EQUITIES HEALTHCARE March 2017
By: Zhijie Zhao https://www.research.hsbc.com China Pharmaceuticals China Pharmaceuticals Spring is in the air – we expect a year of healthy growth
The policy pain of 2016 starts to ease and the industry’s fundamentals remain robust
Multinational companies are reducing their focus on off-patent drugs in China, opening up a range
Equities // Healthcare of opportunities
We raise our target prices between 11% and 25%; we prefer Hengrui, Sino Biopharm and CMS, all rated Buy March 2017
Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it EQUITIES ● HEALTHCARE March 2017
THIS CONTENT MAY NOT BE DISTRIBUTED TO THE PEOPLE'S REPUBLIC OF CHINA (THE "PRC") (EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAO)
The dark clouds are lifting
The pain is easing as the risks associated with industry reforms recede We forecast that the net profit growth of our covered companies will average 19% in 2017e and 23% in 2018e, up from 18% in 2016e We raise our target prices by 11-25%; we prefer Hengrui, Sino Biopharm and CMS, all rated Buy
Last year we wrote that China’s attempts to improve the healthcare system were proving painful for pharma companies (China Pharmaceuticals – 2016: Painful symptoms, possible remedies, 1 March 2016). We said that, although efforts to cut the cost of healthcare and improve industry standards would make the first half of 2016 difficult, we remained strong believers in China’s pharma story.
Well, two months into 2017, we believe the pain is easing and the outlook is much brighter. The outlook is much brighter Pharma stocks that had a gloomy 2016 – the average PE multiples of our covered A- and H-share companies slipped from a peak of 67x and 34x in 2015 to 36x and 21x in 2016, respectively – are adjusting to the stricter regulatory environment and the fundamental growth drivers of the healthcare industry remain intact. We believe 2017 will be a much better year for the leading domestic companies. Patient numbers are rising, the downside risks associated with policy reforms are receding, and the pace at which multinational companies (MNCs) are retreating from China’s pharma market is accelerating.
We forecast that the net profit growth of our covered companies – Hengrui, Haohai Pharma, Kanion, Tasly, Nhwa, Sino Biopharm, CSPC and CMS – will average 19% in 2017e and 23% in 2018e, up from 18% in 2016e. We reiterate our Buy ratings on our top picks – Hengrui, Sino Biopharm and CMS – and our preference for companies with strong R&D capabilities, robust product pipelines, and experience in making drug acquisitions. We raise our target prices by 11- 25%. We prefer Hengrui (Buy, TP RMB60.00, up from RMB52.70), Sino Biopharm (Buy, TP RMB7.90, up from RMB6.30) and CMS (Buy, TP HKD15.60, up from HKD14.10). Our target price is 10% above consensus for Hengrui, 14% for Sino Biopharm, and 6% for CMS. See the tables on the next page for more details.
2017: Sell more, sell cheaper and sell better In this report we focus on:
The impact of major policy themes – cost controls, upgrading product quality, and the expansion of medical insurance coverage – and pinpoint potential beneficiaries. Of the three themes, cost control is likely to be the biggest issue for pharma companies, but we think increased sales volumes can redress the balance. The improvements in the drug approval process, a big negative last year, as it slowed drug launches, means than an array of potential blockbuster drugs should hit the market in 2017-18e. We believe this will benefit the performance of pharma companies with strong product pipelines.
1 EQUITIES ● HEALTHCARE March 2017
The fact that, in our view, the increase in the number of patients is not priced in yet. During our recent marketing trip, we talked to over 30 global investors and found that most were well aware of the government-enforced price cuts due to drug tenders and the ongoing cost controls in hospitals. However, while the rise in the number of hospital inpatients – 9.3% y-o- y in 4M16 vs 3.4% y-o-y in 2015 – was starting to attract the market’s attention, the organic growth potential of patient numbers has gone almost unnoticed. It is commonly accepted that China’s population is ageing, but it is less well-known that this ageing process is accelerating. The first expansion of the National Reimbursement Drugs List (NRDL) in eight years, announced last month, is a major development. The NRDL contains drugs that could be fully or partially funded by the government. Once included on the list, the sales volume of drugs rises sharply. Stock prices surged after the list was released.
Multinationals are changing their focus in China. A focus on profitability rather than scale is accelerating the pace of their retreat from the off-patent drug market in China. We expect the pace of product transfers to accelerate and domestic companies with strong sales networks should benefit.
Table 1. Valuation summary Company Ticker Currency Rating New Old Change Price Upside/ Consensus HSBC TP vs Target Target Downside Target Price Consensus Price Price (%) TP
Hengrui 600276 CH RMB Buy 60.00 52.70 14% 49.80 20% 54.6 10.0% Sino Biopharm 1177 HK HKD Buy 7.90 6.30 25% 6.50 21% 6.9 14.5% CMS 867 HK HKD Buy 15.60 14.10 11% 12.80 21% 14.7 6.0% Sinopharm 1099 HK HKD Hold 40.00 40.00 0% 35.40 13% 41.5 -4.0% CSPC 1093 HK HKD Buy 11.20 9.80 14% 9.40 19% 10.1 11.0% Source: Bloomberg, HSBC estimates. Priced as of 3 March 2017.
Table 2. Changes in HSBC estimates Unit 2016e 2017e 2018e Hengrui (600276 CH) Old NP RMBm 2,701 3,489 4,421 New NP RMBm 2,621 3,222 3,950 Change % -2.95 -7.64 -10.66 Consensus NP RMBm 2,689 3,308 4,028 HSBC vs Consensus % -2.52 -2.59 -1.94 Sino Biopharm (1177 HK) Old NP HKDm 2,018 2,235 2,590 New NP HKDm 2,018 2,239 2,609 Change % 0.00 0.20 0.70 Consensus NP HKDm 2,017 2,201 2,501 HSBC vs Consensus % 0.00 1.70 4.30 CMS (867 HK) Old NP RMBm 1,364 1,651 2,010 New NP RMBm 1,294 1,520 1,868 Change % -5.10 -7.90 -7.10 Consensus NP RMBm 1333 1613 1900 HSBC vs Consensus % -3.00 -5.80 -1.70 Sinopharm (1099 HK) Old Recurring NP RMBm 4,421 5,239 5,962 New Recurring NP RMBm 4,393 5,140 5,813 Change % -0.60 -1.90 -2.50 Consensus NP RMBm 4,681 5,269 6,041 HSBC vs Consensus % 4.10 -1.10 -2.40 CSPC (1093 HK) Old NP HKDm 2,113 2,556 3,185 New NP HKDm 2,113 2,588 3,278 Change (%) % 0.00 1.30 2.90 Consensus NP HKDm 2091 2574 3130 HSBC vs Consensus % 1.05 2.33 2.90 Source: Bloomberg, HSBC estimates
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Contents
The dark clouds are lifting 1
2017: a year of recovery 4
Three policy themes for 2017 10
MNCs pay less attention to China’s off-patent drug market 27
A greying society 32
Valuation 38
Company section 45 Hengrui (600276 CH) 46 Sino Biopharm (1177 HK) 52 CMS (867 HK) 56 Sinopharm (1099 HK) 60 CSPC (1093 HK) 65
Disclosure appendix 69
Disclaimer 72
3 EQUITIES ● HEALTHCARE March 2017
2017: a year of recovery
China’s ageing population is pushing up patient numbers Accelerated approvals of new drugs and a new NRDL to fuel industry growth Prefer pharma companies with strong sales and R&D
The worst is over. 2016 was a painful year for China’s healthcare market. Strong policy Industry profits should start to bounce back in 2017e headwinds blew through the whole industry, resulting in sluggish revenue growth and slim margins for both upstream drug developers and downstream drug distributors. We believe that industry profits have bottomed and should start to bounce back in 2017e. Our constructive outlook is based on resilient fundamentals: 1) the population is greying at a rapid rate; 2) a new, expanded National Reimbursement Drugs List (NRDL) has just been released; 3) another round of drug price negotiations between the Ministry of Human Resources and Social Security (MOHRSS) and pharma companies will begin shortly; while prices may be cut, this should be offset by volume gains; 4) the regulator is expected to speed up the drug approval process; and 5) drug tenders in major cities should be wrapped up in 2017e.
China healthcare industry at a glance
Life for China’s pharmaceutical companies is much tougher than it was during the “golden decade” of 2003-13. Government policy that was once so supportive has inflicted considerable pain on the industry. Regulators are committed to improving industry standards, while public healthcare expenses are under tight control as the government has made affordability and accessibility of healthcare services a policy priority. Growth has slowed down, drug prices have been cut by government decree, and the regulator has imposed tough new quality controls on the industry.
Back in 2009 the government launched reforms that included a significant rise in public health financing, the expansion of primary health facilities, and higher subsidies to help achieve universal insurance coverage. Around RMB850bn was spent annually from 2009 to 2013. This not only drove strong sector growth but caught the attention of the stock market.
More recently, the beneficial effects of these reforms have started to wear off. Two numbers tell the story: according to the National Bureau of Statistics (NBS), industry revenue growth declined from 26% in 2007 to 8% as of February 2016. From 2012 to 2015, the rise of China’s hospitals’ pharma sales dropped from over 30% to single digits (IMS data).
We started to see signs of a recovery in 2016. Growth of inpatient numbers is accelerating, Growth of inpatient numbers is accelerating while the impact of policy changes has been digested by the market. We believe China’s healthcare industry still has substantial growth potential, especially when benchmarked against the healthcare expenditure of developed countries. For example, healthcare spending represents more than 17% of US GDP, but only 6% in China.
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Figure 1. Inpatient numbers and industry y-o-y growth
Source: NHFPC, Wind, HSBC
Figure 2. Total healthcare expenditure of countries in 2014 (% of GDP)
18.0% 17.1% Total healthcare expenditure of countries in 2014 (% of GDP) 16.0% 14.0%
12.0% 10.4% 10.2% 10.0% 9.4% 9.1% 10.0% 8.3% 7.4% 8.0% 5.5% 6.0% 4.7% 4.0% 2.0% 0.0% United Canada Japan European Australia United Brazil Korea China India States Union Kingdom
Source: The World Bank, HSBC
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Figure 3. Total healthcare expenditure in China (% of GDP)
6.5%
6.0% 6.1% 5.5% 5.6% 5.4% 5.0% 5.3% 5.1% 5.0% 4.9% 4.5% 4.8% 4.8% 4.7% 4.7% 4.6% 4.5% 4.6% 4.0% 4.3%
3.5% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total healthcare expenditure in China (% of GDP)
Source: NHFPC, HSBC
2017: Sell more, sell cheaper and sell better
Similar to 2016, we believe the impact of reforms will continue to be felt by China’s healthcare industry this year in terms of cost controls, upgrading product quality, and the expansion of medical insurance coverage. In this report, we will elaborate on these issues and pinpoint potential beneficiaries. Of the three, cost control is likely to be the biggest problem for pharma companies.
While product quality weighed on industry growth in 2016, the outlook is improving. Last year The release of the new NRDL will likely create volume the applications for the approval of several key drugs were withdrawn to prepare for stricter gains quality assessments by the regulator. However, several applications have now been re- submitted, and we believe companies are becoming more comfortable with the stricter standards. The release of the new NRDL will likely create volume gains for drug producers, offsetting the impact of price cuts. For more details, see China Pharmaceuticals: MHRSS released the new NRDL (23 February 2017).
We believe a healthier industry environment will benefit market leaders with strong R&D capabilities. Higher quality products and the expansion of medical insurance coverage will contribute to the sustainable growth of the whole industry and offset the negative impact of cost control policies in the long run.
