Asian Insights SparX China Pharmaceutical Distribution Sector

Refer to important disclosures at the end of this report

DBS Group Research . Equity 22 Feb 2018 A brighter future for fewer players HSI: 31,432

 Policy-driven consolidation will eliminate many small ANALYST players, leaving c.20% of the market up for grabs Mark KONG, CFA +852 2820 4619 [email protected]  Market leaders can expect a re-rating due to: market share gain, shorter cash conversion cycle, margin Chris Gao, +852 2863 8841 [email protected] expansion because of reduced competition and disintermediation Top picks  Leader with widest product range and largest logistics T arget Mk t PE network will benefit most. BUY Sinopharm (1099 HK). Price Price Recom Cap 18F Company Name Local$ Local$ Local$m x Sinopharm Group 'H'* Drastic elimination of small players to drive sector re-rating. The HKD 32.85 42.00 BUY 90899 13.0 (1099 HK) government (“govt”) has taken measures that will eliminate many smaller China Resources players in 2016-17: 1) Requiring 33% of players (mostly small players Pharmaceutical Group HKD 10.66 n.a. NR 66993 17.1 with weak financials) to upgrade their operations or close. 2) Forcing (3320 HK) Shai.Pharms.Hldg. 'H' (2607 77% of provinces to reduce layers of middlemen between drug makers HKD 19.40 n.a. NR 55137 11.8 HK) and public medical institutes to just one distributor. We estimate this will Jointown Pharm.Gp.'A' CNY 16.89 n.a. NR 31734 20.7 leave c.20% of the market up for grabs by larger players. Also, their profit (600998 CH) Nanjing Pharm.'A' (600713 margin can expand due to less price competition and more direct sales CNY 5.44 n.a. NR 5666 19.4 (reduction of sub-distributors). We expect industry gross margin to CH) China Meheco 'A' (600056 expand from 7% to 7.5% in 2016-20, driving the re-rating. CNY 22.22 n.a. NR 23742 15.7 CH) Huadong Medicine 'A' Another re-rating factor: a shorter cash conversion cycle starting CNY 57.31 n.a. NR 55712 24.5 (000963 CH) from late 2018. This is due to a shorter accounts receivable collection Realcan Pharm.'A' (002589 CNY 13.35 n.a. NR 20088 14.8 period. The govt has established the payment period to drugs distributors CH) Yunnan Baiyao Group 'A' as a new key performance indicator (“KPI”) for public hospitals. Thanks to CNY 96.01 n.a. NR 99985 26.2 (000538 CH) the recent price surge of medical services (e.g. Ningxia govt allows a 25% Cachet Pharm.'A' (002462 CNY 22.72 n.a. NR 5692 16.4 surge for the prices of 65 medical services), public hospitals’ financial CH) Guangxi Liuzhou Pharm. 'A' strength should improve, better allowing them to pay drugs distributors CNY 43.57 n.a. NR 8063 15.7 on time. (603368 CH) Source: Thomson Reuters, *DBS Vickers Sinopharm will benefit most in the industry change. The consolidation will benefit industry players with a wide product range and Note: Our proprietary research is based on interviews with 12 drugs distributors with a combined market share of 40%, govt officials (from logistics network, most notably Sinopharm. It can win new customers to Ministry of Commerce, China Food & Drug Administration, National grow its sales at 12% CAGR (2ppt above the expected industry growth) Health & Family Planning Commission, Fujian Provincial Medical Security Management Committee Office), and 4 drugstore companies and widen its net margin from 1.78% to 1.97% on better economies of scale in 2017F-20F. Trading at a 13x 1-year forward PE, its valuation is at a trough since its IPO in 2009 which is attractive for investors.

ed-STV / sa- CW, DL, CS

Asian Insights SparX China Pharmaceutical Distribution Sector

XXXXXXX The DBS Asian Insights SparX report is a deep-dive look into thematic angles impacting the longer-term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one-off treatise on the topic, and invite feedback from our readers and, in particular, welcome follow-on questions worthy of closer examination. Table of Contents

Investment summary 3

Re-rating of China pharmaceutical distributors will occur in 2018 4

Why isn’t the re-rating happening now? 8

Who will benefit most from the industry consolidation ? 10

Comparison of the pharmaceutical distribution industry in China and the US 18

Appendix 1: Implementation of the ‘two-invoice system’ in various provinces 21

Appendix 2: Regulatory changes in the last 10 years 23

Appendix 3: Sales channels of drugs and medical devices in China 28

Sinopharm (1099 HK) 30

Note: Prices used as of 21 Feb 2018

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Asian Insights SparX China Pharmaceutical Distribution Sector

Investment summary revenue driver. As a result, they might ask for more AR days, raising the distributors’ debt to finance the AR Re-rating of China pharmaceutical distributors will occur in and interest expenses. 2018. The re-rating will be driven by: We believe the above concerns have been priced in given 1) c.20% of the market should be freed up for leading that leading players are trading at multi-year lows of 1-yr players thanks to the elimination of small players driven forward PE. In our view, both concerns are short-term by govt measures including: worries. First, as most of the leading players procure drugs directly from manufacturers, they control the supply and will a) “Two-invoice system” to eliminate sub-distributors eventually take over the sub-distributing business. The gross between leading distributors and public medical margin of direct sales is 1 to 6ppt higher than sales through institutes. Sales through sub-distributors made up sub-distributors. Second, as discussed above, we expect the 41% of total industry revenue in 2016. AR days to decline starting from late 2018 (thanks to central govt’s policy and price hike of medical services); so will the b) During China Food & Drug Administration (CFDA) related debt and interest costs. inspection on drug distributors in 2016, 5619 or 44% of players were suspected of illegal activities or Leading players with wide product range, large coverage of sub-par operating standards. CFDA required them to medical institutes, and lower cost of capital will benefit from rectify their operations. Most are small players with the consolidation. As the largest player, Sinopharm is the weak financials. They might fail to rectify and have to strongest in these aspects which enables it to grow sales at close in 2017 & 18. 12% CAGR (2ppt higher than expected industry growth) and widen net margin from 1.78% to 1.97% due to better 2) We expect industry gross margin to increase from 7% economies of scale in 2017F-20F. Trading at 13x 1-yr to 7.5% in 2016-20 due to less price competition and forward PE (the trough since IPO in 2009), the valuation is more direct sales (reduction of sub-distributors). This attractive. We recommend to BUY Sinopharm. TP is happened in 2013-16, when the total no. of drugs HK$42.00. distributors shrunk from 16300 to 12975. Industry sales contributed by sub-distributors dropped from 43% to Industry comparison between China and U.S. revealed that 41%, while the industry gross margin increased from Chinese pharmaceutical distributors are in a more 6.7% to 7%. favourable position relatively. This is due to two reasons:

3) Shorter accounts receivable collection period starting 1) The distributors’ suppliers (drug makers) and customers from late 2018. This is thanks to: (drug stores and hospitals) are fragmented and hence unable to exert much power on them. The market a) Central govt’s determination to achieve this. In share of the top 5 Chinese pharmaceutical May 2017, the State Council’s medical reform manufacturers and retailers were just 6-9% and 11% office stated that the payment period to in 2016 respectively (compared to >40% and >70% in distributors will be a new KPI for public hospitals. the US in 2007). Hospitals remain the largest drug sales Beijing has already implemented this. channel, contributing 68% of drug sales in 2016. There were 29,719 hospitals in China as of Jun 2017, which is b) Surge of prices of medical services will increase still highly fragmented in our view. Unlike their peers in public hospitals’ revenues which will help them to U.S., they are unable to exert price pressure on drug pay distributors on time, e.g. Ningxia provincial distributors, who can thus maximise margins, a crucial govt allowed a 25% price surge of 65 services in condition for their growth in the next 5 years; Jul 2017. 2) Compared with U.S., the development of China’s Why isn’t the re-rating happening now? The market has healthcare industry is still in its infancy, evidenced by its two concerns: low healthcare expenditure as a percentage of GDP 1) Drop of sales to sub-distributors will impact listed (5.5% vs 17% in 2014) and a smaller proportion of its distributors’ revenues. Top 5 players generated 22-50% population aged 60 and over (14% vs 20% in 2013). of their distribution revenues from sub-distributors in That implies plenty of room to grow because as the 2016; population ages, the demand for medicines will increase. 2) Surge of interest expense in 2017 & 18 due to increase of account receivables (AR) days from public hospitals. Public hospitals can no longer mark up prices on drug sales, since Sep 2017. This has deprived them of a key

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Asian Insights SparX China Pharmaceutical Distribution Sector

Re-rating of China pharmaceutical Number of pharmaceutical distributors has been distributors will occur in 2018 decreasing since 2013

We expect China pharmaceutical distributors will be re-rated 17000 16300 in 2018 driven by: 16000 14900 1) Accelerating market share gain for big firms thanks to 15000 13900 drastic reduction of small players resulting from 14000 13500 13508 measures taken by govt in 2016-17; 12975 13000 2) Profit margin expansion thanks to: a) less price pressure 12000 resulting from reduced competition and; b) rising share 11000 of direct sales due to disintermediation (elimination of small sub-distributors); 10000 9000 3) Lower accounts receivables days starting from late 2018 driven by central govt. policies 8000 2011 2012 2013 2014 2015 2016

Source: Ministry of Commerce Accelerating market share gain. The market share of leading pharmaceutical firms increased steadily in 2011-16 (see the following chart). On average, the top 100 players (by Reasons why more small players will have to shut from 2018 revenue) gained 1.6ppt market share annually during that onward: time. We believe this will accelerate to 4.8ppt in 2016-20 as more small players exit from 2018 onward. We estimate 1. In January 2017, the State Council issued a directive that will free up close to 20% of the market. (‘Two-invoice System’) stipulating that there can be only one distributor between drug manufacturers and public medical institutes (including public hospitals, urban Market share of leading pharmaceutical distributors (by revenue) community health service centres, township health centres), which account for over 70% of drug sales (see 70.9% 75.0% 68.9% Appendix 1: Implementation of the “Two-invoice 65.9% 63.0% 64.0% 64.3% 65.3% System”). 65.0% 63.2% 60.0% 57.5% 58.1% 55.9% We believe these institutes will choose large distributors 55.0% with a wide range of products, stable supply and 46.9% 47.6% 44.0% cheaper prices, thereby squeezing out smaller 41.6% 42.4% 45.0% 39.4% distributors and sub-distributors, which currently supply 33.5% 33.5% >20% of the market. 30.9% 35.0% 28.6% 29.7% 26.5% We will see the impact of this restructuring in 2018. 25.0% 2011 2012 2013 2014 2015 2016 2. A lot of players may not be able to pass the inspections Market share of top 3 Market share of top 10 by China Food & Drug Administration (CFDA). In 2016, Market share of top 50 Market share of top 100 CFDA inspected 11,200 pharmaceutical distributors (87% of the total). Of those, it targeted 1,383 or 11% Source: Ministry of Commerce for further investigations on suspicions of illegal activities. It asked another 4,236 or 33% to rectify and improve their operations. This implies that 44% of pharmaceutical distributors were problematic. CFDA is reviewing them in 2017-18. We believe most of them,

small players with weak financial strength, will have to

close as they are unlikely to meet CFDA’s requirements.

3. Public hospitals (one of the public medical institutes), which account for over 60% of drug sales, have become more cost-conscious in their drug procurement. This is because of a govt directive effective September 2017 banning drug mark-ups (hitherto a major profit driver).

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Asian Insights SparX China Pharmaceutical Distribution Sector

Hospitals are shifting towards bulk purchases to cut Profit margin expansion. Historical data showed that an costs. The Fujian provincial govt recently proposed joint increase in players will drag on industry gross margin procurement of drugs with public hospitals in four other while a decrease can expand the margin, thanks to less provinces. This shift favours large distributors with scale price competition (see the following chart). As discussed economies, squeezing out smaller players. above, we believe there will be a reduction of players from 2018 onward. That helps to expand industry gross 4. Exit of foreign players. We estimate they made up margin. c.1.8% of the market in 2016. Due to their relatively smaller size, we believe it will be hard for them to compete in the long run. Some have already decided to Pharmaceutical distribution industry’s gross margin exit the market. For example, Cardinal Health (CAH US) sold their China distribution business to Shanghai Pharm 18,000 16,300 7.3% 7.2% (2607 HK) in 2H17. This will accelerate the 16,000 14,900 7.2% 13,500 13,900 13,508 consolidation. 14,000 12,975 7.1% 12,000 7%7.0% We believe it is unlikely that the number of players will 10,000 6.9% 6.9% 6.9% rebound after the consolidation because we believe the industry entry barriers have been raised. The new industry 8,000 6.8% 6.8% structure favours large firms that can reap scale 6,000 6.7% 6.7% economies, lower per unit drug costs, and grow market 4,000 6.6% share. Newcomers will find it hard to establish such a cost 2,000 6.5% advantage to compete with the incumbents. Also, CFDA 0 6.4% is improving quality control at pharmaceutical distributors 2011 2012 2013 2014 2015 2016 by making more spot checks. The number of inspections Number of pharmaceutical distributors grew from 36 in 2015 to 79 in 2016 and 160 in 2017. Industry gross margin CFDA’s tighter control further raises the industry’s entry barrier. Source: Ministry of Commerce

On the back of the above factors, we believe the annual market share gain of the top 100 players can accelerate from 1.6ppt in 2011-16 to 4.8ppt in 2016-20. Our Also, leading players generate significant portion of projection is also in line with the target set in ‘National distribution revenue from sales to sub-distributors (see the Pharmaceutical Distribution Industry Development Plan following chart). They can bypass sub-distributors (2016-20)’ (全國葯品流通行業發展規(2016-2020 年)) gradually and sell directly instead, on condition that issued by the Ministry of Commerce in December 2016. It pharmaceutical manufacturers assigned them as first-level aims to increase the market share of the top 100 players distributors and provide them the drugs directly, which from 70.9% in 2016 to 90% in 2020. means that these distributors control the drug supply. National players and leading regional players have We estimate that the top 3 players’ combined market obtained these rights in many provinces; Sinopharm is share will increase from 34% in 2016 to around 40% in one of them. Increasing direct sales to public medical 2020. The consolidation in China is still in its nascent institutes can expand gross margin in the long run as the stage compared with developed countries. For example, gross margin of direct sales to public medical institutes is the top 3 U.S. players took over a decade to increase their higher than sales to sub-distributors (6-8% vs 2-5%). combined market share from 31% in 1995 to 96% in According to the Ministry of Commerce, this happened in 2007. From 2020 onward, we believe the top 3 players 2013-16 – the pharmaceutical distribution industry’s will take another five years to increase their market shares direct sales to medical institutes climbed to 59% in 2016 to above 50%. from 56.9% in 2013, while the industry’s gross margin rose to 7% from 6.7% in the same period.

