17.3% Source: Company Data, Oppenheimer & Co. Estimates
58 Sinopharm Group Co Ltd
Exhibit 93. Balance Sheet Balance Sheet (RMB millions) 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E Assets: Land use right 398 385 416 584 665 933 1,048 1,163 1,278 1,393 1,508 1,623 Investment properties 78 82 71 164 150 154 154 154 154 154 154 154 PP&E 1,088 1,193 1,263 1,794 3,331 4,431 5,073 6,052 7,032 8,011 8,991 9,971 Intangible assets 216 217 204 423 1,592 4,642 4,676 4,710 4,743 4,777 4,810 4,844 Investment in associates 217 255 307 314 486 671 671 671 671 671 671 671 Available for sale financials 36 57 53 56 56 58 58 58 58 58 58 58 Deferred income tax assets 148 139 143 193 234 284 360 462 573 688 815 956 Other non-current assets 13 5 5 12 638 222 222 222 222 222 222 222 Total non-current assets 2,193 2,332 2,462 3,540 7,151 11,395 12,262 13,492 14,731 15,974 17,229 18,499 Inventories 2,043 2,634 3,155 5,301 7,530 12,214 14,441 18,349 21,344 26,340 30,485 36,669 Trade receivables 4,872 6,110 7,914 11,980 17,752 26,592 31,748 39,990 46,801 57,371 66,664 79,808 Prepayments and other receivables 519 606 597 1,022 1,373 3,136 4,025 4,949 5,988 7,187 8,557 10,106 Available-for-sale financial assets 0 0 0 1 1 1 1 1 1 1 1 1 Short-term loan receivable 0 0 0 2,906 0 0 0 0 0 0 0 0 Pledged bank deposits 125 649 286 330 732 1,199 1,199 1,199 1,199 1,199 1,199 1,199 Cash and cash equivalents 1,839 1,956 1,712 7,568 7,475 13,091 9,321 12,602 9,172 9,243 10,534 12,513 Total current assets 9,398 11,955 13,664 29,107 34,863 56,233 60,735 77,089 84,504 101,341 117,440 140,296 Total assets 11,590 14,287 16,125 32,647 42,014 67,628 72,996 90,582 99,236 117,315 134,669 158,795
Borrow ings 178 158 130 51 91 5,182 12,229 12,229 15,229 16,229 18,229 20,229 Deferred income tax liabilities 70 67 68 110 266 518 656 843 1,045 1,254 1,485 1,743 Post-employment benefit obligation 242 250 303 403 369 435 435 435 435 435 435 435 Other non-current liabilities 241 247 330 642 816 813 813 813 813 813 813 813 Non-current liabilities 730 722 831 1,206 1,541 6,948 14,133 14,320 17,522 18,731 20,962 23,220
Trade payables 5,630 7,210 9,053 13,703 19,831 27,054 31,458 40,521 46,609 58,039 66,601 80,681 Accruals and other payables 872 997 864 1,886 2,333 4,270 5,479 6,737 8,151 9,783 11,648 13,757 Dividents payable 0 464 364 35 14 12 15 19 23 28 33 39 Current income tax liabilities 63 115 96 126 233 289 367 471 584 700 829 973 Borrow ings 1,704 1,522 1,504 1,668 3,344 8,667 557 5,557 557 557 557 557 Loans from parent company 0 640 0 0 0 0 0 0 0 0 0 0 Current liabilities 8,270 10,947 11,881 17,418 25,754 40,292 37,874 53,304 55,923 69,106 79,668 96,007 Total liabilities 9,000 11,669 12,712 18,624 27,295 47,240 52,008 67,624 73,446 87,837 100,630 119,226 Total equity 2,590 2,618 3,413 14,023 14,719 20,388 20,989 22,958 25,790 29,479 34,039 39,569 Total equity and liabilities 11,590 14,287 16,125 32,647 42,014 67,628 72,996 90,582 99,236 117,315 134,669 158,795 Source: Company Data, Oppenheimer & Co. Estimates
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Exhibit 94. Cash Flow Statement Cash Flow Statement (RMB millions) 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E Pre-tax income 364 820 1,079 1,909 2,398 3,128 3,967 5,092 6,315 7,576 8,974 10,531 Adjustment: Share of profit from associates (19) (40) (54) (68) (90) (107) (138) (144) (151) (166) (183) (201) Asset impairment 52 51 1 53 39 65 65 65 65 65 65 65 Depreciation 88 96 126 187 231 323 474 568 678 788 898 1,007 Amortisation 39 39 48 62 70 137 137 137 137 137 137 137 Gain on disposal of land use right and plant and (5) (15) (4) 4 24 (57) ------equipment Gain on disposal of partial interests in subsidiaries - (91) (76) (137) ------Write-back of certain liabilities - - - (53) (48) (33) ------Gain on disposal of available-for-sale financial assets - - - - (38) (4) ------Loss on transfer for no consideration of certain 82 ------interests in tw o subsidiaries Dividend income on available-for-sale financial assets (1) (0) (0) (0) ------Finance income (12) (18) (24) (26) ------Finance cost 96 139 241 225 312 847 1,133 1,160 1,140 1,255 1,380 1,518 Gain on fair value re-measurement of existing stake in - - - - (29) (0) ------connection w ith acquisitions Gain on disposal of subsidiaries - (5) 11 - (4) (124) ------Gain on fair value re-measurement of retained interest in connection w ith disposal of controlling interest in a - - - - (42) ------subsidiary Subtotal 321 155 269 247 425 1,047 1,671 1,785 1,869 2,078 2,296 2,526