Figure 4. Three themes for 2017 China healthcare policies
Products Cost control quality upgrade
Expansion of medical insurance coverage
Source: HSBC
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Figure 5. Key events and drivers
Source: CFDA, MOH, HSBC
The new strategy of MNCs; opportunities for Chinese companies
The priorities of multinational companies (MNCs) are shifting from quantity to profitability, MNCs are shifting their focus to R&D of cutting-edge leading to an accelerated pace of drug transfers to local companies. MNCs are shifting their products focus to R&D of cutting-edge products, while marginalising off-patent drugs that undershoot sales targets. The retreat of MNCs is most visible in several therapeutic areas, including oncology, mental diseases, and anaesthesia. We believe that this trend will continue and even accelerate in 2017-19e, especially for drugs with outdated patents or an unsatisfactory sales performance for two consecutive years.
This creates opportunities for both industry leaders and emerging companies. We prefer companies with the following traits: 1) strong R&D capacity to ensure a steady stream of product launches; 2) a resourceful sales network; 3) a comprehensive drug portfolio or pipeline covering important therapeutic areas; and 4) a strong presence in MNC markets and experience in making drug acquisitions.
Figure 6. Market share of MNCs 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16
Oncology Anesthetics Mental diseases Digestive diseases Antibiotics
Source: PDB, HSBC
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Our top picks
Hengrui (600276 CH) and Sino Biopharm (1177 HK) remain our conviction Buy-rated stocks as we expect sales of several potential blockbuster drugs to boom in 2017-18e. With its experience of making product acquisitions and a comprehensive sales network, we believe CMS (867 HK) is well-placed to take advantage of the retreat of MNCs.
Table 3. Summary of key investment thesis Company Investment thesis Hengrui (600276 CH) We are rolling over our target multiple to 2017e (from 2016e) and raise our target price to RMB60.00 (from RMB52.70) based on a 46x 2017e PE, with a 1.8x PEG (2017e PE/2017-19e CAGR), in line with the historical average of 1.8x. We maintain our Buy rating as we expect Hengrui, which has strong R&D and sales capacities, to benefit strongly in the long run in a market with increasing entry barriers. Sino Biopharm (1177 HK) Our new target price of HKD7.90 is based on a 26x 2017e PE (previously at a 21x 2017e PE). with a 1.5x PEG (2017e PE/2017-19e CAGR), slightly above the historical average of a 1.4x PEG and a 24x PE, and at a 35% premium to its peers’ 20x 2017e PE average, due to product launches and strong R&D and sales capacities. We maintain our Buy rating. CMS (867 HK) We are rolling over our target multiple to 2017e (from 2016e) and raise our target price to RMB15.60 (from RMB14.10) based on a 21x 2017e PE (from a 21x 2016e PE), 24% above its peers’ 17x 2017e PE average. The premium is based on its leading position in acquiring products and sales. We maintain our Buy rating. Sino Pharm (1099 HK) Our unchanged target price of HKD40.00 is based on a 19x 2017e PE (previously at a 21x 2016e PE), slightly lower to its five-year average PE of 22x. We maintain our Hold rating, because we believe the earnings upside from lower interest rates is limited and non-direct sales may be affected by the two- invoice system. CSPC (1093 HK) Our new target price of HKD11.20 (from HKD9.80) is based on a 26x 2017e PE (previously at a 28x 2016e PE), with a 1.3x PEG (2016e PE/2016-18e CAGR; same as previously), slightly above CSPC’s historical average of a 1.2x PEG, and at a 40% premium to its peers’ 20x 2017e PE average, due to its strong growth profile and high percentage of exclusive products. We maintain our Buy rating. Source: HSBC estimates
Table 4. HSBC coverage table ______PE (x) ______CAGR (%) PEG (x) ___ PB (x) ______ROE (%) ___ Wind Code Company Mkt Cap (USDm) Price (lcy) T/O (USDm) 2016a 2017e 2018e 2016-18e EPS 2015a 2016a 2015a 2016a A-share (RMB) 600276.SH Hengrui 16,944 49.80 33.9 44.6 36.5 29.7 22.3 2.0 11.8 9.4 24.3 24.2 600196.SH Fosun Pharma - A 8,867 25.68 32.6 20.5 17.6 15.4 20.1 1.3 3.3 2.6 14.1 14.9 600535.SH Tasly 5,993 38.27 27.7 28.4 23.4 19.7 20.1 1.4 5.5 4.9 24.0 18.2 600998.SH Jointown 4,822 20.20 14.1 38.0 31.3 26.3 22.8 2.1 3.6 3.4 7.1 8.3 600079.SH Humanwell 3,786 20.31 29.5 34.1 26.7 22.9 22.0 1.6 3.3 3.0 9.1 9.3 600521.SH Huahai Pharma 3,200 21.18 18.3 44.4 34.6 23.6 37.0 1.2 6.1 5.7 11.9 12.4 002038.SZ SL Pharm 2,779 27.99 20.8 40.7 23.2 15.7 61.2 0.7 5.4 4.9 17.1 12.4 002262.SZ Nhwa 2,029 22.20 10.3 43.3 33.8 26.8 27.2 1.6 5.9 6.7 18.1 16.2 600557.SH Kanion 1,615 18.08 15.4 27.8 23.7 19.9 14.3 2.2 4.0 3.5 12.6 12.5 Average 34.0 26.6 21.4 26.1 1.5 5.1 4.6 14.8 13.9 H-share (HKD) 1099.HK Sinopharm 12,598 35.35 19.6 20.1 17.2 15.2 14.6 1.4 1.2 1.0 12.9 13.1 2196.HK Fosun Pharma - H 8,867 26.60 5.3 18.9 16.2 14.2 20.1 1.2 3.0 2.4 14.1 14.9 1093.HK CSPC 7,351 9.43 12.8 27.0 22.0 17.4 24.2 1.1 6.4 5.5 19.8 22.4 3320.HK CR Pharma 6,864 8.48 4.3 17.8 15.0 12.7 18.4 1.0 2.4 1.3 13.3 9.7 1177.HK Sino Biopharm 6,243 6.54 13.4 24.6 22.2 19.1 11.8 2.1 6.3 5.3 24.8 23.9 867.HK CMS 4,113 12.84 6.2 21.5 18.3 14.9 20.1 1.1 5.1 4.5 21.4 23.9 2186.HK Luye 2,096 4.90 6.1 17.2 14.1 12.6 17.0 1.0 2.5 2.2 14.3 14.0 6826.HK Haohai 772 37.45 0.3 17.3 15.0 13.1 18.8 1.1 2.0 1.8 15.3 11.0 0963.HK Bloomage 522 11.16 1.1 14.4 11.7 9.7 21.2 0.8 2.9 2.4 24.1 21.3 Average 19.3 16.4 14.0 18.0 1.2 3.3 2.8 17.0 16.5 Source: Wind, Bloomberg, HSBC. Priced as of 3 March 2017.
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Table 5. Key summaries Three main themes Status Major events Introduction Current status and impact Cost control In progress Drug tender Drug tenders are a mandatory process for all pharma To date, provinces accounting for 56% of the Chinese companies that want to sell drugs to public hospitals in pharma market have completed drug tenders or are close China. The tenders take place every 3-4 years and to announcing the results. Two major markets, Beijing around 15 provinces completed drug tenders in 2016. and Jiangsu, are about to announce tender results, according industry experts. We expect drug tenders to have a limited negative impact on market sentiment as the process is complete in most major provinces. In progress Zero mark-up Chinese hospitals used to charge patients a price that We expect the zero mark-up policy to be fully was 15% above cost for their drugs. In mid-May 2015, implemented in all of Class III hospitals, which account the government set out to erase this mark-up to reduce for nearly 50% of patient flow in China. We expect this drug prices in hospitals and ease the burden on medical will lower the industry’s top line by about 3%. insurance funds. In progress Restrictions on Drugs sales used to be the largest part of public hospitals’ Based on our estimates, if the zero mark-up policy is fully drug sales in revenue, at above 60%. To keep medical insurance implemented, drug sales will represent only 34% of total public hospitals spending below budget, public hospitals are required to hospital revenues. The separation of the prescription and keep the proportion of drug sales to revenue below 30%, dispensing of drugs – will also reduce the amount of and lift the income from providing medical services. profits hospitals generate through drug sales. This, combined with an 8% cut in sales due to the outsourcing of the pharmacy business, suggests that the target of keeping drug sales below 30% of hospital revenue is achievable. Likely to be The Sanming A pilot healthcare programme in the city of Sanming in After a successful trial run, the central government may implemented model Fujian province has made headlines. The Sanming model try to introduce the Sanming model in other parts of features: zero drug mark-ups at hospitals, price cuts at the country. drug tenders, and strict control on insurance claims. Implemented Two-invoice The two-invoice system only allows a single level of We expect the impact of the two-invoice policy to system distributors for the sale of pharmaceutical products from gradually materialise in 2017e. It will help drive further the manufacturers to the hospitals. This is expected to consolidation in the fragmented pharmaceutical benefit pharmaceutical companies that have a wide distribution market by eliminating small distributors distribution network. without cross-province networks. Implemented Anti-bribery and Following several scandals, Chinese officials are We believe the new anti-bribery campaign will pave the corruption efforts tightening compliance on drug sales in hospitals. As a way for gradual reforms rather than solve the problem result, domestic and overseas companies are changing immediately. The negative impact of the campaign on their sales strategy. sales revenue of pharmaceutical companies is likely to be temporary. Improving quality In progress Lifting standards The industry was shocked in July 2015 when the CFDA We estimate all previous drug applications will be reviewed of clinical studies suspended the approval process of 1,622 new drug by the end of 2017e and expect industry consolidation to applications, requiring further inspection of clinical trial continue as many smaller companies may be squeezed out data. The CFDA issued a circular in November 2015, of the market due to rising R&D expenses. stating that it would start inspecting clinical data of individual drug registration applications itself. In progress Environmental Environmental pollution is always a major concern in the With a limited negative impact in the near term, rising protection pharmaceutical industry. Hebei issued an order in environmental standards will likely push up the costs for regulations November 2016 requiring all pharma enterprises in pharmaceutical companies in the long term, especially Shijiazhuang city to suspend production; several listed API producers. companies were affected, including CSPC. Implemented BE The CFDA requires consistency evaluations for generic We believe that strict requirements of consistency (bioequivalence) drugs. The aim is to narrow the difference between evaluation will raise the entry barrier for China’s generic testing domestic generic drugs and their branded originals in drug industry. R&D-driven companies will be terms of quality, consistency and efficacy, based on vivo beneficiaries, in our view. bioequivalence tests or in vitro dissolution studies. Expanding medical In progress Merger of urban Through merging Urban Basic Medical Insurance (UBMI) We expect the rural market to be the main pillar of insurance coverage and rural and New Rural Cooperative Medical Insurance (NRCMI), industry growth as recent government policies target medical participants in these two insurance schemes will have increasing the accessibility of healthcare insurance in the insurances identical reimbursement criteria. 17 cities have countryside. announced specific plans so far. Implemented Revision of the The latest National Reimbursement Drug List (NRDL) We believe Hengrui and CSPC are likely to be the National was released in 2009. 1,140 chemical drugs and 960 biggest beneficiaries of the NRDL revision, given the Reimbursement traditional Chinese medicine therapies were on the NRDL potential inclusion of a number of their products. Drug List list, including all drugs on the Essential Drug List. The NRDL is expected to be revised in 2017. Source: HSBC
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Three policy themes for 2017
Cost control policies squeeze profitability; expansion of medical insurance coverage, and patient growth bring volume gains Drug quality upgrades benefit the whole industry in the long run The downsides risks of the reforms are receding
1. Cost control
Price cuts in drug tenders In China, all pharmaceutical companies have to go through a drug tender process before they Tenders are generally associated with price cuts can sell drugs to public hospitals. Tenders are conducted at the provincial level, divided into three categories: low-cost drugs, Essential Drug List (EDL) drugs, and non-EDL drugs. The process can be a double-edged sword for pharmaceutical companies. On the one hand, it is a great opportunity for new products to enter the lucrative hospital market; on the other hand, tenders are generally associated with price cuts, particularly for those drugs facing intense market competition.