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Asian Insights SparX China Pharmaceutical Distribution Sector

Even though public hospitals are more cost cautious after 1) The central govt is determined to shorten the removal of the mark-up on drug price in Sep 2017, we payment period from public hospitals to distributors. believe the above factors are more than enough to offset It had shortened the payment period required from the pressure, particularly the disintermediation. Thanks to public hospitals to distributors from 60 to 30 days, the disintermediation, distributors can be selling at higher based on ‘State Council’s guidance to perfect prices than previously sold to sub-distributors; for the centralised drug procurement of public hospitals’ (國 public hospitals, prices will actually go down because they 務院辦公廳關於完善公立醫院葯品集中採購工作的 are buying direct. Both large distributors and public 指導意見) issued in 2015. To further enforce this hospitals stand to gain from disintermediation. Public policy, the State Council’s medical reform office said hospitals can have lower prices and distributors can have in May 2017 that it will set payment days to higher gross margin. pharmaceutical distributors as an important KPI of public hospitals. Beijing has already implemented Thanks to the above factors, we expect the industry gross this. Fewer payment days can reduce the debt raised margin to expand from 7% in 2016 to 7.5% in 2020. by distributors to finance account receivables.

We believe the central govt’s motive is to lower the overall gearing ratio of state-owned enterprises

Portion of top 5 players’ 2016 distribution revenue (SOEs). According to the Ministry of Commerce, SOEs contributed by sales to sub-distributors made up 61% of the pharmaceutical distribution industry’s market share in 2016. Moves to lower the 60% 50% account receivable days of the industry overall will 50% 45% help SOEs lower their gearing and interest costs. 37% 40% 30% 2) Surge for prices of medical services will increase 30% 22% public hospitals’ revenues which will help them to 20% pay distributors on time. Public hospitals contribute 10% over 50% of distributors’ revenues. After September 0% 2017, they have not been allowed to mark-up procurement costs when selling drugs (the mark-ups were as high as 15%). Investors worry that this could

hurt public hospitals’ revenues as drug sales

Jointown

HK)

HK) (600998 CH) (600998

Pharmaceutical contributed 34% of their sales in 2016. Our analysis

(1099 HK) (1099 Shanghai

Guangzhou suggests that a rise in prices of medical services of at

China Resources China

Baiyunshan (874 HK) (874 Baiyunshan Sinopharm Group Co Group Sinopharm Pharmaceutical (3320 Pharmaceutical least 10% will be enough to offset any income loss Pharmaceuticals (2607 Pharmaceuticals from drug mark-ups (see the table “Analysis of public Source: companies hospitals’ revenue & expenses”). This is possible as the govt is encouraging these price rises. For

example, Ningxia’s provincial govt announced in July Lower accounts receivable days starting from late 2018. 2017 that it is allowing public hospitals there to We believe the accounts receivable days will decrease increase prices of 65 medical services by up to 25%. starting from late 2018 because: As such, we believe they are financially able to pay distributors on time.

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Asian Insights SparX China Pharmaceutical Distribution Sector

Analysis of public hospitals’ revenue & expenses

RMB m 2015 2016 Average revenue per public hospital 165 189 Drug sales 60 65 Medical services 72 85 Financial subsidy 15 17 Others 19 22 Average expenses per public hospital (160) (184) Average net income per public hospital 5 5

Assuming the removal of mark-up on procurement cost when selling drugs 2015 2016 Average revenue per public hospital 159 184 Drug sales (after the removal of any mark-up on procurement cost) 53 59 Medical services 72 85 Financial subsidy 15 17 Others 19 22 Average expenses per public hospital (160) (184) Average net income per public hospital (1.5) (0.3)

Assuming the removal of mark-up on procurement cost when selling drugs and 10% increase in 2015 2016 the price of medical services Average revenue per public hospital 166 192 Drug sales (after the removal of any mark-up on procurement cost) 53 59 Medical services (assuming 10% increase in price) 79 94 Financial subsidy 15 17 Others 19 22 Average expenses per public hospital (160) (184) Average net income per public hospital 6 8

Source: National Health & Family Planning Commission, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

Why isn’t the re-rating happening now? We believe there are two market concerns which caused the weak performances (see the following table). But since Despite the consolidation story mentioned above, the share these have already been priced in, there should be limited price performance of pharmaceutical distributors has been downside to their share prices. Also, we think the market weak in the last 12 months. Consider 10 players listed in may have overestimated the negative impact and failed to Hong Kong and mainland China with revenue contributions see that these factors can expand major players’ net profit from pharmaceutical distribution of over 50% in 2016. margins in the long run (see the following table). Most of their share prices underperformed the Hang Seng Index, with 1-year forward PE below 5-year average (see the following table).

Share price performance of pharmaceutical distributors

1 y r 12 months 1 y r forw ard performance forw ard Related listed co English Name PE below % 21 F eb PE at 5 5 y r 18 y r low av erage

Sinopharm Group Co (1099 HK) -6.6% Y Y China Resources Pharmaceutical (3320 22.0% N* N* HK) Shanghai Pharmaceuticals (2607 HK) -0.1% Y N Jointown Pharmaceutical (600998 -17.6% Y Y CH) Nanjing Pharmaceutical Co Ltd -35.1% Y Y (600713 CH) China Meheco Co Ltd (600056 CH) 4.8% Y N Huadong Medicine Co Ltd (000963 44.9% N N CH) Realcan Pharmaceutical Co Ltd -10.0% Y N (002589 CH) Yunnan Baiyao Group Co Ltd 19.5% N N (000538 CH) Cachet Pharmaceutical Co Ltd -38.1% Y N (002462 CH) Hang Seng Index 31.2% N N

Source: Bloomberg Updated on 21 Feb 2018 *China Resources Pharmaceutical was listed in Oct 2016

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Asian Insights SparX China Pharmaceutical Distribution Sector

Concerns Our view

Concern 1: Possible elimination of sales to sub- Based on three reasons, we think the market has distributors could reduce revenues by more than 20%. overestimated the sales drop resulting from declining sales to sub-distributors, when this can actually shift the Sales to sub-distributors make up a significant portion of sales structure and expand gross margin in long run. industry revenues. It contributed 22-50% of top 5 players’ distribution revenues in 2016 (Sinopharm, China Resources Firstly, the ‘two-invoice system’ only restricts sales through sub- Pharmaceutical, Shanghai Pharmaceutical, Jointown, distributors to public medical institutes. If the ultimate Guangzhou Baiyunshan). The ‘two-invoice system’ stipulates destination of the sales is not to public medical institutes, that there can only be one distributor between a public medical distributors can keep using sub-distributors. For example, even institute and a drug manufacturer, making sales to sub- though Jointown generated 45% of their 2016 distribution distributors illegal. They will eventually be eliminated, which will revenue from sales to sub-distributors, only c.15% of the substantially reduce pharmaceutical distributors’ revenues. revenue from this segment is ultimately from public hospitals. Even if all this revenue is gone, only c.6% of its total distribution revenue is impacted. This is likely the case for other distributors as well, where not all their sales to sub-distributors will be eliminated.

Secondly, even if all sales to sub-distributors are eventually to public medical institutes, as discussed above, on condition that the pharmaceutical manufacturers assigned them as first-level distributors (directly procure drugs from manufacturers), they can bypass sub-distributors and sell directly to customers. That could raise gross margin by 1 to 6 ppt.

Lastly, pharmaceutical distributors are increasing sales to other channels to offset the decrease in sales to sub-distributors. For example, Sinopharm has been raising its distribution revenue generated from drug stores. Drug stores’ contribution to its distribution revenue increased to 7.8% in 1H17 from 6.6% in 2016. The gross margin of this segment is also higher than the sales to sub-distributors (average gross margin: 4% vs 3.5%). This can also help expand overall gross margin in the long run.

Concern 2: Surge in interest expense due to an increase We think the industry accounts receivable days will start in accounts receivable days from public hospitals could to fall from late 2018, as will interest costs, while the squeeze profit margin. gross margin expansion can offset any short-term interest cost surge. Public hospitals contribute over 50% of distributors’ revenues. After September 2017, they are not allowed to mark up As discussed above, with central govt’s determination to reduce procurement costs when selling drugs (mark-ups were as high industry accounts receivable days and price surge of medical as 15%). This could hurt public hospitals’ revenues as drug sales services in public hospitals, the industry accounts receivable days contributed 34% of their sales in 2016. Investors worry that this will start to fall in late 2018. could hurt their finances, prompting them to ask for longer credit terms from pharmaceutical distributors. To finance an Even if there is a temporary surge in interest costs due to increase in accounts receivable days, distributors’ interest increased accounts receivable days, we believe the gross margin expense could surge and squeeze profit margin. expansion, thanks to increasing direct sales to public medical institutes, can offset it and may even be sufficient to expand net margins. Following our talks with the top 3 players, namely, Sinopharm, China Resources Pharm and Shanghai Pharm, we believe they can achieve stable or higher margins in regions where the ‘Two-invoice System’ has been implemented and mark-up on drug sales to public hospitals banned.

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Asian Insights SparX China Pharmaceutical Distribution Sector

Who will benefit most from the industry consolidation ?

Here are our criteria to judge if a firm can benefit from the industry consolidation:

Criteria Remarks 1) Ability to gain market share in this round of consolidation. With the following strengths, the players should be able to grab market share.

a) Ability to provide the widest range of pharmaceutical products. Medical institutes tend to go to players that have a wide product range as that saves them time and effort from sourcing from different distributors. Revenue size is an indicator of a distributor’s width of product range.

b) Relatively low cost of capital to support business activities. That enables a distributor to offer more flexible payment terms to medical institutes (its customers) while making punctual payments to drug manufacturers (suppliers), keeping both happy during this industry shake-up. In our view, state-owned distributors will find it easier to source capital at lower interest as their probability of bankruptcy is much lower than private companies. Those that are directly under central govt are in an even better position.

c) Widest coverage of medical institutes in a region. To further penetrate a region, pharmaceutical manufacturers tend to assign distribution rights to companies with the widest customer coverage in a region. The more manufacturers a distributor obtains distribution rights from, the broader its product range, which can then help it to win more contracts with medical institutes. It is a virtuous cycle that favours large distributors.

2) Ability to soften the negative impact arising from industry The consolidation could cause revenue to decline due to a drop in sales consolidation. to sub-distributors as a result of the ‘two-invoice system’.

a) Is the distributor assigned by the pharmaceutical manufacturer as a As long as the pharmaceutical manufacturer assigns the distributor as a first-level distributor? first-level distributor and provides it with drugs directly, this distributor has control of the drug supply. Such distributors can directly contact and supply their customers (e.g. medical institutes) without having to go through sub-distributors. Any loss of sales to sub-distributors will gradually be recouped through direct sales to customers.

