China Health Care Pharma Sector Comes of Age
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l Equity Research l China l Pharmaceuticals l 27 June 2014 China health care Pharma sector comes of age Strong growth visibility: We expect health-care spending to account for a growing share of China’s economy: over 8% of GDP by 2020, from the current 5%. In the US, only two sectors – health care and entertainment – have claimed a larger share of the household wallet in the past 50 years. We believe this trend could also apply to China. China’s multiple secular drivers – ageing population, widening insurance coverage, and improving innovation capabilities – should underpin strong growth in its health-care sector and drive investor return, in our view. Climbing the wall of policy worry: We believe the main risks to the sector are regulatory and competitive. Contrary to popular perception, our research shows that health-care affordability in China has improved since the mid-2000s. We expect this trend to eventually lower the risk of state-mandated price cuts. Provincial tenders for medicines and the opening up of the health-care service sector will increase competition but should also allow industry leaders to gain market share, in our view. Our picks: We see growing potential at both ends of the value curve in health care: pharmaceuticals and health-care services. Since the private health-care provider sub-sector is at an early stage of development, our report focuses on pharmaceuticals. Our proprietary framework, which is based on analysis of a ‘smiley curve’ trend, selects stocks based on products, financials, corporate governance, valuations and potential earnings upside. Accordingly, we initiate coverage of five stocks: Sihuan Pharma (OP), The United Laboratories (TUL, OP), China Shineway (OP), Lee's Pharm (IL) and CSPC Pharma (IL). Our top picks are Sihuan and TUL. Click here to get the Scoop, an audiovisual summary of the report. Su Zhang +852 3983 8526 Equity Research Standard Chartered Bank (HK) Limited Important disclosures can be found in the Disclosures Appendix All rights reserved. Standard Chartered Bank 2014 http://research.standardchartered.com Equity Research l China health care Contents Executive summary 3 Proprietary investment framework: smiley curve, franchise scores, rotation map 7 China health care: uniquely positioned for ‘growth certainty’ 15 Climbing the wall of policy worry 22 Innovative and generic drugs: choose the real leaders 27 TCM: unique risk and reward 35 Health-care services: journey has just begun 38 Appendix 1: Top 20 multi-baggers in China 42 Appendix 2: Medicine price cuts mandated by the NDRC 43 Appendix 3: Provincial tenders – Timeline 44 Appendix 4: HK-listed peers – Financial comparison 45 Appendix 5: Glossary 47 Companies China Shineway Pharmaceutical 50 CSPC Pharmaceutical 60 Lee’s Pharmaceutical 71 Sihuan Pharmaceutical 84 The United Laboratories International 99 Disclosures appendix 112 SCout is Standard Chartered’s premium research product that offers Strategic, Collaborative, Original ideas on Universal and Thematic opportunities 27 June 2014 2 Equity Research l China health care Executive summary Solid fundamentals: China’s health-care market registered a strong 20% CAGR in value terms in 2008-12, We expect health-care spending to and we expect a CAGR of 16% in 2013-17. Admittedly, the sector is not immune to a rise to 8% by 2020, from 5% macro slowdown – pharma industry sales growth slowed to 14% YoY in 1Q14 from 17-29% in the past decade, according to the National Bureau of Statistics (NBS). Nevertheless, we believe the health-care sector stands out for its strong growth visibility in the next few decades. We expect the ageing of China’s population to match Japan’s pace and push health-care spending to 8% of GDP by 2020 (from the current 5%). Medical insurance coverage expanded to 96% of the population in 2012 from 56% in 2006. We observe that domestic companies are gradually climbing the value chain and taking market share from multinationals. These trends bode well for investors. Figure 1: China pharma – Sales growth 35 30 28.8 26.1 26.0 26.2 24.4 25 20.9 20.1 20 17.4 17.5 17.9 15 13.8 % revenue% change 10 5 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q 14 Source: NBS The sector trades at 2.8x trailing PBR on the MSCI China Health-care Index and 3.9x on the WIND China Health-care Index, a decent performance compared with 15-20% trailing ROE and low betas. Its valuations are also consistent with a 10-20% return on the index in the next 12 months, as we indicate in Figures 2 and 3. We would start to be concerned about overheating only if the valuation gauge exceeded 4-5x PBR. Figure 2: MSCI Health-care – Trailing PBR vs. subsequent Figure 3: WIND China – A-share trailing PBR vs. 12M median return subsequent 12M median return 40% 60% 30% 50% 20% 40% 10% 30% 20% 0% 10% -10% 0% -20% median 12m return -10% 12 month12 median return -30% -20% -40% -30% Below 2x 2-3x 3-4x 4-6x