The State Council introduced the double-envelope bidding system in 2010, compressing prices of most drugs sharply. Under this system, tenders are divided into two stages: in the first stage, candidates must prove their technical competencies, production capability, quality control system, and distribution network. Only companies that pass the first stage can proceed to the tender, which is purely based on price.
In the fourth round of tenders starting in 2013, the State Council further lowered drug prices by adding lowest national drug prices as a reference point in the double-envelope bidding system. Prices of certain drugs are benchmarked directly against the lowest national prices. Therefore, candidates can only benefit from tenders if their volume gains outweigh the losses of price cuts. Suffering from slim margins, pharmaceutical companies gave up bidding completely in some provinces.
To date, provinces accounting for 64% of China’s pharma market have completed drug tenders The consensus view is that drug prices will decline by or are close to announcing results. The consensus view is that drug prices will decline by around around 15% in this round 15% in this round of tenders, hurting margins and revenue growth across the whole industry. The of tenders results of recent provincial drug tenders suggest that prices of drugs with exclusive molecules or formulations fell less than others. Drugs approved in the US, the EU and Japan markets are also excluded from tight price controls in major provinces, including Guangdong, Zhejiang, Hunan, Shandong, Anhui and Fujian. The table below indicates the scale of price cuts between the last two drug tenders (2010 and 2016) for major products of our covered companies.
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Table 6. Price cut analysis of key products Further potential price cut in this round of drug Current price cut in this tender (if national lowest Company Generic name (EN) Generic name (CN) Brand name (CN) round of drug tender price is adopted)
Hengrui Docetaxel for Injection 注射用多西他赛 艾素 -24.4% -16.1% Oxaliplatin for Injection 注射用奥沙利铂 艾恒 -27.2% -21.7% Apatinib Tablets 阿帕替尼片 艾坦 NA -0.8% Imrecoxib Tablets 艾瑞昔布片 恒扬 NA -7.1% Pegaspargase for Injection 培门冬酶注射液 艾阳 -4.0% -6.1%
CSPC Butylphthalide Soft Capsules 丁苯酞软胶囊 恩必普 -7.2% -6.4% Butylphthalide and Sodium Chloride 丁苯酞氯化钠注射液 恩必普 -0.4% -1.5% Injection Oxiracetam for Injection 注射用奥拉西坦 欧来宁 -19.5% -3.5% Oxiracetam Capsules 奥拉西坦胶囊 欧来宁 -9.4% -6.3% Levoamlodipine Maleate Tablets 马来酸左旋氨氯地平片 玄宁 -18.8% -15.5% Levoamlodipine Maleate Dispersible 马来酸左旋氨氯地平分散片 玄宁 -2.6% 0.0% Tablets Doxorubicin Hydrochloride Liposome 盐酸多柔比星脂质体注射液 多美素 3.9% 0.2% Injection PEGylated Recombinant Human 乙二醇化重组人粒细胞刺激因 津优力 -23.5% -20.1% Granulocyte Colony-Stimulating 子注射液 Factor Injection Imatinib mesylate Tablets 甲磺酸伊马替尼片 诺利宁 NA -17.5%
Luye Paclitaxel liposome for Injection 注射用紫杉醇脂质体 力扑素 -9.9% -6.5% Sodium Glycididazole for Injection 注射用甘氨双唑钠 希美纳 -6.6% -5.5% Traditional Chinese Medicine (TCM) 血脂康胶囊 血脂康 4.2% -1.1% Sodium Aescinate for Injection 注射用七叶皂苷钠 麦通纳 -12.7% -15.8% Acarbose Capsules 阿卡波糖胶囊 贝希 -2.0% -0.4%
CMS Flupentixol and Melitracen Tablets 氟哌噻吨美利曲辛片 黛力新 -7.6% -4.4% Ursodeoxycholic Acid Capsules 熊去氧胆酸胶囊 优思弗 -1.4% -1.9% Lyophilized Recombinant Human 冻干重组人脑利钠肽 新活素 -3.1% -7.8% Brain Natriuretic Peptide Felodipine Sustained Release 非洛地平缓释片 波依定 -7.8% -8.3% Tablets Tanshinone 丹参酮 丹参酮 -6.6% -4.1% Nuodikang 诺迪康 诺迪康 -8.0% -5.3% Mucopolysaccharide Polysulfate 多磺酸粘多糖乳膏 喜辽妥 -3.4% -2.2% Cream
Sino Biopharm Decitabine Injections 注射用地西他滨 晴唯可 NA -15.5% Capecitabine 卡培他滨片 首辅 NA -27.2% Imatinib Mesilate Tablets 甲磺酸伊马替尼胶囊 格尼可 NA -16.2% Dasatinib Tablets 达沙替尼片 依尼舒 NA -8.2% Entecavir Maleate 马来酸恩替卡韦片 天丁 NA -1.2% Entecavir Dispersible Tablets 恩替卡韦分散片 润众 -27.8% -20.5% Magnesium isoglycyrrhizinate 异甘草酸镁注射液 天晴甘美 -6.8% -7.3% Injections
Humanwell Remifentanil for Injection 瑞芬太尼注射液 瑞捷 NA NA Sufentanil for Injection 舒芬太尼注射液 舒芬尼 NA NA
Nhwa Midazolam Tablets 咪达唑仑片 力月西 16.8% -2.0% Midazolam for Injection 咪达唑仑注射液 力月西 -7.7% -8.3% Etomidate Emulsion Injection 依托咪酯乳状注射液 福尔利 -0.8% -2.0% Risperidone Tablets 利培酮片 思利舒 -23.3% -18.5% Risperidone Dispersible Tablets 利培酮分散片 泰维思 -42.6% -30.3%
SL Pharma Coenzyme Complex for Injection 注射用复合辅酶 贝科能 -7.9% -4.3% Arsenic trioxide for Injection 注射用三氧化二砷 纳维雅 -18.2% -16.5% Thymopentin for Injection 注射用胸腺五肽 欧宁 -43.8% -35.3% Xingling Dripping Pill 杏灵滴丸 立迈 -14.6% -25.0%
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Table 6. Price cut analysis of key products Further potential price cut in this round of drug Current price cut in this tender (if national lowest Company Generic name (EN) Generic name (CN) Brand name (CN) round of drug tender price is adopted) Huahai Paroxetine Hydrochloride Tablets 盐酸帕罗西汀片 乐友 -11.0% -10.8% Losartan Potassium Tablets 氯沙坦钾片 倍怡 -31.3% -25.4% Irbesartan and Hydrochlorothiazide 厄贝沙坦氢氯噻嗪片 倍悦 -22.7% -13.9% Tablets Risperidone Tablets 利培酮片 索乐 -57.1% -53.3% Fosinopril Sodium Tablets 福辛普利钠片 雅利 -11.6% -5.9% Sertraline hydrochloride tablets 盐酸舍曲林片 乐元 -20.6% -20.9% Lisinopril Tablets 赖诺普利片 诺朴利 -30.8% -2.7% Irbesartan Tablets 厄贝沙坦片 安来 -35.8% -27.1%
Kanion Guzhi Fuling Capsule 桂枝茯苓胶囊 / -2.4% -0.7% Yaobitong Capsule 腰痹通胶囊 / 0.4% -0.2% Sanjie Zhentong Capsule 散结镇痛胶囊 / -5.4% -13.2% Tian Shu Capsule 天舒胶囊 / -2.1% -2.2% Reduning for Injection 热毒宁注射液 / -6.0% -5.8% Diterpene Ginkgolides Meglumine 银杏二萜内酯葡胺注射液 尤塞金 NA -2.4% Injection
Tasly Compound Danshen Dripping Pill 复方丹参滴丸 / 1.2% 0.0% Yangxue Qingnao Granule 养血清脑颗粒 / -4.7% -4.1% Yiqi Fumai Powder 益气复脉粉针 / -23.3% -15.5% Silibinin Capsules 水飞蓟宾胶囊 水林佳 4.5% 1.5% Temozolomide Capsules 替莫唑胺胶囊 蒂清 -1.8% -3.3% Source: Yaozhi, HSBC. NA – Not Applicable
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In theory, the ongoing fourth round of drug tenders is supposed to be completed by the end of 2016. Although the National Health and Family Planning Commission (NHFPC) urged all provinces to complete drug tenders by June 2016, the process has been behind schedule since 2013. To date, provinces accounting for 64% of China’s pharma market have completed drug tenders or are close to announcing results. Two major markets, Beijing and Jiangsu, are expected to announce results soon. By then, 81% of the drug tenders will be completed.
We expect drug tenders to have a limited impact on market sentiment as the process is completed in most major provinces. Our discussions with several institutional investors confirms our view that the impact of the drug tenders is largely priced in.
Table 7. Drug tender tracker Percentage of Latest tender price Province Province total pharma market Process announcement date 北京 Beijing 9.01% In progress 15 Dec 2014 上海 Shanghai 8.68% Releasing result 18 Oct 2016 江苏 Jiangsu 8.49% In progress 24 Nov 2016 广东 Guangdong 7.57% Monthly/quarterly result 2 Sep 2016 浙江 Zhejiang 7.32% Completed 26 Jan 2016 安徽 Anhui 6.50% Completed 10 Dec 2014 山东 Shandong 5.92% Releasing result 28 Oct 2016 重庆 Chongqing 4.14% Releasing result 28 Nov 2016 河南 Henan 3.66% In progress 25 Jul 2011 河北 Hebei 3.58% In progress 3 Jan 2013 云南 Yunnan 3.58% In progress 30 Dec 2015 四川 Sichuan 3.54% Releasing result 2 Feb 2016 湖北 Hubei 3.29% Releasing result 1 Sep 2016 湖南 Hunan 3.09% Completed 20 May 2016 天津 Tianjin 2.47% Completed 23 Mar 2016 辽宁 Liaoning 2.29% In progress 2 May 2013 福建 Fujian 2.16% Completed 31 Dec 2015 山西 Shanxi 2.01% Releasing result 19 Oct 2016 黑龙江 Heilongjiang 1.86% Releasing result 25 Jul 2016 吉林 Jilin 1.70% Not started 26 May 2014 陕西 Shaanxi 1.60% Releasing result 28 Sep 2016 广西 Guangxi 1.42% Releasing result 8 Nov 2016 江西 Jiangxi 1.41% In progress 1 Nov 2015 海南 Hainan 1.27% Releasing result 1 Jun 2016 贵州 Guizhou 0.90% In progress 31 May 2013 新疆 Xinjiang 0.83% In progress 23 Sep 2014 甘肃 Gansu 0.66% Releasing result 14 Mar 2016 内蒙古 Inner Mongolia 0.53% In progress 30 Jun 2015 西藏 Tibet 0.25% Not started NA 宁夏 Ningxia 0.20% Releasing result 9 Sep 2016 青海 Qinghai 0.07% In progress 24 Mar 2014 Source: HSBC. NA – Not Applicable.