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Asian Insights SparX China Pharmaceutical Distribution Sector

Based on the criteria above, we believe the following Among the many beneficiaries in this round of players will be able to gain market share in this round of consolidation, our top pick is Sinopharm (1099 HK) because: consolidation: Sinopharm (1099 HK), CR Pharm (3320 HK), Shanghai Pharm (2607 HK), Jointown (600998 CH), 1) Sinopharm is able to gain market share in this round of Guangzhou Pharmaceutical (subsidiary of Baiyunshan consolidation on the back of: 874 HK), Nanjing Pharm (600713 CH), China Meheco a) Sinopharm has the largest revenue size, implying (600056 CH), Huadong Medicine (000963 CH), Anhui its product range is the widest in the industry; Huayuan Pharmaceutical (non-listed), Chongqing Pharmaceutical (non-listed), Zhejiang International Group b) Thanks to its central govt SOE status, Sinopharm’s (000411 CH), Sihuan Kelun Pharmaceutical (002422 credit rating is better than its peers (see the CH), Realcan Pharm (002589 CH), Yunnan following table “Top 100 pharmaceutical Pharmaceutical (non-listed). They are among top 15 distributors”); players (see the following table “Top 100 pharmaceutical distributors”) and they have three things c) Sinopharm has the largest market share in 16 in common which enables them to gain market share in provinces, implying that its coverage of medical consolidation: institutes is widest which makes it an attractive distributor for many manufacturers; 1) Their annual revenue in 2016 was larger than average of top 100 players (Rmb11bn) implying We expect Sinopharm’s market share to increase from their range of products supply could be larger than 16% in 2016 to c.18% in 2020. The market share gain average which is important to win new customers; enables its revenue to grow at 12% CAGR in 2017F- 20F which is 2ppt above expected industry growth. 2) They have SOE background or credit rating above A grade which enables them to access capital at a 2) Sinopharm is able to soften the negative impact arising lower cost than industry average from financial from industry consolidation. Sales to sub-distributors institutes which is another criteria to win new made up 20.8% of Sinopharm’s distribution revenue in customers; 1H17. As the ‘two-invoice system’ gets implemented in more provinces, sales to this segment will gradually 3) Their coverage of medical institutes in some regions decline. But we believe Sinopharm can replace it with is strong which can attract more drug makers to co- direct sales to public medical institutes as it is the first- operate with them to widen product range to gain level distributor for many drug manufacturers, implying new customers. For example, Shanghai Pharm is it has direct access to manufacturers and can control strong in Shanghai and Eastern China, Guangzhou the drug supply. Pharmaceutical is strong in Guangdong province and Southern China, Realcan Pharm is strong in The gross margin of direct sales is higher than that of Shandong province. sales to sub-distributors (6-8% vs 2-5%). Increasing revenue contribution from direct sales will raise overall In addition, there are a few exceptional firms which, gross margin going forward. We expect Sinopharm’s even though they may not meet the above criteria, can gross margin to increase to 8.08% in 2020 from 7.93% also expand their market shares in industry in 2017. consolidation. Consider Liuzhou Pharm (603368 CH). Even though its 2016 revenue size was smaller than top The accounts receivable days from direct sales is higher 100 players’ average (Rmb8bn vs Rmb11bn), its than from sales to sub-distributors. Increasing direct coverage of medical institutes in Guangxi province is very sales means Sinopharm must raise more debt to finance strong evidenced by: a) c.28% market share in Guangxi, its accounts receivable, thus incurring higher interest nd 6ppt higher than 2 largest player; b) Guangxi Medical costs. However, we believe the gross margin expansion University owns a 47% stake in a Liuzhou Pharm and a lower percentage of selling, general & subsidiary and 1/3 of top tier grade A hospitals in administration expenses (SG&A) in sales – thanks to Guangxi are affiliated hospitals of that university. That economies of scale – can offset and expand the net ensures revenue from these hospitals. Thanks to this margin. Based on our estimates, Sinopharm can achieve strong coverage, more and more drug makers targeting this in 2H17 in the provinces of Anhui, Hunan, and the Guangxi market will co-operate with Liuzhou Pharm. Zhejiang. We expect Sinopharm’s net margin to That will broaden its product range to win new increase from 1.78% in 2017 to 1.97% in 2020. customers in Guangxi.

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Asian Insights SparX Pharmaceutical Distribution Industry

Top 100 pharmaceutical distributors Credit rating profile (Bloomberg)

Listed co Listed co Listed co - - Net - Net Net debt Dagong Shanghai 2016 dis 2016 debt to debt to to equity Global Brilliance rev enue rev enue Mark et EBIT DA EBIT DA (J un China Credit Credit Credit Central / total Chinese name English name (Rmb bn) Share Related listed co English Name (2016) (1H17) 2017) Chengxin Rating Co Lianhe Rating Rating SOE SOE rev enue 中国医药集团总公司 Sinopharm Group 298.81 18.8% Sinopharm Group Co (1099 HK) 0.70 1.95 48.63% AAA AAA- Yes Yes 66.8% 国药控股 Sinopharm Group Co (1099 HK) 258.39 16.2% Sinopharm Group Co (1099 HK) 0.70 1.95 48.63% AAA AAA- 66.8% 298.81 华润医药商业集团有限公司 CR Pharmaceutical Commercial 114.59 7.2% China Resources Pharmaceutical (3320 HK) 0.76 1.51 28.27% Yes Yes 75.2% 上海医药集团股份有限公司 Shanghai Pharmaceuticals Holding Co Ltd 113.77 7.1% Shanghai Pharmaceuticals Holding Co Ltd 1.12 1.20 15.76% AAA Yes 82.4% (601607 SH + 2607 HK) (601607 SH + 2607 HK) 九州通医药集团股份有限公司 Jointown Pharmaceutical (600998 CH) 61.56 3.9% Jointown Pharmaceutical (600998 CH) 6.17 5.65 87.69% AA+ 92.6% 广州医药有限公司 Guangzhou Pharmaceuticals Corporation 36.28 2.3% Guangzhou Baiyunshan Pharmaceutical -8.92 -6.24 -61.43% Yes Holdings Co Ltd (600332 CH) 南京医药股份有限公司 Nanjing Pharmaceutical Co Ltd (600713 CH) 26.62 1.7% Nanjing Pharmaceutical Co Ltd (600713 CH) 1.76 5.18 117.52% AA A+ Yes 100.0%

中国医药健康产业股份有限公司 China Meheco Co Ltd (600056 CH) 25.74 1.6% China Meheco Co Ltd (600056 CH) -1.39 -0.39 -8.33% Yes Yes 99.9% 康德乐股份（香港）有限公司 Cardinal Health (H.K.) Co. Limited 25.40 1.6% 华东医药股份有限公司 Huadong Medicine Co Ltd (000963 CH) 25.38 1.6% Huadong Medicine Co Ltd (000963 CH) -0.38 -0.09 -2.82% AA 48.9% 安徽华源医药股份有限公司 Anhui Huayuan Pharmaceutical Co.Ltd 20.96 1.3% Yes 重庆医药（集团）股份有限公司 Chongqing Pharmaceutical (Group) Co. Ltd 20.42 1.3% Yes 浙江英特集团股份有限公司 Zhejiang Int'l Group Co. Ltd 17.22 1.1% Zhejiang International Group (000411 CH) 1.86 3.65 88.09% AAA AAA- Yes 98.4% 四川科伦医药贸易有限公司 Sichuan Kelun Medicine & Trade Co.,Ltd. 15.82 1.0% Sichuan Kelun Pharmaceutical (002422 CH) 3.89 5.21 77.66% AA+ AA-pi 山东瑞康医药股份有限公司 Realcan Pharmaceutical Co Ltd (002589 CH) 15.63 1.0% Realcan Pharmaceutical Co Ltd (002589 CH) 0.51 1.77 33.71% AA+ AA- 100.0%

云南省医药有限公司 Yunnan Pharmaceutical Co. Ltd 13.49 0.8% Yunnan Baiyao Group Co Ltd (000538 CH) -1.44 -2.00 -40.75% NA AApi Yes 39.9% 天津天士力医药营销集团股份有限公司 Tianjin Tasly Medicine Distribution Group Co. 13.49 0.8% Ltd 山东海王银河医药有限公司 Shandong Neptunus Galaxy Medicine Co., 11.28 0.7% Ltd. 嘉事堂药业股份有限公司 Cachet Pharmaceutical Co Ltd (002462 CH) 10.90 0.7% Cachet Pharmaceutical Co Ltd (002462 CH) 1.68 1.93 43.62% Yes 100.0%

Source: Ministry of Commerce, Bloomberg Finance L.P.

Page 12 Asian Insights SparX Pharmaceutical Distribution Industry

Top 100 pharmaceutical distributors Credit rating profile (Bloomberg)

Listed co Listed co Listed co - - Net - Net Net debt Dagong Shanghai 2016 dis 2016 debt to debt to to equity Global Brilliance rev enue rev enue Mark et EBIT DA EBIT DA (J un China Credit Credit Credit Central / total Chinese name English name (Rmb bn) Share Related listed co English Name (2016) (1H17) 2017) Chengxin Rating Co Lianhe Rating Rating SOE SOE rev enue 民生药业集团有限公司 Hangzhou minsheng pharmceutical group Co. 10.80 0.7% Ltd 中国北京同仁堂（集团）有限责任公司 China Beijing Tong Ren Tang Group Co. Ltd 9.90 0.6% Yes 11.96 0.8% Beijing Tongrentang Co (600085 CH) -2.20 -2.30 -39.49% 4.67 0.3% Tong Ren Tang Technologies (1666 HK) -1.90 -1.88 -34.03% 0.93 0.1% Beijing Tong Ren Tang Chinese Medicine Co -2.87 -2.90 -71.19% Ltd (8138 HK) 石药集团河北中诚医药有限公司 CSPC Heibei Zhongcheng Pharmaceutical 9.65 0.6% CSPC Pharmaceutical Group Ltd (1093 HK) -0.65 -0.56 -18.24% AA Yes Co.Ltd 哈药集团医药有限公司 Harbin Pharmaceutical Group 8.96 0.6% Harbin Pharmaceutical Group (600664 CH) -2.36 -1.76 -31.73% AA+ 96.3% 广西柳州医药股份有限公司 Guangxi Liuzhou Pharmaceutical 7.55 0.5% Guangxi Liuzhou Pharmaceutical (603368 -2.91 -1.17 -16.34% 100.0% CH) 鹭燕医药股份有限公司 Luyan Pharma Co Ltd 7.00 0.4% Luyan Pharma Co Ltd (002788 CH) 2.98 6.23 106.17% 98.6%

天津中新药业集团股份有限公司医药公司 Tianjin Zhongxin Pharmaceutical Group 6.92 0.4% Tianjin Zhong Xin Pharm Co (600329 CH) -1.89 -1.58 -11.67% Yes 同济堂医药有限公司 Co.LtdXin Jiang Ready Health Ind 6.21 0.4% Xin Jiang Ready Health Ind (600090 CH) -1.03 -2.34 -37.10% AA+ 江西南华医药有限公司 Jiangxi Nanhua Medicine Co Ltd 6.13 0.4% Yes 陕西医药控股集团派昂医药有限责任公司 Shaanxi Pharmaceutical Holding Paiang 5.57 0.3% Yes Pharmaceutical Co.Ltd 浙江省医药工业有限公司 Zhejiang Pharmaceutical Industry Co. Ltd 5.20 0.3% Yes 江西汇仁集团医药科研营销有限公司 Jiangxi Huiren Group Medicine Research and 5.15 0.3% Sales Co., Ltd 江苏省医药有限公司 Jiangsu Pharmaceutical Co.Ltd 4.99 0.3% Yes

天津医药集团太平医药有限公司 Tianjin Pharmaceutical Holdings Pacific Co.Ltd 4.99 0.3% Yes

重庆桐君阁股份有限公司 Chongqing Tong Jun Ge Co. Ltd 4.86 0.3% 重庆长圣医药有限公司 Chongqing Changsheng Medicine Co., Ltd. 4.61 0.3%

Source: Ministry of Commerce, Bloomberg Finance L.P.

Page 13 Asian Insights SparX Pharmaceutical Distribution Industry

Top 100 pharmaceutical distributors Credit rating profile (Bloomberg)

Listed co Listed co Listed co - - Net - Net Net debt Dagong Shanghai 2016 dis 2016 debt to debt to to equity Global Brilliance rev enue rev enue Mark et EBITDA EBITDA (J un China Credit Credit Credit Central / total Chinese name English name (Rmb bn) Share Related listed co English Name (2016) (1H17) 2017) Chengxin Rating Co Lianhe Rating Rating SOE SOE rev enue 修正药业集团营销有限公司 Xiuzheng Pharmaceutical Group Marketing 4.01 0.3% Co., Ltd. 湖北人福医药集团有限公司 Humanwell Healthcare (Group) Co.,Ltd. 3.71 0.2% Humanwell Healthcare Group (600079 CH) 4.63 4.67 77.34% AA- AA+ 创美药业股份有限公司 Charmacy Pharmaceutical Co (2289 3.70 0.2% Charmacy Pharmaceutical Co (2289 HK) 3.02 0.00 162.89% 100.0% HK) 广州采芝林药业有限公司 Guangzhou Cai Zhi Lin Pharmaceutical Co., 3.43 0.2% Yes Ltd. 云南东骏药业有限公司 Yunnan Dongjun Pharmaceutical Co., Ltd. 3.42 0.2% 辽宁省医药对外贸易有限公司 Liaoning Pharmaceutical Foreign Trade Co. Ltd 3.36 0.2% Yes 江苏先声药业有限公司 Jiangsu Xiansheng Pharmaceutical Co.,ltd 3.23 0.2% 葵花药业集团医药有限公司 Sunflower Pharmaceutical Group Co., Ltd. 3.15 0.2% Sunflower Pharmaceutical (002737 CH) -1.16 -1.35 -26.50% 重庆恒韵医药有限公司 Chongqing Hero Medicine Co., Ltd. 3.15 0.2% 湖南博瑞新特药有限公司 Hunan BRI New & Special Medicine Co. Ltd 3.05 0.2% 罗欣医药集团有限公司 Shandong Luoxin Pharmaceutical Group Co. 2.94 0.2% LTd 安徽乐嘉医药科技有限公司 Anhui Luckra Pharmaceutical Technology Co., 2.76 0.2% Ltd. 青岛百洋医药科技有限公司 Qingdao Pearl Ocean Medical Science 2.73 0.2% Technologies Co., Ltd. 江苏康缘医药商业有限公司 Lianyungang Kanion Medicine Trading Co Ltd 2.72 0.2% Jiangsu Kanion Pharmaceutical (600557 CH) 0.05 0.71 12.13% AA Yes

安徽省医药（集团）股份有限公司 Anhui Medical Group Co. Ltd 2.65 0.2% Yes 江苏省润天生化医药有限公司 Jiangsu Runddy Biochemical Pharmaceutical 2.58 0.2% Yes Co., Ltd. 浙江震元股份有限公司 Zhejiang Zhenyuan Share Co.,Ltd. 2.43 0.2% Zhejiang Zhenyuan Co. Ltd (000705) -0.48 -0.32 -2.51% 海南鲁海医药有限公司 Hainan Luhai Medicine Co., Ltd. 2.40 0.2% 回音必集团有限公司 Huiyinbi group co. ltd 2.40 0.2% Yes 上海外高桥医药分销中心有限公司 shanghai Waigaoqiao Pharmaceutical Business 2.36 0.1% and Distribution Centre Co. Ltd 昆药集团医药商业有限公司 Kunming Pharmaceutical Commercial Co. Ltd. 2.32 0.1% KPC Pharmaceuticals Inc (600422 CH) -0.36 -0.83 -10.76% Api AA- Yes

福建省医药集团有限责任公司 Fujian Province Pharmaceutical group Co. Ltd 2.29 0.1% Yes

海尔施生物医药股份有限公司 Health Biomed Co.,ltd. 2.28 0.1%

Source: Ministry of Commerce, Bloomberg Finance L.P.