Changes in working capital: Inventories (112) (586) (453) (940) (1,562) (3,014) (2,227) (3,908) (2,995) (4,996) (4,145) (6,184) Trade receivables (1,044) (1,280) (1,747) (2,088) (3,484) (5,550) (5,156) (8,242) (6,812) (10,570) (9,292) (13,145) Prepayments and other receivables (34) (64) (52) (103) (373) (1,703) (888) (924) (1,039) (1,199) (1,370) (1,549) Trade payables 1,155 1,594 1,918 2,428 3,917 4,767 4,404 9,064 6,088 11,429 8,562 14,080 Accruals and other payables 137 32 (58) 96 454 3,174 1,209 1,258 1,414 1,632 1,865 2,109 Net change in w orking capital 103 (304) (393) (607) (1,048) (2,327) (2,659) (2,752) (3,343) (3,704) (4,380) (4,689)
Cash from operation 788 672 955 1,549 1,775 1,847 2,980 4,125 4,841 5,949 6,890 8,368 Income tax paid (149) (231) (301) (432) (507) (828) (1,038) (1,328) (1,645) (1,972) (2,335) (2,739) Operating cash flow , Net of tax 638 441 654 1,118 1,268 1,019 1,942 2,797 3,196 3,977 4,555 5,629
Proceeds from disposal of land use right 7 23 7 - 0 0 ------Proceeds from disposal of PP&E 40 81 36 50 66 148 ------Proceeds from disposal of available fo sale financials 5 3 0 7 47 4 ------Proceeds from disposal of associates - - - 35 2 ------Proceeds from disposal of equities in associates 1 2 26 ------Proceeds from disposal of investment properties - - - - 0 12 ------Proceeds from disposal of equities in subsidiaries - 104 83 156 ------Proceeds from disposal of subsidiaries, net of cash - (49) 6 - (67) (0) ------Dividends received from associates 15 30 25 43 49 85 ------Dividends from available for sale financials 1 0 0 0 - 3 ------Payment/Disposal of loan receivable 2,585 ------Interest received 11 13 24 26 ------Payment for acquisition - - - - (296) (191) ------Purchase of land use right (68) (22) (29) (54) (87) (103) (115) (115) (115) (115) (115) (115) Purchase of PP&E (180) (236) (269) (534) (1,429) (997) (1,116) (1,116) (1,116) (1,116) (1,116) (1,116) Purchase of intangibles (11) (2) (7) (10) (15) (30) (34) (34) (34) (34) (34) (34) Purchase of investment properties - - - - - (2) ------Acquisition of available-for-sale financial assets (1) - - - - (16) ------Disposal/acquisition of short-term loan receivable - - - (2,906) ------Short term investment ------Acquisition of subsidiaries, net of cash acquired (19) 55 (25) (79) (2,321) (1,386) (1,372) (1,372) (1,372) (1,372) (1,372) (1,372) Consideration paid for prior year acquisitions - - - - - (145) ------Increased equity investment in subsidairies (42) (16) (11) ------Acquisition of associates (29) - (15) (46) - (190) ------Acquisition of non-controlling interests of subsidiaries - - - - (433) (24) ------Cash from investing activities (271) (14) (148) (3,312) (1,897) (2,831) (2,637) (2,637) (2,637) (2,637) (2,637) (2,637)
Increase in restricted cash (24) (525) 363 (35) (402) (466) ------Banking borrow ings 1,774 1,436 1,416 5,738 4,820 14,353 3,000 3,000 3,000 3,000 3,000 3,000 Borrow ings from parent company - 640 1,680 1,850 ------Repayment of borrow ings (1,383) (1,691) (1,497) (6,021) (3,658) (13,167) (8,667) (2,000) (5,000) (2,000) (1,000) (1,000) Repayment of borrow ings from parent company (350) - (2,320) (1,850) ------Retirement of bonds ------Issue of bond, net of expense - - - - - 4,954 4,000 4,000 - - - - Issue of shares, net of expense - - - 8,845 - 2,835 ------Payment of share issuance and listing expenses - - - (317) (26) ------Proceeds from