Zero mark-up policy encourages hospitals to renegotiate drug prices To make up for insufficient subsidies, China’s government used to permit public hospitals to charge patients premiums on wholesale drug prices – 15% for western drugs and 20-25% for traditional Chinese medicines. The mark-up helped to fund public hospitals but also inflated drug prices and put a large burden on medical insurance funds. In May 2015, the NHFPC banned hospitals from charging these premiums. It said that the loss of revenue from drug sales would be compensated for by charging higher fees for medical services, an increase in government subsidies, and better budget management by hospitals.
We believe the zero mark-up policy will hurt margins of pharma companies. Although the reform We believe the zero mark-up policy will hurt margins appears to only change hospitals’ income structure on paper, it actually influences the whole value chain, from drug manufacture to distribution. Instead of increasing medical services fees,
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many hospitals negotiated with pharma manufacturers to reduce drug prices. This generally results in discounts of 8-10%.
One option is to adopt an agency sales model, so the discount will be absorbed by drug manufacturers and agencies. The zero mark-up policy also presents an opportunity for pharma distributors as hospitals will be more willing to outsource their pharmacies to third-party distributors. We expect major distributors to react proactively to take over the hospital pharmacy market. Each hospital is likely to reduce the number of distributors to one or two after outsourcing their pharmacy business.
We think the zero-mark up policy will have a limited impact on market sentiment in 2017e. Like the drug tenders, it is largely priced in. By the end of 2017e, we expect the policy to be fully implemented in all Class III hospitals, which account for nearly 50% of all patient flow in China. To date, the policy is already in effect in eight provinces, accounting for 66% of the market. The rest of the market, including major provinces, such as Jiangsu, Guangdong and Zhejiang, will remove the mark-up soon. If all the discount from the zero mark-up policy is transferred to pharma companies and distributors, we expect it to reduce the industry’s top line by about 3%.
Table 8. Zero mark-up policy has been implemented in most provinces Province Percentage of total Status of zero mark-up (Chinese) Province pharma market implementation Details 北京 Beijing 9.01% Full implementation Fully promoted in 2016 上海 Shanghai 8.68% Full implementation Fully promoted in 2015 江苏 Jiangsu 8.49% Partial implementation Most of the region in 2016; full implementation in Nanjing started from 1 January 2017 广东 Guangdong 7.57% Partial implementation Promoted in all county-level hospitals and in leading public hospitals in some cities, such as Shenzhen and Guangzhou 浙江 Zhejiang 7.32% Partial implementation Promoted in all county-level hospitals and some leading hospitals; will cover all hospitals in 2017 安徽 Anhui 6.50% Full implementation Fully promoted in 2015 山东 Shandong 5.92% Partial implementation Promoted in most hospitals 重庆 Chongqing 4.14% Full implementation Fully promoted in 2015 河南 Henan 3.66% Partial implementation Promoted in county-level hospitals 河北 Hebei 3.58% Partial implementation Promoted in all county-level hospitals and some leading hospitals 云南 Yunnan 3.58% Partial implementation Promoted in all county-level hospitals 四川 Sichuan 3.54% Partial implementation Promoted in all county-level hospitals 湖北 Hubei 3.29% Partial implementation Promoted in all county-level hospitals 湖南 Hunan 3.09% Partial implementation Promoted in all county-level hospitals and some leading hospitals 天津 Tianjin 2.47% Full implementation Fully promoted in 2016 辽宁 Liaoning 2.29% Partial implementation Promoted in all county-level hospitals 福建 Fujian 2.16% Full implementation Fully promoted in 2015 山西 Shanxi 2.01% Partial implementation Removed half mark-up in some public hospitals and will fully promote zero mark-up in 2017 黑龙江 Heilongjiang 1.86% Partial implementation Promoted in all county-level hospitals 吉林 Jilin 1.70% Partial implementation Promoted in all county-level hospitals and some leading hospitals 陕西 Shaanxi 1.60% Partial implementation Promoted in all county-level hospitals 广西 Guangxi 1.42% Partial implementation Promoted in all county-level hospitals 江西 Jiangxi 1.41% Partial implementation Promoted in all county-level hospitals 海南 Hainan 1.27% Full implementation Fully promoted in 2016 贵州 Guizhou 0.90% Partial implementation Promoted in some public hospitals 新疆 Xinjiang 0.83% Partial implementation Promoted in some public hospitals 甘肃 Gansu 0.66% Partial implementation Promoted in all county-level hospitals 内蒙古 Inner Mongolia 0.53% Partial implementation Promoted in some public hospitals 西藏 Tibet 0.25% Not implemented Not promoted 宁夏 Ningxia 0.20% Full implementation Fully promoted in 2016 青海 Qinghai 0.07% Partial implementation Promoted in some public hospitals Source: HSBC
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Restrictions on drug sales in public hospitals The zero mark-up policy is only one of the efforts being made to control drug sales in public hospitals. As of 2015, around 22% of all drug sales in China were made in retail pharmacies and 78% in hospitals (Frost & Sullivan). From the perspective of hospitals, sales of pharmaceutical products have contributed 40-60% of their revenue for decades. However, to control medical insurance spending, in May 2015, the State Council urged hospitals to cut the share of drug sales in their revenue mix from 40% to 30% by 2017 (excluding TCM herbs).
Based on our estimates, if the zero mark-up policy is fully implemented, drug sales will represent only 34% of total hospital revenue. The separation of two key functions – the prescription and dispensing of drugs – will also reduce the amount of profits hospitals generate through drug sales. This, combined with an 8% cut in sales due to the outsourcing of the pharmacy business, suggests that the target of keeping drug sales below 30% of hospital revenue is achievable.
Figure 7. Breakdown of Chinese public hospital income
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2010 2011 2012 2013 2014 2015 Drug sales (% of total revenue) Other hospital income (% of total revenue)
Source: NHFPC, HSBC
Figure 8. Breakdown of hospital inpatient Figure 9. Breakdown of hospital outpatient income income
100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Drugs Diagnosis services Others Drugs Diagnosis services Others
Source: NHFPC, HSBC Source: NHFPC, HSBC
Two-invoice system In this new invoice system, introduced by the State Council, only two invoices are allowed in a whole drug transaction. One is issued by drug manufacturers to distributors and the other is issued by distributors to hospitals. This reduction in the number of intermediate transactions suggests that only companies with a strong sales and delivery network will survive. Five provinces (Shaanxi, Jilin, Anhui, Fujian and Guangdong) have already implemented the two- invoice system, while nine provinces are expected to introduce the two-invoice system this year.
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Figure 10. Nine provinces have implemented two-invoice policies; Beijing and Guangxi will do so soon
Heilongjiang
Jilin
Liaonin Xinjian g g Inner Mongolia Beijing Tianjin Hebei Shan Ningxi xi Shandong Qinghai a Gansu Jiangsu Shaanxi Henan Xizang (Tibet) Anhui Shanghai Hubei Sichuan Chongqing Zhejian g Hunan Jiangxi Guizhou Fujian
Full implementation Yunnan Taiwan Guangxi Guangdon Expected to implement in 2017 g Expected to implement by the end of 2018 Hong Kong No related policies have been announced
Hainan
Source: NHFPC, HSBC
Figure 11. Drug procurement procedure under the two-invoice system
Pharmaceutical Bidding and Winning the Bid Products Procurement
Pharmaceutical Delivering Delivering Hospitals and Other Distributor Manufacturers / Suppliers Medical Institutions
Payment Payment
Source: HSBC
We expect the impact of the two-invoice policy to be felt in 2017e as it becomes more widely implemented. China’s pharmaceutical distribution market is fragmented, with more than 13,000 local companies. The industry has been gradually consolidating and, according to the Ministry of Commerce, the market share of the top three distributors has increased from 30.7% in 2011 to 33.5% in 2015. The two-invoice policy will help drive further consolidation by eliminating small distributors that lack cross-province networks. Direct-to-hospital sales by large distributors may benefit as local and secondary companies could be squeezed out of the distribution process.
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Figure 12. Drug delivery market is becoming more concentrated
2015 2011
30.7% 33.5%
Top 3 distributors Others
Source: MOC, HSBC
The Sanming model – a reform blueprint As of June 2014, the government launched a trial healthcare reform programme in Sanming City, Fujian province, which became known as “the Sanming Model”. The reform targets lifting the burden on medical insurance funds and optimising the use of healthcare budgets. The Sanming model features: 1) zero drug mark-up at hospitals; 2) a two-invoice system; 3) price cuts at drug tenders; 4) raising the price of healthcare services; 5) increasing the use of generics, reducing malpractice and over-prescription; and 6) imposing strict inspection of insurance claims.
The reform works well in Sanming. From 2014 to 2016, the city turned a RMB200m medical insurance fund deficit into a surplus of RMB130m. The share of drug sales at hospitals also fell from 47% to 26% in the revenue mix. The government is determined to replicate the Sanming model in other parts of the country.
Anti-bribery and corruption campaigns An anti-bribery campaign, led by the central government, swept through China at the end of last year. Hunan, Jiangsu and Shanghai have banned sales representatives from entering hospitals to contact doctors, and 30 directors and senior management executives of public hospitals were arrested in December 2016. The efforts remind us of the reaction to the GSK bribery scandal in 2013. We think the ongoing anti-bribery campaign will not change the business model of drug sales structurally, but it can be interpreted as a prelude to a series of gradual reforms.
Looking back to 2013, the penalties imposed after the GSK scandal didn’t change the business model for drug sales in China. On the contrary, the gradual saturation of urban markets and increasingly fierce industry competition motivated pharma companies to continue to invest heavily in promotional activities.
In 2014, another four major MNCs were publically criticised by China’s government for misbehaviour with regard to their sales activities and, after a relatively quiet 2015, several local pharmaceutical companies, including Sino Biopharm, Beijing Double-crane, 3sBio and Nhwa, were in the headlines for similar reasons. However, promotional activities remain a big part of the business. From 2013 to 2016, the sales expenditure of listed H- and A-share pharma companies increased by more than 10% y-o-y, consistently higher than revenue growth.
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Figure 13. Growth rate of revenue and Figure 14. Share of sales expenditure sales expenditure (y-o-y) vs revenue
35% 22%
30% 21% 20% 25% 19% 20% 18% 15% 17% 10% 16%
5% 15% 2013 2014 2015 2016* 2013 2014 2015 2016* Revenue Sales expendiure % of sales expenditure
Source: Wind, HSBC. *Cumulative value for three quarters in 2016. Source: Wind, HSBC. *Cumulative value for three quarters in 2016.
The brushes with the regulator was a sign of things to come for the MNCs. Major international pharmaceutical companies also suffered from sharp price cuts in several provincial drug tenders in 2014, while the price privileges of MNCs’ patent drugs were officially abolished in 2015. The first round of negotiations between the NHFPC and MNCs also cut the prices of several blockbuster drugs by more than half in 2016. The retreat from China had begun.
We believe the new anti-bribery campaign is intended to pave the way for gradual reform and will not resolve the issue of medical corruption in one shot. The impact of the campaign on sales revenue of pharma companies is likely to be temporary. Unlike in 2013, hospitals are at the centre of the investigations, indicating that the next policy move may be directed at the hospital system rather than pharma companies. At the local level, hospitals may be more cautious about their relationships with drug producers. We believe this is a positive catalyst for companies with well-organised sales teams as they are more experienced in communicating with hospitals in a professional way.
2. Product quality upgrades
Lifting the standard of clinical studies The pharma industry was jolted in July 2015 when the China Food and Drug Administration More than 1,000 applications have been withdrawn (CDFA) suspended the approval process of 1,622 new drug applications, demanding further inspection of clinical trial data. Since then, more than 1,000 applications have been withdrawn and 34 rejected, resulting in an inevitable decline in new product launches.