Page 14 Asian Insights SparX Pharmaceutical Distribution Industry

Top 100 pharmaceutical distributors Credit rating profile (Bloomberg)

Listed co Listed co Listed co - - Net - Net Net debt Dagong Shanghai 2016 dis 2016 debt to debt to to equity Global Brilliance rev enue rev enue Mark et EBITDA EBITDA (J un China Credit Credit Credit Central / total Chinese name English name (Rmb bn) Share Related listed co English Name (2016) (1H17) 2017) Chengxin Rating Co Lianhe Rating Rating SOE SOE rev enue 河南省康信医药有限公司 Henan Kangxing Pharmaceutical Co., Ltd. 2.28 0.1% 山东康惠医药有限公司 Shandong Kanghui Medicine Co. Ltd. 2.27 0.1% 海南康宁药业有限公司 Hainan Kangning Pharmaceutical Co. Ltd. 2.21 0.1% 河北金仑医药有限公司 Hebei Jinlun Pharmaceutical Co. Ltd 2.19 0.1% 礼来贸易有限公司 Eli Lilly International Trading (Shanghai) co. ltd 2.16 0.1%

吉林省天和医药科技有限公司 Jilin Tianhe Pharmaceutical Co. Ltd 2.07 0.1% 南京华东医药有限责任公司 Nanjing Huadong Medicine Co., Ltd. 2.03 0.1% Jinling Pharmaceutical (000919 CH) -1.66 -2.86 -33.80% Yes 浙江来益医药有限公司 Zhejiang Laiyi Medicine Co. Ltd 1.99 0.1% Zhejiang Medicine Co Ltd (600216 CH) -0.98 -0.84 -8.99% 上海康健进出口有限公司 Shanghai K J Import & Export Co. Ltd. 1.96 0.1% Yes 浙江珍诚医药在线股份有限公司 Zhejiang Zhencheng Medicne Online Co. Ltd. 1.95 0.1%

浙江恩泽医药有限公司 Zhejiang Enze Medicine Co. Ltd. 1.95 0.1% 浙江嘉信医药股份有限公司 Zhejiang Jiaxin Medical Corp Ltd 1.90 0.1% 徐州医药股份有限公司 Xuzhou Medicine Co., Ltd. 1.88 0.1% Yes 贵州康心药业有限公司 Guizhou Heart kang pharmaceutical co. 1.87 0.1% 西安藻露堂药业集团有限责任公司 Xi'an Zao Lu Tang Group Co. Ltd 1.84 0.1% 湖南达嘉维康医药有限公司 Hunan Dajiaweikang Pharmaceutical Co.,Ltd 1.79 0.1% 浙江瑞海医药有限公司 Zhejiang Ruihai Medicine Co Ltd 1.78 0.1% Zhejiang Hisun Pharmaceutical (600267 CH) 9.03 7.78 101.65% AA+ Yes 山东康诺盛世医药有限公司 Shandong Kangnuo Shengshi Medicine Co 1.73 0.1% Ltd 陕西华远医药集团有限公司 Shannxi Huanyuan Pharmaceutical Group 1.69 0.1% Yes Co.,Ltd. 山西康美徕医药有限公司 Shanxi Kangmeilai Pharmaceutical Co., Ltd. 1.68 0.1% 西藏神威药业有限公司 Xizang Shineway Pharmaceutical Co., Ltd. 1.62 0.1% China Shineway Pharmaceutical (2877 HK) -4.30 -5.00 -60.93% 兰州强生医药有限责任公司 Lanzhou Johnson Pharmaceutical Co., Ltd. 1.61 0.1% 泰州医药集团有限公司 Taizhou Pharmaceutical Group Co. Ltd 1.61 0.1% 江苏恩华和润医药有限公司 Jiangsu Nhwa He Run Pharmaceutical Co. Ltd 1.60 0.1% Jiangsu Nhwa Pharmaceutical Co Ltd -1.02 -1.14 -21.36% Yes (002262 CH)

Source: Ministry of Commerce, Bloomberg Finance L.P.

Page 15 Asian Insights SparX Pharmaceutical Distribution Industry

Top 100 pharmaceutical distributors Credit rating profile (Bloomberg)

Listed co Listed co Listed co - - Net - Net Net debt Dagong Shanghai 2016 dis 2016 debt to debt to to equity Global Brilliance rev enue rev enue Mark et EBITDA EBITDA (J un China Credit Credit Credit Central / total Chinese name English name (Rmb bn) Share Related listed co English Name (2016) (1H17) 2017) Chengxin Rating Co Lianhe Rating Rating SOE SOE rev enue 河南省国药医药集团有限公司 Henan Guoyao Pharmaceutical Group Co.Ltd. 1.59 0.1% Yes

云南同丰医药有限公司 Yunnan Tong Feng Pharmaceutical Co. Ltd 1.55 0.1% 浙江华通医药股份有限公司 Zhejiang Huatong Pharmaceutical 1.52 0.1% Zhejiang Huatong Pharmaceutical (002758 -1.25 2.15 27.48% CH) 辽宁汇明医药有限公司 Liaoning Huiming Pharmaceutical Co., Ltd. 1.48 0.1% 河南东森医药有限公司 Henan Dongsen Pharmaceutical Co., Ltd. 1.45 0.1% 兰州西城药业有限责任公司 Lanzhou Xicheng Pharmaceutical Co., Ltd. 1.39 0.1% 山东新华医药贸易有限公司 Shandong Xinhua Medical Trading Co. Ltd. 1.39 0.1% Shandong Xinhua Pharm Co (000756 CH) 2.67 2.22 53.26% Yes 重庆市万州区医药（集团）有限责任公司 Chongqing Wanzhou Pharmaceutical (Group) 1.38 0.1% Yes Co., Ltd 河北东盛英华医药有限公司 Hebei Dongsheng Yinghua Pharmaceuticals 1.37 0.1% Co Ltd 上海市医药保健品进出口公司 Shanghai Medicines & Health Products Import 1.37 0.1% Yes & Export Corporation 东北制药集团供销有限公司 Northeast Pharmaceutical Group Supply and 1.37 0.1% Northeast Pharmaceutical (000597 CH) 5.96 5.11 99.34% Yes Marketing Co., Ltd 海南天祥药业有限公司 Hainan Tianxiang Pharmaceutical Co. Ltd 1.36 0.1% 宁波市鄞州医药药材有限公司 Ningbo Jinzhou Pharmaceutical Distribution 1.33 0.1% Co. Ltd 四川本草堂药业有限公司 Sichuan Bencaotang Pharmaceutical Co.,Ltd. 1.32 0.1% 成都市蓉锦医药贸易有限公司 Chengdu Rongjin Medicine Trading Co Ltd 1.31 0.1% 厦门片仔癀宏仁医药有限公司 Xiamen Pianzaihuang Hongren Medicine 1.26 0.1% Zhangzhou Pientzehuang Pharmaceutical -1.50 -1.56 -30.11% Co.,Ltd. (600436 CH) 贵州科开医药有限公司 Guizhou Kekai Pharmaceutical Co Ltd 1.25 0.1% 江苏柯菲平医药股份有限公司 Jiangsu KeFeiPing Pharmaceutical Co., Ltd 1.25 0.1% 云南东昌医药股份有限公司 Yunnan Dongchang Pharmaceutical Co Ltd 1.24 0.1%

Source: Ministry of Commerce, Bloomberg Finance L.P.

Page 16 Asian Insights SparX China Pharmaceutical Distribution Sector

3) Attractive valuation. We believe the market has This implies the market think that Sinopharm’s growth mispriced Sinopharm because it overestimates short- prospects are inferior to its peers’. term challenges and underestimates medium-term potential. We think this is unfounded as well. With its broad range of pharmaceutical products, central SOE background, In terms of 1-year forward PE, it is now trading close to better-than-industry-average credit rating, and widest its lowest point since its IPO (see the following chart). coverage of medical institutes in 16 provinces, we think Concerns over declining sales to sub-distributors and Sinopharm has the best chance to gain market share. rising interest costs due to higher accounts receivable days could be the reasons.

We think those fears are unfounded. As discussed, those 1-yr forward PE comparison negative factors can be offset by increasing direct sales One Year to medical institutes, overall gross margin expansion, Related listed co English Name F orward PE and lower percentage of SG&A in sales. Meanwhile, Sinopharm can expand its overall net margin. More Sinopharm Group Co (1099 HK) 13 importantly, after this round of consolidation, China Resources Pharmaceutical (3320 HK) 16 competition will ease as many small to medium-sized Shanghai Pharmaceuticals (2607 HK) 11 distributors shut and the higher entry barriers should Jointown Pharmaceutical (600998 CH) 20 create a more secure operating environment for Sinopharm. Nanjing Pharmaceutical Co Ltd (600713 CH) 13 China Meheco Co Ltd (600056 CH) 15 Huadong Medicine Co Ltd (000963 CH) 23 Realcan Pharmaceutical Co Ltd (002589 CH) 14 Sinopharm’s 1-yr forward PE since IPO Yunnan Baiyao Group Co Ltd (000538 CH) 25 Cachet Pharmaceutical Co Ltd (002462 CH) 15 35 Average 17 30 Source: Bloomberg Financial L.P. Updated on 21 Feb 2018 25 As Sinopharm’s stock is mispriced, we think the current 20 valuation is attractive.

15 Our TP of HK$42.00 is based on 1x PEG. The following events could occur in 2018 and bring 10 Sinopharm’s share price to our TP of HK$42.00: Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Oct-12 Feb-13 Oct-13 Feb-14 Oct-14 Feb-15 Oct-15 Feb-16 Oct-16 Feb-17 Oct-17 1) Revenue growth to accelerate thanks to faster market-share gain as small to medium-sized players Source: Thomas Reuters close;

2) Net margin improvement thanks to increasing direct sales to medical institutes and better economies of scale; Compared with the 1-year forward PE of its peers, Sinopharm’s is below average (see the following table). 3) Lower accounts receivable days thanks to govt regulation to shorten the repayment period from public hospitals to distributors.

Page 17 Asian Insights SparX China Pharmaceutical Distribution Sector

Comparison of the pharmaceutical 2) In China, pharmaceutical manufacturer and retailers and distribution industry in China and the US hospitals find it difficult to exert pricing pressure on distributors like they can in U.S. This enables In terms of the pharmaceutical distribution industry’s pharmaceutical distributors in China to more easily grow revenue CAGR in 2012-16, China is stronger than U.S (12% revenues and profit margins. vs 9%). After comparison, we believe the momentum can U.S completed the consolidation of its pharmaceutical continue on the back of the following factors. That supports distribution industry in 1995-2007. The top 3 players, the re-rating of China’s pharmaceutical distributors. namely Mckesson (MCK US), Cardinal (CAH US) and AmerisourceBergen (ABC US), had increased their Pharmaceutical distribution industry’s revenue: China & combined market share from 31% in 1995 to 96% in U.S.A (US$ bn) 2007. However, in the meantime, their suppliers (pharmaceutical manufacturers) and customers 500 450 450 425.3 (pharmaceutical retailers, making up >70% of total pharmaceutical market in U.S) became stronger too, 400 378.5 331.5 evidenced by their increased market shares (see the 350 317.8 following chart). 300 264.3 276.8 243.8 250 212 200 177.1 Combined market shares of top pharma manufacturers 150 and retailers, U.S. vs China (%) 100 50 0 2012 2013 2014 2015 2016

China Total Revenue US Total Revenue

Source: Ministry of Commerce of China State Council, http://pharmaceuticalcommerce.com/wp-content/uploads/2016-sales- by-channel.jpg, DBS Vickers,

1) China is still in an early stage of development with plenty of room to grow. Compared with other developed nations including U.S, the development of China’s healthcare industry is still in its infancy (see the following table). That implies plenty of room to grow because as the population ages, the demand for Note: U.S. figures are for top 5 pharmaceutical manufacturers and top medicines will accelerate. China State Council estimates 3 pharmaceutical retailers, the % of population aged at 60 or above will increase China figures are for top 5 pharmaceutical manufacturers and top 5 from 14% in 2013 to 25% in 2030 which is a strong pharmaceutical retailers, demand driver for drugs. Source: IMS, Wind, DBS Vickers Indicators related to development of the healthcare industry As they became bigger, their bargaining power % of health % of population increased, placing distributors in a disadvantageous expenditure in GDP aged at 60 or above position, resulting in a gross margin downtrend (see the (2014) (2013) following chart). China 5.5% 14.0% United Kingdom 9.1% 23.0% Japan 10.2% 32.0% United States 17.1% 20.0%