equity holders 310 ------Capital injection from minority holders of subsidiaries 16 7 10 20 143 435 ------Dividends to equity holders (101) - (128) (1,074) (23) (363) (439) (562) (697) (835) (989) (1,160) Dividends to non-controlling interest of subsidiaries (26) (38) (31) (133) (102) (207) (276) (353) (437) (524) (621) (728) Interest paid (96) (139) (244) (228) (314) (750) (692) (963) (855) (909) (1,017) (1,126) Distribution of subsidiary acquired under common - - - (7) (40) (45) ------control prior to acquisition SinoPharm's investment in acquired subsidiaries under - - - 625 ------common control before acquisition Sw ine flu special reserve from government - - - 286 138 (151) ------Cash from financing activities 120 (310) (749) 7,699 536 7,428 (3,075) 3,121 (3,989) (1,268) (627) (1,013)
Net increase in cash and cash equivalents 487 117 (243) 5,504 (93) 5,616 (3,770) 3,281 (3,430) 72 1,291 1,979 Cash and cash equivalents at beginning of year 1,351 1,839 1,956 2,064 7,568 7,475 13,091 9,321 12,602 9,172 9,243 10,534 Cash and cash equivalents at end of year 1,839 1,956 1,712 7,568 7,475 13,091 9,321 12,602 9,172 9,243 10,534 12,513 Source: Company Data, Oppenheimer & Co. Estimates
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Stock prices of other companies mentioned in this report (as of 11/13/2012):
AstraZeneca (AZN-NYSE, $45.46, Not Covered) Bayer AG (BAYN-DE, EUR66.66, Not Covered) Celesio (CLS1-FRA, EUR14.86, Not Covered) Eli Lily (LLY-NYSE, $47.14, Not Covered) GlaxoSmithKline (GSK-NYSE, $42.81, Not Covered) Jiangsu Hengrui (600276-CN, RMB28.88, Not Covered) Merck (MRK-NYSE, $43.68, Not Covered) Novo Nordisk (NVO-NYSE, $155.56, Not Covered) Pfizer (PFE-NYSE, $24.05, Not Covered) Roche (ROG-VX, CHF180.2, Not Covered) E
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Investment Thesis Sinopharm, as the largest pharmaceutical distributor in China, continues to gain market share as the industry consolidates. China's pharmaceutical wholesalers are facing declining margins owing to tightening regulations; however, Sinopharm has been able to maintain stable margins by adjusting its distribution channels and product portfolio. We forecast Sinopharm to grow revenue/net income at 21.5%/21.4% CAGRs during 2011-2017. However, we view the current valuation as fair and will wait until valuation becomes more attractive before becoming more enthusiastic on the shares. Important Disclosures and Certifications
Analyst Certification - The author certifies that this research report accurately states his/her personal views about the subject securities, which are reflected in the ratings as well as in the substance of this report. The author certifies that no part of his/her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report. Potential Conflicts of Interest: Equity research analysts employed by Oppenheimer & Co. Inc. are compensated from revenues generated by the firm including the Oppenheimer & Co. Inc. Investment Banking Department. Research analysts do not receive compensation based upon revenues from specific investment banking transactions. Oppenheimer & Co. Inc. generally prohibits any research analyst and any member of his or her household from executing trades in the securities of a company that such research analyst covers. Additionally, Oppenheimer & Co. Inc. generally prohibits any research analyst from serving as an officer, director or advisory board member of a company that such analyst covers. In addition to 1% ownership positions in covered companies that are required to be specifically disclosed in this report, Oppenheimer & Co. Inc. may have a long position of less than 1% or a short position or deal as principal in the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. Recipients of this report are advised that any or all of the foregoing arrangements, as well as more specific disclosures set forth below, may at times give rise to potential conflicts of interest.