The CFDA then issued a circular in November 2015 saying that it would start inspecting clinical data of drug registration applications itself. The crackdown means that even companies with proven R&D capabilities may find some applications non-compliant. Most drug manufacturers preferred to withdraw and then resubmit applications rather than risk the imposition of a three- year prohibition on making any drug applications.
Despite the temporary pain, we believe higher drug quality standards will increase market concentration and support sustainable industry growth in the long run. The pharmaceutical manufacturing industry is fragmented, with more than 5,000 companies in operation. Similar to the drug distribution business, the market share of the top 10 domestic companies has increased from 14% in 2012 to 20% in 2015 (IMS). We expect industry consolidation to continue as many smaller companies are gradually squeezed out due to rising R&D expenses. For new drug approvals, the average cost of each clinical trial is RMB3-5m. If companies wish to reapply, it will take a year or more to redo the clinical trials and extra R&D expenses will be incurred in the process.
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Accelerated new drug approval process We believe the CFDA wants to streamline the drug approval process. A steady flow of new The CFDA wants to streamline the drug approval drugs is essential for the success of pharma companies. However, the approval process in process China has been log-jammed for many years. The CFDA receives thousands of applications a year and a new product can be stuck in the queue for 5-6 years before being reviewed.
Aware of the problem, the CFDA is outsourcing some reviewing processes and introducing priority reviews for selected generic drugs. In addition, the agency’s Centre for Drug Evaluation (CDE) is hiring another 20 drug reviewers (it employs fewer than 200 drug reviewers, compared to the US Food and Drug Administration’s (FDA) 4,000 and the European Medicine Agency’s 3,000). In a recent policy announcement, the CFDA also announced that pharma companies that have passed on-site inspections in the US, the EU or Japan are likely to get fast-track approvals – known as the Green Channel – for their products. We expect the processing time to fall from 80 months to 60-70 months in the next three years.
Once the CFDA is satisfied with the clinical data, it aims to ease the backlog in the drug review process and grant fast-track approval. Since November 2016, the CFDA reviewed 70+ drug applications every month. We estimate that all previous drug applications stuck in the queue will be reviewed by the end of 2017.
Figure 15. 137 products have been granted fast-track designation 0 5 10 15 20 25 1st batch 5 6 3rd batch 10 2 5th batch 1 3 7th batch 9 22 9th batch 6 2 11th batch 17 20 13th batch 13 21 Number of drugs granted fast-track designation
Source: CDE, HSBC
Table 9. Our covered companies have 17 products in the fast-track process Drug name (CH) Drug name (EN) Company Status 布地奈德福莫特罗粉吸入剂 Budesonide and Formoterol Fumarate Powder for Sino Biopharm Applying for clinical trials Inhalation 盐酸右美托咪定鼻喷剂 Dexmedetomidine Hydrochloride for Injection Hengrui Applying for clinical trials 治疗用乙型肝炎腺病毒注射液 Adenovirus Injection for HBV Tasly Applying for clinical trials 注射用醋酸卡泊芬净 Caspofungin Acetate for Injection Hengrui Applying for production 来那度胺胶囊 Lenalidomide Capsules SL Pharm Applying for production 利奈唑胺注射液 Linezolid for Injection Sino Biopharm Applying for production 钆布醇注射液 Gadobutrol for Injection Hengrui Applying for production 磺达肝癸钠注射液 Fondaparinux Sodium for Injection Hengrui Applying for production 帕立骨化醇注射液 Paricalcitol for Injection Hengrui Applying for production 钆塞酸二钠注射液 Gadoxetic Acid Disodium Injection Sino Biopharm Applying for production 醋酸加尼瑞克注射液 Ganirelix for Injection Sino Biopharm Applying for production 盐酸决奈达隆片 Dronedarone Hydrochloride Tablets CSPC Applying for production 注射用紫杉醇(白蛋白结合型) Paclitaxel for Injection (Albumin Bound) Hengrui Applying for production 富马酸替诺福韦二吡呋酯片 Tenofovir Disoproxil Fumarate Tablets Sino Biopharm Applying for production 缬沙坦片 Valsartan Tablets Huahai Applying for production 注射用紫杉醇(白蛋白结合型) Paclitaxel for Injection (Albumin Bound) CSPC Applying for production 依非韦伦 Efavirenz Huahai Applying for production Source: CDE, HSBC
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Figure 15. CFDA drug approvals are accelerating
80 70 60 50 40 30 20 10 0 2015/1 2015/3 2015/5 2015/7 2015/9 2015/11 2016/1 2016/3 2016/5 2016/7 2016/9 2016/11 Number of drugs approved by CFDA
Source: CDE, HSBC
Bioequivalence tests The CFDA has also launched consistency evaluations for generic drugs. The test aims to narrow the difference between domestic generic drugs and their branded innovators in terms of quality, consistency and efficacy, based on in vivo bioequivalence tests (BE tests) or in vitro dissolution studies. Generic drug manufacturers are required to pick the original drug or a globally recognised congeneric drug ratified by the CFDA to conduct the evaluation. For generic drugs in oral solid dosage form on the 2012 Essential Drug List (EDL) approved before October 2007, the consistency evaluation must be completed by 2018 or else the approval will be written off. For the rest of the generic drugs, the evaluation work must be completed three years after the first product of its kind was evaluated or the approval will be rejected.
We believe that strict requirements for consistency evaluation will raise the entry barriers for China’s generic drug industry. R&D-driven companies will be beneficiaries because: 1) as smaller companies are eliminated from the market, competition will ease and leading drug manufacturers will face less price pressure; 2) companies with product approvals in the US or the EU will directly get a pass on consistency evaluation for those products; 3) products that have passed consistency evaluations will likely to be granted favourable insurance policies and enjoy preferable treatment in clinical practices; and 4) original drugs and generic drugs qualified for BE tests receive equal scores in provincial drug tenders.
Environmental protection regulations Over 2013 and 2014, the Ministry of Environmental Protection (MEP) launched a series of nationwide campaigns to investigate pollution issues related to pharmaceutical companies. The enactment of an environmental protection law in 2015 also significantly lifted drug producers’ costs. Prior to that, drug producers would rather pay one-off fines as the economic benefit of pollution far outweighed the cost of fines imposed by local environmental protection bureaus. According to the new law, companies will be charged on a daily basis for pollution violations, with no ceiling. The people involved may also face criminal sanctions. In addition, the Green Tax launched in December 2016 is designed to improve policy implementation at the local level.
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Figure 16. Production of drugs
Chemical Chemical Physical Raw material Intermediates APIs Drugs reactions reactions reactions
Source: HSBC
Rising environmental standards will push up costs for pharmaceutical companies in the long term, especially for active pharmaceutical ingredient (API) producers (see chart above). For example, a number of API manufacturers appeared on a black list issued by the Ministry of Environmental Protection in 2013.
The tougher environmental protection policies have forced enterprises to invest heavily in pollution processing facilities. North China Pharmaceutical (600812 CH, Not Rated), a leading API producer with operating profit of RMB80m in 2015, invested RMB500m in 2009-16 to upgrade its waste processing plants. High waste processing costs squeeze the margins of API producers, pushing up API prices and, in the long term, will likely increase industry concentration.
Figure 17. Price of Vitamin A (RMB/kg) Figure 18. Price of Vitamin C powder (RMB/kg)
350 120 A price rebound 300 100 since Jan 2016 250 80 200 A price rebound 60 150 since Nov 2016 40 100 50 20 0 0 2009/01 2011/01 2013/01 2015/01 2017/01 2009/01 2011/01 2013/01 2015/01 2017/01 Price of Vitamin A (RMB/Kg) Price of Vitamin C Powder (RMB/Kg)
Source: Wind, HSBC Source: Wind, HSBC
Figure 19. Price of Vitamin E (RMB/kg) Figure 20. Price of 6-APA (RMB/kg)
250 250
200 200 A price rebound 150 150 since Mar 2016 A price rebound 100 100 since Oct 2016 50 50
0 0 2009/01 2011/01 2013/01 2015/01 2017/01 2013/04 2014/02 2014/12 2015/10 2016/08 Price of Vitamin E (RMB/Kg) Price of 6-APA (RMB/Kg)
Source: Wind, HSBC Source: Wind, HSBC
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3. Expansion of medical insurance coverage
Merging urban and rural medical insurances Since the Universal Medical Insurance Reform was introduced in 2007, over 80% of the As of 2015, UBMI covered 79% of the urban population population is now covered by the two major government-sponsored medical insurance schemes – Urban Basic Medical Insurance (UBMI) and New Rural Cooperative Medical Insurance (NRCMI). As of 2015, UBMI covered 86% of the urban population and NRCMI covered more than 95% of rural residents.
These two schemes account for c30% of China’s total healthcare spending, or nearly half of an individual’s healthcare expenses, the rest of which is paid by out-of-pocket money and commercial insurance. As a result, growth of China’s pharma industry has been slowing down from over 20% y-o-y in 2012 to 8.7% in 1H15, with a slight rebound to 10.7% in December 2015 (National Bureau of Statistics).
In 2015, the government announced plans to merge the two schemes and 17 cities have already started the process. The merger will boost drug consumption in rural areas as now all participants in the two insurance schemes will share identical reimbursement drug lists and reimbursement ratios. We expect the rural market to be the main pillar of growth as the government wants to increase access to healthcare insurance in the countryside.
Third-tier hospitals patient growth have increased significantly since March 2015, when the merger of the two schemes was announced. We expect this to benefit leading providers of generic drugs, such as Hengrui and Sino Biopharm.
Figure 21. Urban Basic Medical Insurance Figure 22. National medical insurance (UBMI) has a high coverage rate (%) contributes half of individual healthcare spending
100% Out of pocket 90% 80% UBMI 70% 25% 34% 60% NRCMI 50% 40% 10% Commercial 30% insurance 2% 8% 20% Fixed asset 21% 10% investment 0% Other discretionary 2006200720082009201020112012201320142015 spending UBMI coverage of urban population
Source: NHFPC, HSBC Source: HSBC
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Figure 23. Outpatient growth in different levels of hospitals Outpatient
50%
40%
30%
20%
10%
0%
-10%
2014-04 2014-07 2011-01 2011-04 2011-07 2011-10 2012-01 2012-04 2012-07 2012-10 2013-01 2013-04 2013-07 2013-10 2014-01 2014-10 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 2016-07 2016-10 -20%
Total growth Top tier hospital grwoth Seound tier hospital growth Third tier hospital growth County hospital growth
Source: MOH, HSBC
Figure 24. Outpatient growth in different levels of hospitals Inpatient
50%
40%
30%
20%
10%
0%
-10%
2014-10 2011-01 2011-04 2011-07 2011-10 2012-01 2012-04 2012-07 2012-10 2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 2016-07 2016-10 -20%
Total growth Top tier hospital grwoth Seound tier hospital growth Third tier hospital growth County hospital growth
Source: MOH, HSBC
Revision of the National Reimbursement Drug List The National Reimbursement Drug List (NRDL) contains drugs that can be fully or partially Once on the list, the sales volume of drugs rises quickly funded by the government. Once on the list, the sales volume of drugs rises quickly. NRDL drugs are divided into Class A and Class B. Costs of Class A drugs are fully reimbursed across the country. For Class B drugs, patients can claim 50-70%, with the amount varying between provinces based on their medical needs and financial strength.
Eight years after the last NRDL was released, the updated version was announced on 23 February 2017. It comprises 2,535 drugs, up 15% from the 2009 list. The number of chemical drugs increased from 1,164 to 2,535 (11%), and the number of traditional Chinese medicine (TCM) drugs rose from 987 to 1,238 (25%).