Source: National Health & Family Planning Commission, World Development Indicators

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Asian Insights SparX China Pharmaceutical Distribution Sector

Gross margin chart PE (x) (1995-2007)

12.0% 40 10.0% 35 8.0% 30 25 6.0% 20 4.0% 15 2.0% 10 0.0% 5

0

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006 2007

Amerisourceberge (ABC US)

Sep-95

Sep-96

Sep-97

Sep-98

Sep-99

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05 Sep-06 Cardinal (CAH US) Sep-07 Mckesson (MCK US) Amerisourceberge (ABC US)

Source: Bloomberg Financial L.P. 40 35 30 In China, the pharmaceutical manufacturing and retailing industries are still highly fragmented. The top 3 25 or 5 players’ market shares are much smaller than peers 20 in U.S. They are not able to exert the same degree of 15 pricing pressure on distributors like their larger U.S. 10 peers. Furthermore, drug stores only contributed c.22% 5 of 1H17 drug sales in China. Hospitals remain the 0 largest drug sales channel, contributing 68% of drug

sales in the same period. There were 29,719 hospitals

Jun-95

Jun-96

Jun-97

Jun-98

Jun-99

Jun-00

Jun-01

Jun-02

Jun-03

Jun-04

Jun-05 Jun-06 as of June 2017, which is still highly fragmented in our Jun-07 view. Cardinal (CAH US)

3) There are other factors contributing to the growth of 800 China’s pharmaceutical distribution industry: a) The 700 number of drugs reimbursable from public medical 600 insurance increased >15% in February 2017; b) Driven 500 by central govt, the percentage of floating population 400 (c.250m, 18% of total population) under effective public medical insurance will increase from 20-32% in 300 2016 to >50% in 2018; c) A rapid increase in the 200 number of private hospitals. The number jumped 12% 100 y-o-y in June 2017 to 17,153 and now makes up 58% 0

of the total number of hospitals in China.

Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 De-rating of U.S pharmaceutical distributors in 1995-2007. Dec-95 Even though the combined market share of top 3 Mckesson (MCK US) pharmaceutical distributors (Mckesson, Cardinal, AmerisourceBergen) increased from 31% in 1995 to 96% in Source: Boomberg Finance LP 2007, but in terms of PE, they were de-rated during the period (see the following charts). We believe there are two reasons for the re-rating:

1) As discussed above, a gross margin squeeze due to pressure exerted by drug manufacturers (suppliers) and retailers (customers);

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Asian Insights SparX China Pharmaceutical Distribution Sector

2) The slowdown of pharmaceutical industry sales growth. The slowdown of sales growth resulted in a slowdown of As the U.S. market matured, the annual spend on medicine earnings growth (see the following chart). grew just c.4% in 2007, slowing from c.11% in 1995, according to IMS. That weighed on revenue growth of the Earnings growth charts top 3 players during that period (see the following chart). 140.0% 120.0% Sales growth chart 100.0% 80.0% 200.0% 60.0% 40.0% 150.0% 20.0% 0.0% 100.0% -20.0% -40.0%

50.0%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006 2007 0.0% Amerisourceberge (ABC US) -50.0% Cardinal (CAH US)

Mckesson (MCK US)

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005 2006 2007 Amerisourceberge (ABC US) Source: Bloomberg Financial L.P. Cardinal (CAH US) Mckesson (MCK US)

Source: Bloomberg Financial L.P.

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Asian Insights SparX China Pharmaceutical Distribution Sector

Appendix 1: Implementation of the ‘two-invoice system’ in various provinces

Implementation of the ‘two-invoice system’ in various provinces

F ull implementation F ull at provincial Date of implementation level (high- Implementation at provincial v alue Prov ince Plan Issuance Implementation Schedule (drugs) level (drugs) consumables) Remark Anhui 29-Sep-16 November 2016: Launch at the provincial level Nov-16 Y December 2017: Implementation in 10 categories of high-value consumables at the provincial level in mid- and top-tier hospitals Beijing 20-Oct-17 October 2017: Launch of the implementation plan Jan-18 January 2018: Implementation in all public medical and healthcare institutions Chongqing 30-Dec-16 December 2016: Pilot implementation Jun-17 June 2017: Implementation at the provincial level

Fujian 25-Jun-14 June 2014: Implementation of centralised procurement Jun-14 Y January 2017: and distribution at the provincial level Implementation in high- (Pilot implementation in Sanming City in February 2012) value consumable sector at the provincial level Gansu 19-Apr-17 April 2017: Launch of the implementation plan, with 4- Oct-17 5 months' transition period for top-tier hospitals June 2017: Implementation in pilot cities October 2017: Implementation in all top-tier hospitals at the provincial level December 2018: Implementation in all mid-tier hospitals at the provincial level Guangdong 13-Jul-17 July 2017: Launch of the implementation plan Apr-18 April 2018: Implementation at the provincial level Guangxi 24-Apr-17 September 2017: Pilot implementation Jan-18 January 2018: Implementation at the provincial level Guizhou 3-May-17 Implementation before next round of provincial N/A Y centralised procurement Hainan 28-Apr-17 May 2017: Pilot implementation Nov-17 Y November 2017: Implementation at the provincial level Hebei 3-Nov-16 May 2017: Pilot implementation Nov-17 November 2017: Implementation at the provincial level Heilongjiang 25-Apr-17 April 2017: Pilot implementation Sep-17 September 2017: Implementation at the provincial level Henan 13-Jun-17 December 2017: Implementation in pilot cities Jun-18 June 2018: Implementation at the provincial level Hubei 9-Jun-17 June 2017: Launch of the implementation plan Jan-18 January 2018: Implementation at the provincial level Hunan 1-Apr-17 April 2017: Pilot implementation Oct-17 October 2017: Implementation at the provincial level Inner 27-Jun-17 July 2017: Pilot implementation Nov-17 Mongolia November 2017: Implementation at the provincial level

Jiangsu 23-Jun-17 2017 December: implementation at the provincial level Dec-17

Jiangxi 14-Apr-17 2017: Implementation in pilot cities Jul-05 2018: Implementation at the provincial level

Source: Provincial govts’ websites, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

Implementation of the ‘two-invoice system’ in various provinces (con’t)

F ull implementation F ull at provincial Date of implementation level (high- Implementation at provincial v alue Prov ince Plan Issuance Implementation Schedule (drugs) level (drugs) consumables) Remark Jilin 19-May-17 June 2017: Launch of the implementation plan Sep-17 September 2017: Implementation at the provincial level Liaoning 13-Apr-17 June 2017: Launch of the implementation plan Sep-17 Y November 2017: September 2017: Implementation at the provincial level Implementation in high- value comsumable sector at the provincial level Ningxia 17-Aug-17 June 2016: Launch of the implementation plan Jan-18 Y December 2017: Implementation at the provincial level

Qinghai 12-Dec-16 December 2016: Launch of implementation plan Dec-16 Y April 2017: 2017: Expanding the area for implementation Implementation in high- value comsumable sector Shandong 13-Sep-17 September 2017: Launch of the implementation plan Dec-17 at the provincial level November 2017: Overall implementation in six pilot cities December 2017: Implementation at the provincial level Shanghai 30-Jun-17 June 2017: Launch of the implementation plan Dec-17 December 2017: Implementation at the provincial level Shaanxi 4-Mar-17 January 2017: Launch of the implementation plan Jun-17 Y February 2017: June 2017: Implementation at the provincial level Implemented in 13 categories of high-value (December 2016: Trail run in Baoji City) consumables August 2017: Implementation of high- value consumables in all public medical and healthcare institutions at the provincial level Shanxi 20-Apr-17 May 2017: Launch of the implementation plan Aug-17 Y August 2017: Implementation at the provincial level

Sichuan 6-Apr-17 April 2017: Pilot implementation, with a transition Sep-17 period of five months September 2017: Implementation at the provincial level Tianjin 1-Jun-17 June 2017: Launch of the implementation plan Sep-17 September 2017: Implementation at the provincial level Tibet 29-Sep-17 September - December 2017: Implementation in public Jan-18 hospitals in pilot cities January 2018: Implementation at the provincial level Xinjiang 25-Apr-17 2017: Implementation in pilot cities Jul-05 2018: Implementation at the provincial level

Yunnan 31-Jul-17 October 2017: Implementation in top-tier hospitals in Oct-18 six pilot cities October 2018: Implementation in all public medical and healthcare institutions at the provincial level Zhejiang 26-May-17 August 2017: Launch of the implementation plan, with Oct-17 Y November 2017: Pilot a transition period of three months launch of the centralised November 2017: Implementation at the provincial level; procurement online Pilot launch of the unified purchase online platform of platform of high-value high-value consumables consumables

Source: Provincial govts’ websites, DBS Vickers

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Appendix 2: Regulatory changes in the last 10 years China major pharma policy

Changes / Major content of the policy related to pharmaceutical T ime Name of Policy distribution industry Impact on industry 1/17/2009 Opinions on Further Regulating Reduced distribution layers and mandated unified distribution. Distribution should be 1. Reduced layers of distributors between Centralised Procurement of Drugs completed by pharmaceutical manufacturers, or entrusted distributors with modern drug manufacturers and medical institutes for Public logistics models; entrustment is allowed only once in principle. Hospitals《进一步规范医疗机构 All non-profit making medical institutions affiliated to: 2. Centralised procurement of drugs 药品集中采购工作的意见》 1) the government at the county level or above; became increasingly popular 2) state-owned enterprises (including state-controlled enterprises should participate in centralised medicine procurement. Centralised procurement cycle is once a year in principle. The full implementation of online centralised procurement is required to improve transparency in drug procurement. 。 “reduce distribution layers and require unified distribution”.

3/17/2009 The Opinions on Promoting Further Adopted stricter market access standard and higher threshold for drug registration 1. More and more public medical institutes Reform of the Healthcare and approval removed the mark-up on procurement cost System《关于深化医药卫生体制 Further regulated manufacturing and distribution activities. when selling drugs 改革的意见》 Accelerated the industrial consolidation of pharmaceutical manufacturing and distribution. 2. Consolidation of the pharmaceutical Outlined that the reform of price controls on medicine should start from community- manufacturing industry; that of the level medical institutions. distribution & retail industry will accelerate - To change the pattern of operation at community-level medical institutions - To reform the policy on the mark-up on drug prices to achieve 'zero mark-up'. 3. Entry barrier to the industry was raised

6/2/2010 The Process of Supervision and The following activities were prohibited during centralised drug procurement: Reduced illegal behaviour of officers Administration of Pharmaceutical (a) intentionally not participating in centralised purchasing activities or, in any other handling the centralised procurement of Centralised way, circumventing centralised procurement activities; drugs in public medical institutes Procurement《药品集中采购监督 (b) providing false data on the history of drug purchases; 管理办法 》 (c) contracts for pharmaceutical purchases and sales with drug manufacturers and distributors that were not in accordance with the requirements; (d) not enforcing the settlement price in the purchase-and-sale contracts with "second-time negotiation; unauthorised procurement of non-short listed drugs; intentionally delaying the settlement; (e) requiring unreasonable or illegal reimbursement during the procedures of procurement, sales, usage, and settlement

7/7/2010 Work Standards for Centralised All non-profit making medical institutions affiliated to: 1. Centralised procurement of drugs in Procurement of Medicines in 1) the government at the county level or above; public medical institutes created pressure on Medical Institutions 2) state-owned enterprises (including state-controlled enterprises) should participate drug prices 《医疗机构药品集中采购工作 in centralised medicine procurement. Sales and procurement should be via the non- 规范》 profit making procurement platform established by the government. 2. Prohibited 'second-time negotiation' in drug procurement and stopped medical Medical institutions should report the annual procurement volume - of no less than institutes from making money by selling 80% of the actual drug use in prior year - to the provincial administrative department drugs ('second-time' negotiation: even if of centralised drug procurement. the price of the medicine has been set in the provincial tender, medical institutes The 'second-time negotiation' in drug procurement is strictly prohibited. The request a lower price) procurement invoice should be reviewed regularly to prevent: 1) the procurement of non-listed drugs; 3. Reduced layers of distributors between 2) price fraud such as falsifying the cost price and selling price, offering discounts drug manufacturers and medical institutes after increasing the price, price-marking that's misleading, etc,; to one 3) procurement through unregulated channels.

Only one layer of entrustment is allowed in principle. However, multiple distributors in the same region can be entrusted. If the entrustee is not capable of completing the distribution, a change in distributor is permitted and no price mark-up is allowed. The manufacturer shall report the change to the authorised institution in charge of centralised drug procurement at the provincial level for record.

Source: Company, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

China major pharma policy (con’t)

Changes / Major content of the policy related to pharmaceutical T ime Name of Policy distribution industry Impact on industry 11/19/2010 《国务院办公厅关于印发建立 Centralised procurement and distribution for all essential medicines (including 1. Promoted centralised procurement of 和规范政府办基层医疗卫生机 additional categories) should be implemented in all community-level medical drugs in public medical institutes at the 构基本药物采购机制指导意见 institutions under the national essential drug system. Centralised procurement should provincial level 的通知》 be carried out at the level of province, district, and city. 2. Time for payment by public medical Community-level medical institutions are required to issue receipts to distributors at institutes to distributors should be the time of acceptance. The billing cycle should be no longer than 30 days (after the shortened issuance of the receipt in principle).