All price targets displayed in the chart above are for a 12- to- 18-month period. Prior to March 30, 2004, Oppenheimer & Co. Inc. used 6-, 12-, 12- to 18-, and 12- to 24-month price targets and ranges. For more information about target price histories, please write to Oppenheimer & Co. Inc., 85 Broad Street, New York, NY 10004, Attention: Equity Research Department, Business Manager.
Oppenheimer & Co. Inc. Rating System as of January 14th, 2008:
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Outperform(O) - Stock expected to outperform the S&P 500 within the next 12-18 months. Perform (P) - Stock expected to perform in line with the S&P 500 within the next 12-18 months. Underperform (U) - Stock expected to underperform the S&P 500 within the next 12-18 months. Not Rated (NR) - Oppenheimer & Co. Inc. does not maintain coverage of the stock or is restricted from doing so due to a potential conflict of interest. Oppenheimer & Co. Inc. Rating System prior to January 14th, 2008: Buy - anticipates appreciation of 10% or more within the next 12 months, and/or a total return of 10% including dividend payments, and/or the ability of the shares to perform better than the leading stock market averages or stocks within its particular industry sector. Neutral - anticipates that the shares will trade at or near their current price and generally in line with the leading market averages due to a perceived absence of strong dynamics that would cause volatility either to the upside or downside, and/or will perform less well than higher rated companies within its peer group. Our readers should be aware that when a rating change occurs to Neutral from Buy, aggressive trading accounts might decide to liquidate their positions to employ the funds elsewhere. Sell - anticipates that the shares will depreciate 10% or more in price within the next 12 months, due to fundamental weakness perceived in the company or for valuation reasons, or are expected to perform significantly worse than equities within the peer group.
Distribution of Ratings/IB Services Firmwide
IB Serv/Past 12 Mos.
Rating Count Percent Count Percent
OUTPERFORM [O] 312 54.07 141 45.19 PERFORM [P] 260 45.06 86 33.08 UNDERPERFORM [U] 5 0.87 2 40.00
Although the investment recommendations within the three-tiered, relative stock rating system utilized by Oppenheimer & Co. Inc. do not correlate to buy, hold and sell recommendations, for the purposes of complying with FINRA rules, Oppenheimer & Co. Inc. has assigned buy ratings to securities rated Outperform, hold ratings to securities rated Perform, and sell ratings to securities rated Underperform.
Company Specific Disclosures
1066.HK, 1928.HK, 1128.HK: This research report is intended for use only by institutions to which the subject security or securities may be sold pursuant to an exemption from state securities registration in the state in which the institution is located.
Oppenheimer & Co. Inc. makes a market in the securities of MCK.
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of any issuer mentioned in the report. Before making an investment decision with respect to any security recommended in this report, the recipient should consider whether such recommendation is appropriate given the recipient's particular investment needs, objectives and financial circumstances. We recommend that investors independently evaluate particular investments and strategies, and encourage investors to seek the advice of a financial advisor. Oppenheimer & Co. Inc. will not treat non-client recipients as its clients solely by virtue of their receiving this report. Past performance is not a guarantee of future results, and no representation or warranty, express or implied, is made regarding future performance of any security mentioned in this report. The price of the securities mentioned in this report and the income they produce may fluctuate and/or be adversely affected by exchange rates, and investors may realize losses on investments in such securities, including the loss of investment principal. Oppenheimer & Co. Inc. accepts no liability for any loss arising from the use of information contained in this report, except to the extent that liability may arise under specific statutes or regulations applicable to Oppenheimer & Co. Inc. All information, opinions and statistical data contained in this report were obtained or derived from public sources believed to be reliable, but Oppenheimer & Co. Inc. does not represent that any such information, opinion or statistical data is accurate or complete (with the exception of information contained in the Important Disclosures section of this report provided by Oppenheimer & Co. Inc. or individual research analysts), and they should not be relied upon as such. All estimates, opinions and recommendations expressed herein constitute judgments as of the date of this report and are subject to change without notice. Nothing in this report constitutes legal, accounting or tax advice. Since the levels and bases of taxation can change, any reference in this report to the impact of taxation should not be construed as offering tax advice on the tax consequences of investments. As with any investment having potential tax implications, clients should consult with their own independent tax adviser. This report may provide addresses of, or contain hyperlinks to, Internet web sites. Oppenheimer & Co. Inc. has not reviewed the linked Internet web site of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for the recipient's convenience and information, and the content of linked third party web sites is not in any way incorporated into this document. Recipients who choose to access such third-party web sites or follow such hyperlinks do so at their own risk.
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