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Stock prices surged after the list was released, which suggests that market participants are well aware of the benefits this brings. Now that policy benefits are largely priced in, we suggest investors shift their focus to the next key catalyst – the product pipelines of companies with strong R&D abilities. The accelerated CFDA approval process indicates that an array of potential blockbuster drugs should hit the market in 2017-18e, which will benefit the performance of selected pharma companies.
In addition to the NRDL list, the Ministry of Human Resources and Social Security (MOHRSS) also plans to step up negotiations with specific drug producers to the lower prices of certain patent drugs. The first round of negotiations took place in October 2015, covering Tenofovir, Icotinib and Gefitinib – three patent drugs from MNCs. After the negotiations, the prices of these drugs generally declined by more than 50%. In exchange for the price cuts, the NHFPC promised pharma companies NRDL inclusion, a process that is managed by the MOHRSS.
The issue here is that, while the NHFPC has made this commitment to include these drugs on the NRDL, it is the MOHRSS that is responsible for making the actual reimbursements to the public. Given that two different regulators are involved, the process of negotiating drug prices and making related reimbursements may be complex.
At this point in time, the MOHRSS is taking full control of drug price negotiations. We expect the MOHRSS to start another round of negotiations following the recent release of the updated NRDL list. The possible inclusion of Apatinib (a treatment for gastric disorders) from Hengrui and Lipusu (a treatment of ovarian cancer) from Luye could result in large volume gains as the lower prices should stimulate drug consumption.
Given recent developments, the method of updating the NRDL list appears to be changing. Rather than revising the list every 5-6 years, the NRDL may be subject to more gradual, flexible adjustments. Through analysis of the current list, we conclude that drugs meeting the following criteria have the potential to be included on the NRDL in the future:
1. Drugs with high clinical significance – those that have a genuine, noticeable effect on a patient’s daily life.
2. Drugs that have been covered by multiple provincial reimbursement drug lists (RDLs).
3. Drugs for serious diseases, children’s medicine, and emergency treatment medicine.
We believe Hengrui, CSPC and Sino Biopharm are likely to be the biggest beneficiaries from the NRDL revision, given their rich product pipelines and strong R&D capacity.
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Table 10. NRDL new inclusion summary – products of covered companies Company Drug name (CN) Drug name (EN) Reimbursement category SH Pharm 复方卡托普利 Compound Captopril Tablets B SH Pharm 多糖铁复合物 Polysaccharide-iron Complex B SH Pharm 坎地沙坦酯 Candesartan Cilexetil B SH Pharm 炔雌醇环丙孕酮 Propargyl Estradiol B SH Pharm 瓜蒌皮注射液 Gualoupi Injection B Sino Biopharm 帕洛诺司琼 Palonosetron B Sino Biopharm 奥美沙坦酯 Olmesartan medoxomil B Sino Biopharm 替加环素 Tigecycline B Sino Biopharm 厄贝沙坦氢氯噻嗪 Irbesartan and hydrochlorothiazide B Sino Biopharm 福多司坦 Fudosteine B Sino Biopharm 伊马替尼 Imatinib B Sino Biopharm 天晴甘美 Tianqingganmei B (From 限抢救、工 to 或无法口服甘草酸口服 制剂的患者) Humanwell 纳布啡 Nalbuphine B Humanwell 盐酸二氢吗啡酮 Dihydromorphinone hydrochloride B Humanwell 复方高滋斑片 Compund Gaoziban Tablets B Humanwell 护肝布祖热颗粒 Hugan buzure Granules B Humanwell 玛木然止泻胶囊 Mamuran antidiarrheal Capsules B Humanwell 石榴补血糖浆 Pomegranate Buxue Syrup B Huahai 厄贝沙坦氢氯噻嗪 Irbesartan and hydrochlorothiazide B CR Pharma 达沙替尼 Dasatinib B SL Pharm 鲑降钙素 Salmon calcitonin B Sinopharm 肠内营养剂 Enteral Nutrition B Sinopharm 依那普利氢氯噻嗪 Enalapril and hydrochlorothiazide B Sinopharm 复方卡托普利 Compound Captopril Tablets B Sinopharm 头孢呋辛酯 Cefuroxime axetil B Sinopharm 溴米那普鲁卡因 Bromisoval and Procaine Injection B Fosun 非布司他 Febuxostat B Fosun 培美曲塞 Pemetrexed B Fosun 格列美脲 Glimepiride From B to A Fosun 喹硫平 Quetiapine From B to A Fosun 环丝氨酸 Cycloserine B Fosun 依诺肝素钠 Enoxaparin Sodium B Fosun 匹伐他汀 Pitavastatin B Fosun 喉咽清颗粒 Houyanqing Granules B Fosun 喉咽清口服液 Houyanqing Oral Liquid B Fosun 复方芦荟胶囊 Compound Aloe Capsules B Tasly 赖诺普利氢氯噻嗪 Lisinopril and hydrochlorothiazide B Tasly 消渴清颗粒 Xiaokeqing Granules B Kanion 九味熄风颗粒 Jiuwei Xifeng Granules B Kanion 七味通痹口服液 Qiwei Tongbi Oral Liquid B Kanion 川贝枇杷糖浆 Chuanbei pipa Syrup B Kanion 杏贝止咳颗粒 Xinbei Zhike Granules B Kanion 大株红景天胶囊 Large rhodiola Capsules B Kanion 龙血通络胶囊 Long Xue Tong Luo Capsules B Kanion 小儿咳喘灵口服液 Xiaoer Kechuanling Oral Liquid B Kanion 桂枝茯苓片 Guizhifulin Tablets From B to A Kanion 桂枝茯苓胶囊 Guizhifulin Capsules From B to A Kanion 腰痹通胶囊 Yaobitong Capsules From B to A Hengrui 艾瑞昔布 Imrecoxib B Hengrui 氮䓬斯汀 Azelastine B Hengrui 磺达肝癸钠 Fondaparinux sodium B Hengrui 帕立骨化醇 Paricalcitol B Hengrui 帕洛诺司琼 Palonosetron B Hengrui 非布司他 Febuxostat B Hengrui 达托霉素 Daptomycin B Hengrui 奥美沙坦酯 Olmesartan medoxomil B Hengrui 右美托咪定 Dexmedetomidine B Hengrui 盐酸氮卓斯汀 Azelastine B Nhwa 右美托咪定 Dexmedetomidine B Nhwa 利鲁唑 Riluzole B Nhwa 齐拉西酮 Ziprasidone B Nhwa 阿立哌唑 Aripiprazole From B to A CSPC 丁苯酞氯化钠 Butylphthalide and Sodium Chloride Injection B CSPC 聚乙二醇重组人粒细胞刺激因子 PEGylated Recombinant Human Granulocyte Colony-Stimulating Factor Injection B CSPC 伊马替尼 Imatinib B Luye 消炎利胆软胶囊 Xiaoyan Lidan Soft Capsules B Source: NRDL 2017, HSBC
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Table 11. Summary of key products Reimbursement Brand name Actual result Generic name Company TA PRDL Justification category Yisaipu In Recombinant Human TNF Receptor-IgG 3sBio Rheumatoid arthritis 1 Important generic drug with B Fusion Protein for Injection urgent high clinical significance NBP injection In Butylphthalide and Sodium Chloride CSPC Stroke 7 Patent drug B Injection Duomeisu Doxorubicin Hydrochloride Liposome CSPC Oncology 2 Patent drug Injection Jinyouli In PEGylated Recombinant Human CSPC Oncology 3 Patent drug B Granulocyte Colony-Stimulating Factor Injection Nuolining In Imatinib mesylate Tablets CSPC, Sino Oncology 4 Important generic drug with B Biopharm urgent high clinical significance Yiluoze In Pemetrexed disodium for Injection Fosun Malignant pleural 1 Important generic drug with B mesothelioma urgent high clinical significance / Febuxostat Tablets Fosun Hyperuricemia 0 Important generic drug with urgent high clinical significance Aitan Apatinib Hengrui Oncology 1 Patent drug Hengyang In Imrecoxib Tablets Hengrui Immune disease 1 Patent drug B Aiyang Pegaspargase Injection Hengrui Oncology 1 Important generic drug with urgent high clinical significance / In Dexmedetomidine Hengrui, Nhwa Anaesthetics 3 Important generic drug with B urgent high clinical significance / In Nalbuphine Humanwell Narcotic analgesics 0 Important generic drug with B urgent high clinical significance Yousaijin Yousaijin Injection Kanion Stroke 3 Patent drug Yilian In Ilaprazole Enteric-coated Tablets Livzon Duodenal ulcer 12 Patent drug B Lipusu Paclitaxel liposome for Injection Luye Oncology 26 15+ PRDL coverage Yinishu In Dasatinib Tablets Sino Biopharm Oncology 0 Important generic drug with B urgent high clinical significance Saiweijian Raltitrexed Injections Sino Biopharm Oncology 6 Important generic drug with urgent high clinical significance / Yiqi Fumai Powder Tasly Coronary heart disease 14 Patent drug / Recombinant Human Prourokinase Tasly Myocardial infarction 0 Patent drug / In Xiaokeqing Granules Tasly Diabetes 18 15+ PRDL coverage B Ruiyang In Febuxostat Hengrui Gout 0 Important generic drug with B urgent high clinical significance / In Daptomycin for Injection Nhwa Infectious diseases 0 Important generic drug with B urgent high clinical significance Genike In Imatinib Sino Biopharm Oncology 4 Important generic drug with B urgent high clinical significance Qingweike In Decitabine Sino Biopharm Oncology 2 Important generic drug with B urgent high clinical significance Ruining In Hydromorphone Humanwell Analgesic 0 Important generic drug with B urgent high clinical significance Beiyue In Irbesartan and Hydrochlorothiazide Huahai Hypertension 6 Important generic drug with B urgent high clinical significance / In Large rhodiola Capsules Kanion Coronary heart disease 15 15+ PRDL coverage B / In Long Xue Tong Luo Capsules Kanion Stroke 1 Patent drug B / In Jiu Wei Xi Feng Granules Kanion ADHD 0 Patent drug B Source: HSBC
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MNCs pay less attention to China’s off-patent drug market
We think the transfer of MNCs’ off-patent products will accelerate in 2017-19e Industry leaders and emerging companies with strong sales teams can benefit We prefer Hengrui, Sino Biopharm and CMS, all rated Buy
Giants from the West are sailing away from the off-patent business in China
China is still one of the most important and fastest-growing pharma markets in the world. However, policy headwinds, saturated urban markets, and rising competition have been weighing on the performance of global pharmaceutical companies’ off-patent business in China. Tightening compliance restrictions have impeded the expansion of MNCs’ sales force teams, while government-led price cuts have lowered margins significantly. In several provincial tenders, MNCs did not even bid for off-patent products as prices were too low. With improving R&D and strong sales teams in less developed areas, local pharmaceutical companies have emerged as strong competitors. The numbers tell the story – the revenue growth of seven major MNCs has declined from around 20% y-o-y in 2012 to less than 10% in 2016 (Figure 25).
Despite a slower growth rate, China is still a more attractive market than other regions in the world. It also has cost advantage in terms of both clinical trials and scientists. The core competitiveness of MNCs – strong R&D capacity, rich product pipelines, and sales teams with more solid academic knowledge – remain distinct advantages. We expect MNCs to retreat from selective areas and devote more resources to the development of innovative drugs.