2/20/2013 《关于巩固完善基本药物制度 Centralised procurement should be carried out at the level of province, district, and 1. Promoted centralised procurement of 和基层运行新机制的意见》 city, to ensure unified procurement and distribution. drugs in public medical institutes at the provincial level The procuring institutions of essential drugs for community-level medical institutions should comply with the unified settlement of payment. The government encouraged 2. Promoted centralised payment to the optimisation of the payment process by setting up a revolving fund for the pharmaceutical distributors after drug procurement of provinces' essential medicines to ensure timely and full payment. procurement so as to avoid delayed payment

9/11/2014 《关于落实2014年度医改重点 Promoted Separation of Dispensing from Prescription (SDP). The department of Reduced public medical institutes' reliance 任务提升药品流通服务水平和 commerce, health, human resource, social security, as well as food and drug on drug sales to generate income, with the 效率工作的通知》 administration, should jointly investigate and summarise the relevant SDP procedures responsibility of supplying drugs shifted to A notification on the carried out at the local-government level and assess their effectiveness. drug stores implementation plan of Deepening the Medical and Health Care System In pilot cities for the reform of public hospitals, large retail pharmacies with stringent Reform in 2014 to improve the quality control and good credit record are encouraged to take up outpatient services pharmaceutical distribution services and other professional services related to drug supply. and efficiency

12/26/2014 Guiding Opinions on Further Supported the development of third-party cold-chain logistics, and encouraged the M&A and co-operation among cold-chain Promoting the Healthy consolidation of cold-chain logistics enterprises by equity transactions, M&A, and logistics companies could increase Development of Cold-Chain strategic alliances. Transportation and Logistics Enterprises Encouraged cold-chain logistics enterprises and distributors to develop joint 《关于进一步促进冷链运输物 distribution businesses through strategic alliances and joint ventures 流企业健康发展的指导意见》

5/8/2015 Guiding Opinions of the General Promoted categorised procurement : 1. Centralised procurement of drugs for Office of the State Council on hospitals will be more popular at provincial Improving Centralised Purchasing of For generic drugs with wide usage, large transaction volumes, and multiple level, particularly for drugs widely used Drugs for Public Hospitals producers, procuring agencies should carry out categorised and centralised 《国务院办公厅关于完善公立 procurement through public bidding. Medical institutions should strictly adhere to 2. Restricted procurement of each drug in 医院药品集中采购工作的指导 the bidding price. only three dosage forms and two 意见》 specifications in each dosage form For each category, no more than three formulations should be procured, and for each formulation, no more than two specifications are allowed to be procured.

Improving the settlement process: The billing cycle should be no longer than 30 days (after the issuance of the receipt in principle). The direct settlement between medical institutions and manufacturers, and between manufacturers and distributors, is encouraged.

Source: Company, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

China major pharma policy (con’t)

Changes / Major content of the policy related to pharmaceutical T ime Name of Policy distribution industry Impact on industry 4/26/2016 2016 Agenda of Deepening the Encouraged the pilot cities in the reform of public hospitals to adopt the 'two- 1. Implementing the 'two-invoice system' Medical and Health Care System invoice system' (one invoice between manufacturers and distributors; one between in selected cities will reduce layers of Reform distributors and medical institutions). distributors between drug manufacturers and medical institutes. (The 'two-invoice 《深化医药卫生体制改革2016 Promoted Separation of Dispensing from Prescription (SDP) and prohibited public system': first invoice issued from drug 年重 点工作任务》 hospitals from restricting prescription outflow. Patients can choose to purchase drugs manufacturer to distributor; second invoice from hospital pharmacies or from retailers in accordance with their prescription. issued from distributor to public medical institute. This is to make sure there is only Promoted centralised procurement of high-value consumables in a normative manner, one distributor between manufacturer and and encouraged online public transactions. public medical institute)

Promoted the hierarchical management of designated retail pharmacies, and 2. Reducing hospitals' reliance on drug sales encouraged the development of pharmaceutical retail chain stores. to generate income

3. Allowing patients to get the drug prescription from hospitals and purchase the drug from drug stores outside the hospital will increase the sales of drug stores

4. Number of drug stores increased

5. Centralised procurement of medical consumables will be increasingly popular in public medical institutes

4/29/2016 CFDA Announcement on The announcement required: Restricted illegal activities in the Regulating Illegal Activities in Drug 1) all pharmaceutical wholesalers to conduct self-inspection; pharmaceutical distribution industry should Distribution 2) sampling inspection of a small number of varieties and extended inspection of fall 总局关于整治药品流通领域违 upstream and downstream drug circulation and authenticity of vouchers; 法经营行为的公告 3) integration, cooperative investigation, and on-site inspection of cases involving multiple administrative regions for thorough investigation

7/13/2016 CFDA Announcement on Quality-control procedures should be implemented at the procurement, storage, and Established traceability of drugs procured Amending the More than two professional personnel are required to take charge of the quality 国家食品药品监督管理总局关 management and acceptance check regarding the distribution of vaccines. The 于修改《药品经营质量管理规 professional personnel should be equipped with a relevant medical degree (secondary 范》的决定 technical school or above), with more than three years' working experience in areas related to vaccine management.

11/8/2016 The Opinions on Further Promoting Implemented coordinated reforms in healthcare, medical insurance, and the 1. Increased the co-ordination among Further Reform of the Healthcare pharmaceutical industry (the 'Three Coordinated Medical Reforms'). government departments looking after System《关于进一步推广深化医 medical services, public medical insurance, 药卫生体制改革经验的若干意 Reduced the reliance of public hospitals on drug sales and established a public- and drug procurement 见》 oriented, motivated, and sustainable mechanism. 2. Public hospitals reduced their reliance on Abolished the policy of marking up drug prices. Local governments should determine drug sales which may affect the demand of relevant compensation policies for public hospitals. drugs in China

Reforms in the pricing of medical services would continue moving toward dynamic 3. Layers of distributors between drug price adjustments. manufacturers and medical institutes reduced because of the 'two-invoice Public hospitals should implement the 'two-invoice system' step-by-step, and other system' medical institutions are highly recommended to participate, in order to reduce distribution layers and accelerate market concentration.

Source: Company, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

China major pharma policy (con’t)

Changes / Major content of the policy related to pharmaceutical T ime Name of Policy distribution industry Impact on industry 12/29/2016 Nationwide Development plan of Promoted the consolidation of pharmaceutical distribution industry, including Accelerated the consolidation of the pharmaceutical distribution industry wholesaling and retailing. pharmaceutical distribution and retail (2016 - The revenue of China's top 100 retailers accounts for more than 40% of the total industry 2020)《全国药品流通行业发展 retail market turnover, and chain retailers account for more than 50% of the total 规划（2016—2020年）》 pharmaceutical retail network.

The revenue of the top 100 pharmaceutical wholesalers should account for more than 90% of the total pharmaceutical wholesale market turnover.

1/9/2017 Notice on the Distribution of the The 'two-invoice system' required one invoice issued between manufacturers and Accelerated the reduction of small- and mid- Opinions on the Implementation of distributors, and one between distributors and medical institutions. sized pharmaceutical distributors the 'Two-Invoice System' in Drug Targeted the implementation of the 'two-invoice system' for medicine purchase and Procurement by Public Medical sale across the country by 2018 Institutions (for Trial Implementation) 《关于在公立医疗机构药 品采购中推行“两票制”的实施 意见（试行）》 1/24/2017 Several Opinions of the General Promoted the transformation of drug distribution enterprises by encouraging M&A to 1. M&A of pharmaceutical distribution and Office of the State Council on improve market concentration. retail companies should increase Further Reform and Improvement of Promoted the implementation of the 'two-invoice system' to reduce distribution Drug Production, Circulation and layers and eliminate unregulated entities to clean up the business environment. 2. Layers of distributors between drugs Use Policies Increased the exposure of medical institutions in the drug distribution channel, and manufacturers and public medical institutes 《国务院办公厅关于进一步改 encouraged cross-region joint distribution. will decrease thanks to the 'two-invoice 革完善药品生产流通使用政策 Encouraged Internet plus medical care, and stimulated the integration of online and system' 的若干意见》 offline distribution. 3. Pressure on drug price should increase Implemented coordinated reforms in healthcare, medical insurance, and the due to joint procurement of drugs by pharmaceutical industry(the 'Three Coordinated Medical Reforms'). public medical institutes in different provinces; Reduced the reliance of public hospitals on drug sales and established a public- oriented, motivated, and sustainable mechanism. 4. Drug sales through internet should increase; Abolished the drug mark-up policy and implemented relevant compensation policies for medical institutions to promote the to promote Separation of Dispensing from 5. Reducing public hospitals' reliance on Prescription(SDP). drug sales to generate income should affect pharmaceutical industry sales; Medical institutions should issue prescriptions in accordance with the generic name of drugs and voluntarily provide prescription to patients.

The control efficiency of medical costs is directly linked to the financial subsidies of public hospitals, performance payrolls, and the presidential rating. For hospitals that failed to reach the cost-control target, applications for grading as well as the approval for new beds and large equipment will be suspended. The president of the hospitals will be liable.

5/5/2017 2017 Agenda of Deepening the Explored the hierarchical management of designated retail pharmacies on a The removal of any mark-up on Medical and Health Care System nationwide scale, and encouraged the development of pharmaceutical retail chain procurement costs when public medical Reform stores. Explored connecting information from hospitals, medical insurance firms as well institutes sell drugs may reduce incentives 《深化医药卫生体制改革2017 as retail pharmacies in real time. for them to do so as well as affect 重点工作任务》 pharmaceutical industry sales

Overall reform in public hospitals nationwide should be introduced before September 2017. 1) Abolish all mark-up on pharmaceuticals; 2) make coordinated progress in reforming health care pricing, staffing and remuneration, medicine distribution, and health insurance payment 3) Lifting the share of medical services in public hospital's total revenue.

Source: Company, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

China major pharma policy (con’t)

Changes / Major content of the policy related to pharmaceutical T ime Name of Policy distribution industry Impact on industry 9/1/2017 Key tasks for Correcting the Promoted the implementation of the 'two-invoice system' and improved the unregulated activities in the centralised procurement system. procurement and sales of medicine Regulated the supply and distribution of high-value medical consumables and Medical Services provision in Promoted the disclosure on medical consumables. The information on essential 2017 medical consumables shall be voluntarily disclosed by medical institutions. 《2017年纠正医药购销和医疗 服务中不正之风专项治理工作 要点》 Source: Company, DBS Vickers

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Asian Insights SparX China Pharmaceutical Distribution Sector

Appendix 3: Sales channels of drugs and medical devices in China

Drug sales channel (2016)

5.74% 3.35% 0.32%

22.22%

68.38%

Hospital Retail - OTC Retail - Online Third-party terminal - urban community health service center Third-party terminal - township health centers

Source: http://www.sinopharm.com/s/1237-4129-34047.html

Medical Device Sales Channel (2016)

9.83%

17.47%

72.70%

Hospital Retail - OTC Retail - Online

Source: ibaogao.com Inc

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Asian Insights SparX China Pharmaceutical Distribution Sector

Peers comparison table

T arget Mk t PE PE PE P/Bk P/Bk ROE ROE Currency Price Price Cap F iscal 16A 17F 18F 17F 18F 17F 18F Company Name Code Local$ Local$ Local$m Yr x x x x x % % Sinopharm Group 'H'* 1099 HK HKD 32.85 42.00 90,899 Dec 15.8 14.7 13.0 2.1 1.9 14.9 15.1 China Resources Pharmaceutical Group 3320 HK HKD 10.66 n.a. 66,993 Dec 18.6 19.6 17.1 1.5 1.4 8.3 8.6 Shai.Pharms.Hldg. 'H' 2607 HK HKD 19.4 n.a. 55,137 Dec 13.8 12.7 11.3 1.3 1.2 10.4 10.8 Jointown Pharm.Gp.'A' 600998 CH CNY 16.89 n.a. 31,734 Dec 31.3 20.8 20.7 2.2 2.0 10.7 10.1 Nanjing Pharm.'A' 600713 CH CNY 5.44 n.a. 5,666 Dec 27.1 24.7 19.4 1.2 1.1 6.6 7.7 China Meheco 'A' 600056 CH CNY 22.22 n.a. 23,742 Dec 24.0 19.5 15.7 3.0 2.6 15.9 17.0 Huadong Medicine 'A' 000963 CH CNY 57.31 n.a. 55,712 Dec 38.2 30.5 24.5 6.7 5.8 22.4 24.8 Realcan Pharm.'A' 002589 CH CNY 13.35 n.a. 20,088 Dec 30.5 30.5 14.8 2.9 2.1 11.7 14.9 Yunnan Baiyao Group 'A' 000538 CH CNY 96.01 n.a. 99,985 Dec 34.2 30.1 26.2 5.4 4.6 18.4 18.0 Cachet Pharm.'A' 002462 CH CNY 22.72 n.a. 5,692 Dec 25.5 20.7 16.4 2.6 2.2 12.1 13.3 Guangxi Liuzhou Pharm. 'A' 603368 CH CNY 43.57 n.a. 8,063 Dec 24.2 24.2 15.7 2.5 2.0 14.2 13.3 Source: Thomson Reuters, *DBS Vickers