Greater than Below 2.4x 2.4x-3.2x 3.2x-4x 4x-4.8x 4.8x-5.6x Greater 6x than 5.6x Source: Bloomberg, Standard Chartered Research estimates Source: WIND, Standard Chartered Research estimates 27 June 2014 3 Equity Research l China health care Balanced risk The main risks to our positive thesis are regulatory and competitive pressure. However, we believe rising disposable income and expansion of insurance coverage have improved health-care affordability for China’s households since the mid-2000s, and this could lower the risk of future state-mandated price cuts. Provincial tenders for medicines and the opening up of health-care services would increase competition, but they should also allow market leaders to thrive in their own sub-sectors. Proprietary stock To pick the right stocks, we use a framework based on a ‘smiley curve’. Our research selection approach shows that sub sectors with the highest long-term growth potential cluster at both ends of the health-care value chain: pharma, device and service companies at one end, and health-care operators at the other. Their relevance could be explained in this way: the former group of sub-sectors drives innovation, and the latter controls points-of-sales in medicine and services. As China’s private health-care operator sub-sector is still at an early stage of development, we place it under review for now, and focus on pharmaceuticals. Figure 4: China health care – Companies on the smiley curve of the value chain added - High value Pharma Devices Services Service providers Sino Mindray, Wuxi Aier Eye, Biopharm, Weigao, Pharmatech, Topchoice, Fosun, Yuyue, Tigermed, Phoenix, Sihuan, Microport, Dian Fosun, CCM TUL, Andon Shineway, CSPC, Consumables Lee’s Pharm Weigao, Lijun, Payers Kelun NA in China Promoters Distributors China Medical Sinopharm, Services, Shanghai Pioneer, Pharma, NT Pharma Huadong, Jointown added - Low value R&D focus Scale focus Service focus Company names in green are under our coverage Source: Standard Chartered Research First, we apply a proprietary ‘franchise score’ based on each company’s products, financials and corporate governance credentials, and cross-check those with its historical mean valuation multiples. Then, we anticipate how much the franchise score could change in the next five years, and assign target multiples accordingly, based on a premium or discount to its historical mean multiple. Lastly, we build a stock selection grid to compare potential valuation upside (relative to our target multiples) and our potential earnings upside (relative to consensus). The next chapter details the rationale behind our framework. 27 June 2014 4 Equity Research l China health care Figure 5: Franchise score table *Sihuan Sino Biopharm *Lee’s Pharm Tongrentang *Shineway Fosun *TUL *CSPC Products: 30/60 Market share (5/60) 5 4 3 4 3 4 4 4 Top sellers (10/60) 8 10 5 8 6 7 6 7 Diversification (5/60) 2 4 2 4 2 4 2 4 Pipeline (10/60) 6 9 6 6 4 8 8 10 Product score 21 27 16 22 15 23 20 25 Financials: 20/60 Margin (5/60) 4 3 3 2 4 4 1 2 Efficiency (5/60) 3 4 4 2 2 2 3 3 Free cash flow & dividend (5/60) 4 4 5 4 4 2 2 3 Leverage (5/60) 4 4 4 4 4 3 2 3 Financial score 15 15 16 12 14 11 8 11 Governance: 10/60 Listing history (3/60) 1 3 3 3 3 1 2 2 Major shareholder (3/60) 3 3 3 1 3 3 3 2 Transparency of business model 2 3 4 1 2 2 3 3 & disclosure (4/60) Governance score 6 9 10 5 8 6 8 7 Franchise score 42 51 42 39 37 40 36 43 *Under our coverage Source: Standard Chartered Research Figure 6: China pharma – Our stock selection grid The United Upside + Upside Shineway (+) Laboratories (+) Sihuan (+) CSPC (=) Lee's Pharm (=) Upside / downside to PT to downside / Upside Downside - Downside Low - High + Earnings upside 2014E EPS vs consensus Source: Standard Chartered Research 27 June 2014 5 Equity Research l China health care In conclusion, we recommend that investors build positions in Sihuan Pharma (OP), The United Laboratories (TUL, OP) and China Shineway (OP), which we believe have significant valuation and/or earnings upside, relative to consensus. We initiate coverage on the stocks, as well as Lee’s Pharm (IL) and CSPC Pharma (IL), which should appeal to long-term investors, as they lack near-term valuation potential in the next 6-12 months, in our view. Figure 7: China pharma – Our stocks Mkt cap hide column-oldPrice Ratingrating PT (lc) PT Up/(Dn) PER (x) EV/EBITDA (x) Div yield (%) Ticker (USD mn) (lc) New Old Rec New Chg (%) (lc) side (%) FY1E FY2E FY1E FY2E FY1E FY2E China Shineway Pharmaceutical^ 2877 HK 1,472.2 - OP - OP 18.00 - 18.00 - 12.3 10.7 6.4 5.2 3.3 3.8 CSPC Pharmaceutical^ 1093 HK 4,611.0 6.05 IL - IL 6.60 - 6.60 9.1 29.6 23.1 15.9 12.9 1.0 1.3 Lee's Pharmaceutical^ 950 HK 695.7 10.02 IL - IL 9.90 - 9.90 (1.2) 30.0 23.2 20.2 16.0 0.9 1.2 Sihuan Pharmaceutical^ 460 HK 6,350.6 4.75 OP - OP 5.90 - 5.90 24.2 23.9 17.8 17.6 12.8 1.2 1.7 The United Laboratories International^3933 HK 1,064.1 5.07 OP - OP 6.70 - 6.70 32.1 16.9 13.6 8.8 7.3 0.0 0.0 ^ Initiations.