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Figure 25. Revenue growth rate of top MNCs (y-o-y
30% 25% 20% 15% 10% 5% 0% -5% 2012 2013 2014 2015 9M16 -10% -15% -20%
GSK Novartis AZ Roche Sanofi BMS Novo Nordisk
Source: Company data, HSBC
Not surprisingly, off-patent drugs, a once lucrative business segment in China, are losing their Off-patent drugs in China are no longer so attractive to attraction for MNCs. We think MNCs will streamline their China business by cutting headcount MNCs and selling loss-making product lines. As can be seen in the table on the next page, several companies – including AstraZeneca, GlaxoSmithKline, UCB and Novartis – are transferring products to Chinese companies. The scale of layoffs is also escalating, involving junior staff, as well as senior management executives. We believe the process will not be reversed and expect to see more products stripped from the product portfolios of MNCs.
Table 12. Retreat of MNCs Time Entity Event Apr-14 Novartis Novartis sold the non-influenza vaccine business to GSK, while acquiring GSK’s oncology business unit Apr-14 Novartis Novartis sold the animal health business to Lilly for USD5.4bn Apr-14 GlaxoSmithKline (GSK) GSK sold the oncology business line to Novartis May-14 Merck Sharp & Dohme (MSD) Merck sold the ophthalmology business to Santen May-14 Merck Sharp & Dohme (MSD) Merck sold the consumer care unit to Bayer Jul-14 Johnson & Johnson Johnson & Johnson sold the Ortho-Clinical Diagnostics business to Carlyle Dec-14 Bristol-Myers Squibb (BMS) Bristol sold the diabetes business to AstraZeneca Dec-14 AstraZeneca (AZ) AZ stopped expanding investment in China’s generic drug market, turning to hospitals in small cities and counties Dec-14 Novartis CMS was authorised to produce and sell Lamisil and Parlodel in Greater China Feb-15 Merck Sharp & Dohme (MSD) MSD exited the JV with Simcere and withdrew four drugs (Zocor, Cozaar, Hyzaar and Renitec) Mar-15 GlaxoSmithKline (GSK) GSK laid off 100 employees in China, including regional director and manager Apr-15 Pfizer Pfizer stopped the sales of Prevenar 7 as its import licence expired; 200 employees were transferred to other business units Nov-15 Novo Nordisk Novo Nordisk cut 130 headcount in China Jan-16 Novartis Novartis stopped promoting Miacalcic and focused on marketing Aclasta Jan-16 Bayer Outsourced the business operation of five drugs (Baijiahei, Redoxon, Saridon, Canesten, and Meike) Feb-16 Bristol-Myers Squibb (BMS) Dissolved the R&D team for HIV drugs Feb-16 AstraZeneca (AZ) AstraZeneca granted CMS with long-term sales permission of Plendil May-16 Novartis Novartis granted assets and licences of the Miacalcic to NT Pharma Jun-16 AstraZeneca (AZ) AstraZeneca sold the anaesthesia business, including Diprivan, Enna and five other local anaesthetics to AGI, a subsidiary company under Aspen Pharma Jul-16 GlaxoSmithKline (GSK) GSK sold holdings in Meirui Pharma, Meirui factory and the related local business line of three urinary products Aug-16 Bristol-Myers Squibb (BMS) BMS closed the CCV business department and dissolved the marketing team of the oncology department Aug-16 AstraZeneca (AZ) Small antibiotics branch (excluding North America) was acquired by Pfizer Sep-16 Novartis Novartis closed the cell and gene therapy department, laying off 120 employees with the remaining 280 staff transferred to the oncology department Sep-16 GlaxoSmithKline The anaesthesia and thrombus business of GSK was acquired by Aspen Pharma Company Oct-16 AstraZeneca (AZ) Four diabetes products, including Bydureon, are acquired by 3Sbio Oct-16 AstraZeneca (AZ) Nasal spray business (excluding North America) acquired by Johnson & Johnson Oct-16 Novartis Novartis closed the biologics department and laid off 18 employees Nov-16 Lilly China Lilly China sold the promotion and distribution rights of Cefaclor and Vancomycin to
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Table 12. Retreat of MNCs Time Entity Event Edding Pharm; the antibiotic team was dissolved Dec-16 Roche Lay-off in Pegasys’ team Dec-16 Bristol-Myers Squibb (BMS) BMS dissolved the OTC marketing team, laying off 150 employees Dec-16 Johnson & Johnson Johnson & Johnson laid off 32 regional representatives and 4 regional managers Source: HSBC
After talking with several MNCs, we believe profitability instead of business scale is the top concern in China. We expect MNCs to continue to shift their R&D functions to China in view of the relative cost advantage of human resources in China. This means their competitiveness in new drugs will remain a priority. As for generic drugs and original drugs, the removal of favourable policies and more fierce market competition may lead some MNCs to leave the market.
The drug tenders provide another clue. In the latest round of national drug tenders, 23 out of 31 provinces granted equal treatment to original drugs and generic drugs qualified for BE tests. Several provinces, including Shandong, Henan and Shanxi, also treat original drugs and first-to- market (FTM) generic drugs equally.
Table 13. Tender policy Generic drug and original Details of Province Year drug are in the same group group classification Hunan 2013 No Original drug in Tier 2 Anhui 2014 No Original drug in Tier 1 Zhejiang 2014 No Original drug in Tier 1 Beijing 2015 Yes In the same group Fujian 2015 Yes Original drug and First Generic Drug get the same score in technology bidding Guangxi 2015 Yes Original drug and Generic Drug passing BE test in Tier 1, First Generic Drug in Tier 2 Guizhou 2015 Yes Original drug and Generic Drug passing BE test in Tier 1, First Generic Drug in Tier 2 Heilongjiang 2015 Yes Original drug and Generic Drug passing BE test in Tier 1, First Generic Drug in Tier 2 Inner Mongolia 2015 Yes Original drug and Generic Drug passing BE test in Group 1, First Generic Drug in Group 2 Jiangsu 2015 Yes Original drug, Generic Drug passing BE test and First Generic Drug in Tier 2 Jiangxi 2015 Yes Original drug and Generic Drug passing BE test get 50 points in technology bidding Jilin 2015 Yes Original drug and Generic drug passing BE test in Tier 1 Liaoning 2015 Yes Original drug and Generic Drug passing BE test in Tier 1 Ningxia 2015 Yes Original drug and Generic Drug passing BE test in Tier 2 Shandong 2015 Yes Original drug, Generic Drug passing BE test and First Generic Drug in Tier 1 Shanghai 2015 Yes No group classification Shanxi 2015 Yes Original drug and Generic Drug passing BE test in Tier 1, First Generic Drug in Tier 2 Sichuan 2015 No In different groups Tianjin 2015 Yes Original drug and Generic Drug passing BE test in Tier 1 Xinjiang 2015 Yes Original drug and Generic Drug passing BE test in Group 1 Yunnan 2015 No Original drug in Tier 1, Generic Drug in Tier 2 Chongqing 2016 Yes No group classification Guangdong 2016 Yes Original drug and Generic Drug in Tier 3 Hainan 2016 No Original drug get 40 points in quality assessment of technology bidding Hebei 2016 Yes In the same group Henan 2016 Yes Original drug, Generic Drug passing BE test and First Generic Drug in Group B Hubei 2016 No Original drug in Tier 1, Generic Drug in Tier 2 Shaanxi 2016 Yes Original drug and Generic drug passing BE test in Tier 1, First Generic Drug in Tier 2 Tibet 2016 No Original drug get 30 points and Generic Drug get 25 points in quality assessment of technology bidding Source: MOH, HSBC
Products that MNCs are abandoning share two features. First, revenue growth has been in negative territory for two consecutive years. Second, even with a relatively strong market share, the patents of these products have expired several years ago.
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With these criteria in mind, we have examined the product mix of top MNCs and highlight several business lines that could be potential sell-off targets. From the perspective of diagnostic fields, anti-infection, endocrine systems and cardiovascular drugs are on top of the list. MNCs are more likely to sell their generic drug products to local companies as prices and margins tend to be lower.
Table 14. Underperforming sectors of MNCs Company Treatment area BMS Cardiovascular (CCV), metabolism, musculoskeletal, oncology AZ CCV, musculoskeletal MSD Digestive system GSK Anti-infection, endocrine system, respiratory system, CCV Johnson & Johnson Dermatology, respiratory system Lilly Anti-infection, mental disease Novartis Anti-infection, endocrine system Pfizer Anti-infection, endocrine system Roche Endocrine system Sanofi Digestive system Source: HSBC
As shown in the table above, CCV, anti-infection and endocrine systems are three worst performing categories. Drugs in these treatment areas are, as such, most likely to be sold to local companies. Buyers with strong sales resources and mature channels can generate the greatest synergy through acquisition. In our view, CMS (867 HK, Buy) fits the bill.
Opportunities for Chinese companies
From 2012 to 2016, the market share of international companies in oncology, anti-infection, digestive system, anaesthetics and mental disorder categories had decreased by 5-15% (Figure 26). This will likely reshape China’s pharmaceutical industry in the long run. We believe companies with established sales networks and emerging companies can both be beneficiaries. The former can take over the markets of MNCs and the latter can enrich the product mix. In addition, we believe industry leaders with competitive products and resourceful sales networks will take the market share left by MNCs.
Figure 26. Market share of MNCs 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16
Oncology Anesthetics Mental diseases Digestive diseases Antibiotics
Source: PDB, HSBC
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As their interest in China declined, international pharmaceutical companies cut headcount and even business lines last year. GSK exited its JV, BMS closed its OTC marketing operation, Johnson & Johnson cut the headcount of senior managers, and AstraZeneca sold its products to Chinese companies.
This implies that the market share of MNCs will continue to decline in the next 3-5 years, creating a window of opportunity for Chinese competitors. Those react the fastest, especially in terms of filling the gap at hospitals, will be the winners, in our view. We believe Chinese companies with strong sales force teams, such as Hengrui and Sino Biopharm, are best positioned.
Table 15. Sales resources of covered companies Time Number of sales staff Percentage of total employees Tasly 5,770 53% Hengrui 5,491 54% Sino Biopharmaceutical More than 7,8000 Around 52% Shanghai Pharma Around 3,000 Around 10% Fosun 2,956 17% Jiangsu Kanion 2,516 58% CR Pharma Around 2,000 Around 5% Sinopharm Group Around 1,700 17% Humanwell Around 1,500 Around 12% Luye 1,300 41% Nwha 1,220 36% CSPC More than 1,000 5% CMS 2,500 80% Zhejiang Huahai 191 4% Beijing SL 40 6% Source: Company data
The retreat of MNCs also creates an opportunity for smaller, emerging companies to build a more comprehensive product mix and expand their sales teams. Companies with a limited product pipeline but strong sales teams have a chance to expand their market share. In addition to non-core products, MNCs are also releasing their sales people who are generally more educated than their peers in domestic companies, offering Chinese companies a chance to improve their sales teams. We believe CMS could leverage this opportunity in view of its rich drug acquisition experience and well-educated sales team.
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A greying society
Ageing baby boomers are set to boost inpatient numbers Chronic diseases and cancers are key markets to watch Individual healthcare expenses also have great potential
Rising inpatient numbers
We are optimistic about the long-term prospects of China’s healthcare industry as its fundamental driver, growth in inpatient numbers, will remain robust. This is the result of a rapidly ageing population and the increase in life expectancy across the country. As illustrated below, industry revenue is highly correlated with inpatient growth, with inpatient flows contributing around 80% of hospital revenues.