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China / Hong Kong Company Guide Sinopharm Group Version 5 | Bloomberg: 1099 HK EQUITY | Reuters: 1099.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity 22 Feb 2018 BUY Better prospect on declining competition Last Traded Price ( 21 Feb 2018):HK$33.05 (HSI : 31,432) BUY for market-share gain and better economies of scale. Riding on Price Target 12-mth: HK$42.00 (27% upside) the government’s policy to eliminate small players to reduce layers of Analyst Mark Kong CFA, +852 2820 4619 [email protected] distributors between drug makers and medical institutes, we believe Sinopharm can remain the largest drug distributor in China and expand its market share from 16% in 2016 to 17-18% in 2020. Its Price Relative national logistics network and range of products , which is the HK$ Relative Index biggest in China, can help it to win new customers and boost its 219 42.9 199 revenue to grow at 12% CAGR from 2017F to 2020F, 2ppt above 37.9 179 the expected industry CAGR. Thanks to its enlarging revenue and 32.9 159 better economies of scale, we believe it can widen net margin from 139 27.9 119 1.78% to 1.97% in 2017F-20F, helping its earnings to grow at 16% 22.9 99 CAGR in the period. 17.9 79 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Our expected earnings CAGR in 2017-20 is higher than consensus Sinopharm Group (LHS) Relative HSI (RHS) (16% vs 10%). We are more positive as we believe the group’s Forecasts and Valuation revenue can grow faster than industry thanks to steady market share FY Dec (RMB m) 2016A 2017F 2018F 2019F Turnover 258,388 280,996 307,195 347,479 gain in 2017-19. Also, we expect that its net interest cost as a EBITDA 11,926 12,837 14,509 16,755 percentage of sales will drop from 0.75% in 2017F to 0.61% in Pre-tax Profit 8,927 9,715 10,749 12,960 2020F as its debt used to finance account receivables should decline, Net Profit 4,647 5,013 5,673 6,623 thanks to a shorter payment period from public hospitals (its largest Net Pft (Pre Ex) (core profit) 4,649 5,016 5,677 6,628 Net Profit Gth (Pre-ex) (%) 23.2 7.9 13.2 16.8 customer). EPS (RMB) 1.68 1.82 2.06 2.40 EPS (HK$) 2.08 2.24 2.54 2.96 Potential share price catalysts. 1) Lower competition due to a EPS Gth (%) 23.5 7.9 13.2 16.8 Diluted EPS (HK$) 2.07 2.23 2.53 2.95 remarkable decline in the number of players from 2018 onwards; 2) DPS (HK$) 0.62 0.60 0.68 0.80 Lowering of net debt-to-equity ratio to alleviate market concerns BV Per Share (HK$) 14.18 15.80 17.73 20.00 about the company’s high gearing. PE (X) 15.9 14.7 13.0 11.2 P/Cash Flow (X) 8.0 nm 7.7 4.3 Valuation: P/Free CF (X) 9.7 nm 9.0 4.1 Our previous TP is based on 17x 17F PE. We rolled it over to 17x 18F EV/EBITDA (X) 7.5 8.4 7.3 5.7 Net Div Yield (%) 1.9 1.8 2.1 2.4 PE, resulting in a new TP of HK$42.00 which implies 1x PEG. P/Book Value (X) 2.3 2.1 1.9 1.7 Key Risks to Our View: Net Debt/Equity (X) 0.1 0.4 0.3 0.0 ROAE (%) 15.0 14.9 15.1 15.7 Decelerating pharmaceutical industry sales growth resulting from public hospitals’ budget control may impact the revenue growth of Earnings Rev (%): Nil Nil Nil Sinopharm.. Consensus EPS (RMB) 1.90 2.17 2.03 Other Broker Recs: B: 8 S: 0 H: 9 At A Glance Source of all data on this page: Company, DBSV, Thomson Reuters, Issued Capital - H shares (m shs) 1,193 HKEX - Non H shares (m shs) 1,574 H shs as a % of Total 43 Total Mkt. Cap (HK$m/US$m) 91,452 / 11,688 Major Shareholders CNPGC (%) 56.9 Major H Shareholders JPMorgan Chase & Co. (%) 20.03 Oppenheimer Developing Markets Fund (%) 11.13 BlackRock, Inc. (%) 6.97 Mirae Asset Global Inv. (HK) Ltd. (%) 5.9 H Shares-Free Float (%) 56.0 3m Avg. Daily Val. (US$m) 24.5 ICB Industry : Health Care / Pharmaceuticals & Biotechnology

ed-TH / sa- AH / CS Company Guide Sinopharm Group

CRITICAL DATA POINTS TO WATCH Sinopharm’s revenue growth (%) (2017F-20F) 14 13 13 Market share gain to drive revenue growth. The total number of 12 pharmaceutical distributors has been dropping since 2013 (see 9 10 9 the chart “Number of players in pharmaceutical distribution 8 industry”). This should accelerate as the government wants to 6 keep eliminating small players, evidenced by two measures 4 implemented: 1) Asking 77% of provinces in 2016/17 to cut 2 layers of distributors between drug-makers and public medical 0 institutes to one layer. Only large players will survive, in most 2017F 2018F 2019F 2020F cases; 2) Asking 33% of players to upgrade their operations. Number of players in the pharmaceutical distribution industry Most of them are small players with weak financials, and may 16300 have to close down because they can’t meet the requirements. 17000 With the widest range of products and the largest national 16000 14900 15000 13900 logistics network, we believe Sinopharm can take advantage of 13500 13508 this vacuum and expand its market share from 16% in 2016 to 14000 12975 17-18% in 2020, boosting its revenue by 12% CAGR in 2017- 13000 20 which is 2ppt above the expected industry growth. 12000 11000 Control of account receivables to lower interest cost. We expect 10000 2011 2012 2013 2014 2015 2016 the net debt-to-equity to increase from 7% in Dec 2016 to 39% in Dec 2017 and then drop steadily afterward (see the Sinopharm’s net debt-to-equity ratio (%) chart “Sinopharm net debt-to-equity ratio”). This increase in 2016-17 is because public hospitals (largest customer, 50 contributing >50% revenue) have lengthened their payment 39 40 period due to their weaker financials as they are not allowed to 27 mark up over procurement cost when selling drugs. The group 30 thus needs to gear up to finance the account receivables. 20 However, we believe their payment time to Sinopharm will 7 shorten in 2018, resulting in a lower net debt-to-equity ratio, 10 2 thanks to a couple of developments: 1) In May 2017, the 0 medical reform office of the State Council expressed that it will 2016 2017F 2018F 2019F set payment days (30 days at most) to pharmaceutical Public medical insurance programs – Urban areas (X) distributors as a key appraisal standard for the dean of public 1.50 1.38 1.39 hospitals. Beijing has already adopted this; 2) The government 1.34 1.35 1.40 1.31 has allowed public hospitals to raise the prices of medical 1.25 1.30 1.21 1.19 1.20 1.22 services, which can compensate >50% of the revenue decline 1.20 resulting from the removal of mark-up on procurement cost 1.10 when selling drugs. Our analysis suggests that a small 3% price 1.00 surge in overall medical services will be sufficient to help a 2012 2013 2014 2015 2016 public hospital generate net income; 3) The largest source of Total income / Total expenses cashflow for public hospital is the public medical insurance Cumulative reserves / Total expenses programs. It has been running well, evidenced by the fact that SG&A % in revenue revenue / expense and cumulative reserves / expenses have remained above 1.19x and 1.3x since 2012 (see the chart” 4.20 4.15 Public medical insurance programs – Urban areas”). It can 4.02 finance the needs of public hospitals. 4.00 3.92 3.86 Better economies of scale to lower operating cost as a 3.80 percentage of sales. Thanks to increasing revenue and better 3.80 economies of scale, we estimate Sinopharm’s distribution & admin cost as a percentage of sales will drop from 4.15% in 3.60 2016 to 3.8% 2020. 2016 2017F 2018F 2019F 2020F Source: Company, DBS Vickers, Ministry of Commerce, Ministry of Human Resources & Social Security

Page 31 Company Guide Sinopharm Group

Leverage & Asset Turnover (x) 1.8 Balance Sheet: 0.90 1.8 0.80 We expect Sinopharm’s net debt-to-equity to drop from 2018 as it 1.8 0.70 can lower its debt used to finance account receivables as its largest 1.7 0.60 customer - public hospitals - will shorten their payment period to 1.7 0.50 distributors as requested by the central government. 1.7 0.40 1.7 0.30 1.7 0.20 1.6 Share Price Drivers: 0.10 1.6 0.00 1.6 1) Lower competition, thanks to a remarkable decline in the number 2015A 2016A 2017F 2018F 2019F of players in 2018; 2) Lowering of net debt-to-equity in 2H18 to Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure alleviate market concerns about the company’s high gearing. RMBm 4,500.0 4,000.0 3,500.0 Key Risks: 3,000.0 Decelerating pharmaceutical industry sales growth resulting from 2,500.0 public hospitals’ budget control may impact the revenue growth of 2,000.0 1,500.0 Sinopharm. 1,000.0 500.0 0.0 2015A 2016A 2017F 2018F 2019F

Capital Expenditure (-) Company Background: ROE Sinopharm is the largest pharmaceutical distributor in China with 16% market share in 2016. Its parent company is China National 14.0% Pharmaceutical Group Corp, which is one of the 98 state-owned 12.0% enterprises directly under State-owned Assets Supervision & 10.0% Administration Commission of State Council. 8.0% 6.0%

4.0%

2.0%

0.0% 2015A 2016A 2017F 2018F 2019F Forward PE Band (x)

22.9

20.9 +2sd: 19.9x 18.9 +1sd: 18x 16.9 Avg: 16.1x 14.9 -1sd: 14.1x 12.9 -2sd: 12.2x 10.9 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 PB Band (x) 3.5

3.0 +2sd: 3.05x

+1sd: 2.71x 2.5 Avg: 2.36x

2.0 -1sd: 2.02x

-2sd: 1.67x 1.5 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Source: Company, DBS Vickers

Page 32 Company Guide Sinopharm Group

Key Assumptions FY Dec 2015A 2016A 2017F 2018F 2019F Revenue growth % 14.3 13.0 8.7 9.3 13.1 Gross Margin % 8.2 8.0 7.9 8.0 8.0 SG&A % in revenue 4.3 4.2 4.0 3.9 3.9 Source : Company, DBS Vickers Segmental Breakdown (RMB m)

FY Dec 2015A 2016A 2017F 2018F 2019F Revenues (RMB m) Pharmaceutical 215,597 243,883 265,833 289,758 327,426 distribution Retail pharmacy 8,715 10,202 11,936 13,726 15,785 Other business operations 4,361 4,303 3,227 3,711 4,268 Total 228,673 258,388 280,996 307,195 347,479 EBIT (RMB m) Pharmaceutical 8,413 9,373 10,354 11,742 13,633 distribution Retail pharmacy 216 298 329 373 434 Other business operations 618 602 600 680 790 Total 9,247 10,273 11,283 12,796 14,856 EBIT Margins (%) Pharmaceutical 3.9 3.8 3.9 4.1 4.2 distribution Retail pharmacy 2.5 2.9 2.8 2.7 2.7 Other business operations 14.2 14.0 18.6 18.3 18.5 Total 4.0 4.0 4.0 4.2 4.3 Source: Company, DBS Vickers Income Statement (RMB m) FY Dec 2015A 2016A 2017F 2018F 2019F Revenue 228,673 258,388 280,996 307,195 347,479 Cost of Goods Sold (209,953) (237,717) (258,713) (282,681) (319,577) Gross Profit 18,720 20,671 22,283 24,514 27,903 Other Opng (Exp)/Inc (9,493) (10,457) (11,000) (11,718) (13,047) Operating Profit 9,227 10,214 11,283 12,796 14,856 Other Non Opg (Exp)/Inc 65 411 70 77 87 Associates & JV Inc 165 232 460 522 606 Net Interest (Exp)/Inc (1,988) (1,932) (2,102) (2,649) (2,594) Dividend Income 1 2 3 4 5 Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 7,470 8,927 9,715 10,749 12,960 Tax (1,728) (2,033) (2,174) (2,386) (2,964) Minority Interest (1,969) (2,244) (2,525) (2,686) (3,368) Preference Dividend 0 0 0 0 0 Net Profit 3,772 4,647 5,013 5,673 6,623 Net Profit before Except. 3,773 4,649 5,016 5,677 6,628 EBITDA 10,464 11,926 12,837 14,509 16,755 Growth Revenue Gth (%) 14.3 13.0 8.7 9.3 13.1 EBITDA Gth (%) 17.6 14.0 7.6 13.0 15.5 Opg Profit Gth (%) 17.4 10.7 10.5 13.4 16.1 Net Profit Gth (%) 31.2 23.2 7.9 13.2 16.8 Margins & Ratio Gross Margins (%) 8.2 8.0 7.9 8.0 8.0 Opg Profit Margin (%) 4.0 4.0 4.0 4.2 4.3 Net Profit Margin (%) 1.6 1.8 1.8 1.8 1.9 ROAE (%) 13.1 15.0 14.9 15.1 15.7 ROA (%) 2.8 3.1 3.0 3.0 3.2 ROCE (%) 10.1 10.3 10.0 9.9 10.6 Div Payout Ratio (%) 30.1 29.8 27.0 27.0 27.0 Net Interest Cover (x) 4.6 5.3 5.4 4.8 5.7 Source: Company, DBS Vickers

Page 33 Company Guide Sinopharm Group

Interim Income Statement (RMB m) FY Dec 1H2015 2H2015 1H2016 2H2016 1H2017

Revenue 111,057 117,615 126,799 131,589 137,768 Cost of Goods Sold (101,918) (108,034) (116,525) (121,192) (126,875) Gross Profit 9,139 9,581 10,274 10,397 10,892 Other Oper. (Exp)/Inc (4,517) (4,976) (5,050) (5,407) (5,006) Operating Profit 4,622 4,605 5,223 4,990 5,886 Other Non Opg (Exp)/Inc 68 (3) 427 (16) 30 Associates & JV Inc 91 74 105 127 240 Net Interest (Exp)/Inc (1,027) (961) (894) (1,038) (998) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 3,754 3,716 4,861 4,064 5,157 Tax (865) (863) (1,106) (927) (1,125) Minority Interest (975) (994) (1,219) (1,025) (1,267) Net Profit 1,914 1,858 2,536 2,112 2,765 Net profit bef Except. 1,914 1,858 2,536 2,112 2,765

Growth Revenue Gth (%) 17.1 11.7 14.2 11.9 8.7 Opg Profit Gth (%) 17.8 16.9 13.0 8.4 12.7 Net Profit Gth (%) 30.6 31.9 32.5 13.6 9.0

Margins Gross Margins (%) 8.2 8.1 8.1 7.9 7.9 Opg Profit Margins (%) 4.2 3.9 4.1 3.8 4.3 Net Profit Margins (%) 1.7 1.6 2.0 1.6 2.0 Source: Company, DBS Vickers

Page 34 Company Guide Sinopharm Group

Balance Sheet (RMB m) FY Dec 2015A 2016A 2017F 2018F 2019F

Net Fixed Assets 8,036 7,160 7,831 8,417 8,916 Invts in Associates & JVs 1,133 3,328 3,512 3,721 3,721 Other LT Assets 12,360 14,464 16,755 16,541 16,325 Cash & ST Invts 24,570 30,596 23,596 31,634 40,685 Inventory 22,553 25,760 26,692 29,070 32,219 Debtors 65,033 69,245 92,423 101,152 101,434 Other Current Assets 5,743 7,159 10,059 10,775 10,798 Total Assets 139,430 157,712 180,868 201,310 214,097

ST Debt 28,355 22,363 34,363 37,566 33,810 Creditors 43,332 50,257 53,228 59,844 67,986 Other Current Liab 23,934 27,118 32,366 35,614 36,400 LT Debt 608 11,135 8,635 9,440 8,496 Other LT Liabilities 2,321 2,306 2,094 2,194 2,306 Shareholder’s Equity 30,110 31,811 35,440 39,760 44,851 Minority Interests 10,768 12,722 14,742 16,891 20,259 Total Cap. & Liab. 139,430 157,712 180,868 201,310 214,109

Non-Cash Wkg. Capital 26,063 24,789 43,581 45,539 40,065 Net Cash/(Debt) (4,393) (2,902) (19,402) (15,373) (1,621) Debtors Turn (avg days) 104.7 94.8 105.0 115.0 106.4 Creditors Turn (avg days) 73.4 72.2 73.3 73.3 73.3 Inventory Turn (avg days) 37.4 37.3 37.1 36.1 35.1 Asset Turnover (x) 1.7 1.7 1.7 1.6 1.7 Current Ratio (x) 1.2 1.3 1.3 1.3 1.3 Quick Ratio (x) 0.9 1.0 1.0 1.0 1.0 Net Debt/Equity (X) 0.1 0.1 0.4 0.3 0.0 Net Debt/Equity ex MI (X) 0.1 0.1 0.5 0.4 0.0 Capex to Debt (%) 6.4 4.9 9.1 3.0 (2.5) Z-Score (X) 2.6 2.7 2.5 2.5 2.5 Source: Company, DBS Vickers

Cash Flow Statement (RMB m) FY Dec 2015A 2016A 2017F 2018F 2019F

Pre-Tax Profit 7,469 8,925 9,712 10,745 12,955 Dep. & Amort. 1,006 1,068 1,020 1,110 1,201 Tax Paid (1,728) (2,033) (2,174) (2,386) (2,964) Assoc. & JV Inc/(loss) (165) (232) (460) (522) (606) (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. 4,352 2,136 (17,792) (1,958) 3,942 Other Operating CF 2,479 (605) 808 2,667 2,594 Net Operating CF 13,412 9,258 (8,886) 9,657 17,122 Capital Exp.(net) (1,858) (1,653) (3,900) (1,401) 1,065 Other Invts.(net) 0 0 0 0 0 Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 99 139 276 313 364 Other Investing CF 116 (92) 373 278 395 Net Investing CF (1,643) (1,606) (3,251) (809) 1,825 Div Paid (772) (1,135) (1,384) (1,353) (1,532) Chg in Gross Debt (492) 4,534 9,500 4,009 (4,701) Capital Issues (272) (1,812) 0 0 0 Other Financing CF (5,624) (3,615) (2,462) (3,466) (3,664) Net Financing CF (7,160) (2,027) 5,655 (810) (9,896) Currency Adjustments 124 (18) 0 0 0 Chg in Cash 4,734 5,607 (6,482) 8,037 9,050 Opg CFPS (RMB) 3.27 2.58 3.23 4.21 4.78 Free CFPS (RMB) 4.18 2.76 (4.63) 2.99 6.59

Source: Company, DBS Vickers

Page 35 Company Guide Sinopharm Group

Target Price & Ratings History

HK$ S.No. Date Closing 12-mth Rating 39.0 1 2 Price T arget 3 38.0 Price 37.0 1: 28-Mar-17 HK$36.85 HK$36.40 Hold 36.0 2: 29-Aug-17 HK$33.35 HK$36.40 Hold 35.0 3: 22-Dec-17 HK$32.55 HK$42.00 Buy 34.0 33.0 32.0 31.0 30.0 29.0 Jul-17 Jan-18 Jun-17 Oct-17 Feb-17 Feb-18 Apr-17 Sep-17 Dec-17 Nov-17 Mar-17 Aug-17 May-17

Source: DBS Vickers

Analyst: Mark Kong CFA,

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Page 39 Asian Insights SparX China Pharmaceutical Distribution Sector

DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 22 Feb 2018 08:25:36 (HKT) Dissemination Date: 22 Feb 2018 14:52:22 (HKT) Sources for all charts and tables are DBS Vickers unless otherwise specified. GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Vickers (Hong Kong) Limited (“DBSV HK”). This report is solely intended for the clients of DBS Bank Ltd., DBS Bank (Hong Kong) Limited (DBS HK), DBSV HK, and DBS Vickers Securities (Singapore) Pte Ltd. (“DBSVS”), its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSV HK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., DBS HK, DBSV HK, DBSVS, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”) have not conducted due diligence on any of the companies, verified any information or sources or taken into account any other factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we do not make any representation or warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group, may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may not contain all material information concerning the company (or companies) referred to in this report and the DBS Group is under no obligation to update the information in this report. This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and (b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein. Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBSVUSA, a US-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making.

Page 40 Asian Insights SparX China Pharmaceutical Distribution Sector

ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s) primarily responsible for the content of this research report, in part or in whole, certifies that he or his associate1 does not serve as an officer of the issuer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the management of the issuer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or his associate does not have financial interests2 in relation to an issuer or a new listing applicant that the analyst reviews. DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately. There is no direct link of DBS Group's compensation to any specific investment banking function of the DBS Group.

COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBS Bank Ltd, DBS HK, DBSVS, DBSV HK or their subsidiaries and/or other affiliates have proprietary positions in Sinopharm Group Company Limited (1099 HK) and China Resources Pharmaceutical Group Limited (3320 HK) recommended in this report as of 20 Feb 2018.

2. Neither DBS Bank Ltd, DBS HK nor DBSV HK market makes in equity securities of the issuer(s) or company(ies) mentioned in this Research Report.

3. Compensation for investment banking services: DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively.

4. Disclosure of previous investment recommendation produced: DBS Bank Ltd, DBSVS, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA may have published other investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12 months. Please contact the primary analyst listed in the first page of this report to view previous investment recommendations published by DBS Bank Ltd, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA in the preceding 12 months.

1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst. 2 Financial interest is defined as interests that are commonly known financial interest, such as investment in the securities in respect of an issuer or a new listing applicant, or financial accommodation arrangement between the issuer or the new listing applicant and the firm or analysis. This term does not include commercial lending conducted at arm's length, or investments in any collective investment scheme other than an issuer or new listing applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new listing applicant.

Page 41 Asian Insights SparX China Pharmaceutical Distribution Sector

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Wong Ming Tek, Executive Director, ADBSR Singapore This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) or DBSVS (Company Regn No. 198600294G), both of which are Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd and/or DBSVS, may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, DBS Bank Ltd accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact DBS Bank Ltd at 6327 2288 for matters arising from, or in connection with the report. Thailand This report is being distributed in Thailand by DBS Vickers Securities (Thailand) Co Ltd. United This report is produced by DBSVHK which is regulated by the Hong Kong Securities and Futures Commission Kingdom This report is disseminated in the United Kingdom by DBS Vickers Securities (UK) Ltd (“DBSVUK”). DBSVUK is authorised and regulated by the Financial Conduct Authority in the United Kingdom. In respect of the United Kingdom, this report is solely intended for the clients of DBSVUK, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVUK. This communication is directed at persons having professional experience in matters relating to investments. Any investment activity following from this communication will only be engaged in with such persons. Persons who do not have professional experience in matters relating to investments should not rely on this communication. Dubai This research report is being distributed by DBS Bank Ltd., (DIFC Branch) having its office at PO Box 506538, 3rd Floor, International Building 3, East Wing, Gate Precinct, Dubai International Financial Centre (DIFC), Dubai, United Arab Emirates. DBS Bank Financial Ltd., (DIFC Branch) is regulated by The Dubai Financial Services Authority. This research report is intended only for Centre professional clients (as defined in the DFSA rulebook) and no other person may act upon it.

Page 42 Asian Insights SparX China Pharmaceutical Distribution Sector

United Arab This report is provided by DBS Bank Ltd (Company Regn. No. 196800306E) which is an Exempt Financial Adviser as defined Emirates in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. This report is for information purposes only and should not be relied upon or acted on by the recipient or considered as a solicitation or inducement to buy or sell any financial product. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situation, or needs of individual clients. You should contact your relationship manager or investment adviser if you need advice on the merits of buying, selling or holding a particular investment. You should note that the information in this report may be out of date and it is not represented or warranted to be accurate, timely or complete. This report or any portion thereof may not be reprinted, sold or redistributed without our written consent. United States This report was prepared by DBSVHK. DBSVUSA did not participate in its preparation. The research analyst(s) named on this report are not registered as research analysts with FINRA and are not associated persons of DBSVUSA. The research analyst(s) are not subject to FINRA Rule 2241 restrictions on analyst compensation, communications with a subject company, public appearances and trading securities held by a research analyst. This report is being distributed in the United States by DBSVUSA, which accepts responsibility for its contents. This report may only be distributed to Major U.S. Institutional Investors (as defined in SEC Rule 15a-6) and to such other institutional investors and qualified persons as DBSVUSA may authorize. Any U.S. person receiving this report who wishes to effect transactions in any securities referred to herein should contact DBSVUSA directly and not its affiliate. Other In any other jurisdictions, except if otherwise restricted by laws or regulations, this report is intended only for qualified, jurisdictions professional, institutional or sophisticated investors as defined in the laws and regulations of such jurisdictions. DBS Vickers (Hong Kong) Limited 18th Floor Man Yee building, 68 Des Voeux Road Central, Central, Hong Kong Tel: (852) 2820-4888, Fax: (852) 2868-1523 Company Regn. No. 31758

Page 43 Asian Insights SparX China Pharmaceutical Distribution Sector

DBS Regional Research Offices

HONG KONG MALAYSIA SINGAPORE DBS Vickers (Hong Kong) Ltd AllianceDBS Research Sdn Bhd DBS Bank Ltd Contact: Carol Wu Contact: Wong Ming Tek (128540 U) Contact: Janice Chua 18th Floor Man Yee Building 19th Floor, Menara Multi-Purpose, 12 Marina Boulevard, 68 Des Voeux Road Central Capital Square, Marina Bay Financial Centre Tower 3 Central, Hong Kong 8 Jalan Munshi Abdullah 50100 Singapore 018982 Tel: 852 2820 4888 Kuala Lumpur, Malaysia. Tel: 65 6878 8888 Fax: 852 2863 1523 Tel.: 603 2604 3333 Fax: 65 65353 418 e-mail: [email protected] Fax: 603 2604 3921 e-mail: [email protected] Participant of the Stock Exchange of Hong Kong Ltd e-mail: [email protected] Company Regn. No. 196800306E

INDONESIA THAILAND PT DBS Vickers Sekuritas (Indonesia) DBS Vickers Securities (Thailand) Co Ltd Contact: Maynard Priajaya Arif Contact: Chanpen Sirithanarattanakul DBS Bank Tower 989 Siam Piwat Tower Building, Ciputra World 1, 32/F 9th, 14th-15th Floor Jl. Prof. Dr. Satrio Kav. 3-5 Rama 1 Road, Pathumwan, Jakarta 12940, Indonesia Bangkok Thailand 10330 Tel: 62 21 3003 4900 Tel. 66 2 857 7831 Fax: 6221 3003 4943 Fax: 66 2 658 1269 e-mail: [email protected] e-mail: [email protected] Company Regn. No 0105539127012 Securities and Exchange Commission, Thailand

At a Glance

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