Figure 27. Inpatient number and industry y-o-y growth
Source: Wind, NHFPC, HSBC
We expect inpatient numbers to surge soon as the first batch of baby boomers, born in 1950s, move into their sixties. According to the National Health and Family Planning Commission (NHFPC), 65% of the aged population suffer from at least one chronic disease, up from 50% a decade earlier. Older people are the major source of inpatient growth. The growth rate of the
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ageing population (people older than 65) has already increased from 3.5% to 4.5% in 2013-14; 7% is the benchmark growth rate of an ageing society. More baby boomers will soon accelerate the ageing of the population in China, pushing the “grey” growth rate to an estimated 5% in 2019.
According to the NHFPC, the share of China’s population aged 65 years and above increased from 9.1% (122.9m people) to 10.5% (143.9m) in 2011-15. This group will likely further expand to 186.6m, or 13.2% of the population, by the end of 2020. In addition to those born in the 1950s, two subsequent baby booms in the 1960s and 1980s will reinforce the changes to the country’s demographic structure.
Patient numbers are bound to keep rising and the strong momentum of 2H16 should be Patient numbers are bound to keep rising maintained in the next five years. For 10M16, inpatient number roses by 8.1% y-o-y vs 3.4% y-o-y in 2015 (according to the NHFPC). This is consistent with our estimate for a rebound in patient numbers, and our recent discussions with more than 30 hospitals across the country confirmed the upward trend.
In terms of specific diagnostic fields, the most common areas include hypertension, heart disease, cancer, diabetes, Alzheimer’s disease and Parkinson’s disease. Not surprisingly, pharma companies have put significant resources into developing therapies in the areas of cardio-cerebral vascular (CCV), the central nervous system (CNS), and oncology.
Cancer is another important market. The World Health Organisation (WHO) estimated that around 2.2m people across China die from cancer each year. According to the WHO, as of February 2015, lung cancer is the most common cancer among Chinese male patients; for women, it is breast cancer.
We believe that the increase in the number of patients is not priced in yet. During our recent The increase in the number of patients is not priced in yet marketing trip to the US and the UK, we talked to over 30 global investors and found that most are well aware of the price cuts in drug tenders and the ongoing cost controls in hospitals. However, the uptick in patient growth – the number of inpatients rose 9.3% y-o-y in 4M16 vs 3.4% y-o-y in 2015 – has gone almost unnoticed. We reiterate that patient growth is a key driver for the healthcare sector and demographic changes are supporting this trend. It is commonly accepted that China’s population is ageing, but it is less known that this ageing process is accelerating.
Figure 27. We expect a jump in the growth rate of the aged population over 2014-19e
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e 2017e 2018e 2019e
Source: NBS, HSBC estimates
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Figure 28. Chronic disease incidence rate Figure 29. Chronic disease incidence rate among age groups (2008) among 65+
70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 0% 10% 35-44 45-54 55-64 65+ 0% Age group 1993 1998 2003 2008
Source: NHFPC, HSBC Source: NHFPC, HSBC
Figure 30. UBMI fund outflow growth is Figure 31. Growth rate of aged population correlated with inpatient growth (above 65) 6.0% 40% 35% 5.0% 30% 25% 4.0% 20% 3.0% 15% 10% 2.0% 5% 1.0% 0% 2005 2008 2011 2014 0.0% YoY growth rate of inpatient number 2003 2006 2009 2012 2015 2018e YoY growth rate of aged population YoY growth rate of outpatient number (above 65)
Source: NBS, NHFPC, HSBC Source: NHFPC, HSBC
Figure 32. China: Births 1949-2009 (m) Figure 33. Patient number rebounded in 2016
20% 35 Three baby booms
15% 30
10% 25
20 5%
15 0% 2010 2012 2014 2016YTD
10 YoY growth rate of inpatient number 1949 1959 1969 1979 1989 1999 2009
Source: NBS, HSBC Source: NHFPC, HSBC
34 EQUITIES ● HEALTHCARE March 2017
Healthcare expenses
In addition to the expansion of inpatients, we also expect China’s healthcare market to expand in terms of rising unit healthcare expenditure. While China’s healthcare industry been growing at a 12.7% CAGR in 2011-15 (Frost & Sullivan), it is still relatively small compared with developed countries. In 2015, China’s total healthcare expenditure accounted for c5.8% of its GDP versus 17.1% in the US. By comparing per capita healthcare expenditure, China ranked No 11 at USD458.7 among the world’s 12 largest countries by GDP. This implies that there remains considerable long-term growth potential in the sector.
Despite Chinese government’s endeavour to cut drug costs, the cost per patient spent on medical treatment is still rising. We believe this is due to: 1) other revenue sources for hospitals, including in-vitro diagnosis (IVD) and medical imaging; and 2) hospitals increasing the portion of first-line medications (the first choice for treating a specific condition). These prescriptions sometimes involve cutting-edge but expensive treatments, such as monoclonal antibodies, a type of biologics therapy.
Figure 34. Inpatient medical expenditure Figure 35. Outpatient medical expenditure per capita (RMB) per capita (RMB)
9,000 250 8,000 7,000 200 6,000 150 5,000 4,000 100 3,000 2,000 50 1,000 0 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Inpatient medical expenditure per capita (RMB) Outpatient medical expenditure per capita (RMB)
Source: NHFPC, HSBC Source: NHFPC, HSBC
Figure 36. Total healthcare expenditure in China (% of GDP)
6.5% 6.0% 6.1% 5.5% 5.6% 5.4% 5.0% 5.3% 5.1% 5.0% 4.9% 4.5% 4.8% 4.8% 4.7% 4.6% 4.7% 4.5% 4.6% 4.0% 4.3% 3.5% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total healthcare expenditure in China (% of GDP)
Source: NHFPC, HSBC
35 EQUITIES ● HEALTHCARE March 2017
Figure 37. Total healthcare expenditure of countries in 2014 (% of GDP)
18.0% 17.1% Total healthcare expenditure of countries in 2014 (% of GDP) 16.0% 14.0%
12.0% 10.4% 10.2% 10.0% 9.4% 9.1% 10.0% 8.3% 7.4% 8.0% 5.5% 6.0% 4.7% 4.0% 2.0% 0.0% United Canada Japan European Australia United Brazil Korea China India States Union Kingdom
Source: The World Bank, HSBC
Figure 38. Growth rate of medical treatment expenditure per patient (y-o-y)
12%
10%
8%
6%
4%
2%
0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 9M16 Outpatients Inpatients Source: NHFPC, HSBC
36 EQUITIES ● HEALTHCARE March 2017
Table 16. Coverage table ______PE (x) ______CAGR EPS PEG (x) __ PB (x) ___ _ ROE (%) __ (%) Wind Code Company Mkt Cap (USDm) Price (lcy) T/O (USDm) 2016a 2017e 2018e 2016-18e 2015a 2016e 2015a 2016e A shares (RMB) 600276.SH Hengrui 16,944 49.80 33.9 44.6 36.5 29.7 22.3 2.0 11.8 9.4 24.3 24.2 600196.SH Fosun Pharma - A 8,867 25.68 32.6 20.5 17.6 15.4 20.1 1.3 3.3 2.6 14.1 14.9 600535.SH Tasly 5,993 38.27 27.7 28.4 23.4 19.7 20.1 1.4 5.5 4.9 24.0 18.2 600998.SH Jointown 4,822 20.20 14.1 38.0 31.3 26.3 22.8 2.1 3.6 3.4 7.1 8.3 600079.SH Humanwell 3,786 20.31 29.5 34.1 26.7 22.9 22.0 1.6 3.3 3.0 9.1 9.3 600521.SH Huahai Pharma 3,200 21.18 18.3 44.4 34.6 23.6 37.0 1.2 6.1 5.7 11.9 12.4 002038.SZ SL Pharm 2,779 27.99 20.8 40.7 23.2 15.7 61.2 0.7 5.4 4.9 17.1 12.4 002262.SZ Nhwa 2,029 22.20 10.3 43.3 33.8 26.8 27.2 1.6 5.9 6.7 18.1 16.2 600557.SH Kanion 1,615 18.08 15.4 27.8 23.7 19.9 14.3 2.2 4.0 3.5 12.6 12.5
Average 34.0 26.6 21.4 26.1 1.5 5.1 4.6 14.8 13.9
H shares (HKD) 1099.HK Sinopharm 12,598 35.35 19.6 20.1 17.2 15.2 14.6 1.4 1.2 1.0 12.9 13.1 2196.HK Fosun Pharma - H 8,867 26.60 5.3 18.9 16.2 14.2 20.1 1.2 3.0 2.4 14.1 14.9 1093.HK CSPC 7,351 9.43 12.8 27.0 22.0 17.4 24.2 1.1 6.4 5.5 19.8 22.4 3320.HK CR Pharma 6,864 8.48 4.3 17.8 15.0 12.7 18.4 1.0 2.4 1.3 13.3 9.7 1177.HK Sino Biopharm 6,243 6.54 13.4 24.6 22.2 19.1 11.8 2.1 6.3 5.3 24.8 23.9 867.HK CMS 4,113 12.84 6.2 21.5 18.3 14.9 20.1 1.1 5.1 4.5 21.4 23.9 2186.HK Luye 2,096 4.90 6.1 17.2 14.1 12.6 17.0 1.0 2.5 2.2 14.3 14.0 6826.HK Haohai 772 37.45 0.3 17.3 15.0 13.1 18.8 1.1 2.0 1.8 15.3 11.0 0963.HK Bloomage 522 11.16 1.1 14.4 11.7 9.7 21.2 0.8 2.9 2.4 24.1 21.3
Average 19.3 16.4 14.0 18.0 1.2 3.3 2.8 17.0 16.5 Source: Wind, Bloomberg, HSBC estimates. Priced as of 3 March 2017.
37 EQUITIES ● HEALTHCARE March 2017
Valuation
Earnings growth of covered companies to grow 19% and 23% in 2017-18e, respectively Sector PE has declined to nearly 60% of the 2015 peak PE value Hengrui, CSPC and Sino Biopharm are our top picks, all rated Buy
We believe current valuations are still attractive, given the strong earnings growth potential of Concerns that once weighed on market sentiment are pharmaceutical companies. After a two-year correction, the PE multiples of the China easing healthcare sector for both the H- and A-shares have declined to 36x and 21x, respectively, almost 60% of their respective peak PE value in 2015. With reforms implemented and patient numbers rising, concerns that once weighed on market sentiment are easing. We forecast 2016e will be the bottom of the operational performance for pharmaceutical companies. With the launch of a series of innovative products and favourable policy support, we expect the net profit growth of our key covered companies (including Hengrui, Huahai Pharma, Kanion, Tasly, Nhwa, Sino Biopharm, CSPC and CMS) to average 19% and 23% for 2017-18e, respectively.
We mainly use PEG for valuation. Hengrui, CSPC and Sino Biopharm, all rated Buy, are our top picks. We believe they deserve to trade at a premium to their peers as their R&D ability and rich product pipelines will help them deliver strong earnings growth.
Figure 39. Net profit growth of covered companies 2015-18e
Source: Bloomberg, HSBC estimates
38 EQUITIES ● HEALTHCARE March 2017
Figure 40. A-share PE band of covered stocks
70,000
60,000 Max: 67x
50,000
40,000 +1 SD: 46x
Mean: 40x 30,000 -1 SD: 33x 20,000 Min: 25x 10,000
0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 25x 33x 40x 46x 67x
Source: Company data, HSBC
Figure 41. H-share PE band of covered stocks
80,000
70,000 Max: 40x
60,000
50,000 +1 SD: 28x
40,000 Mean: 22x 30,000
20,000 -1 SD: 15x
10,000 Min: 8x
0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 8x 15x 22x 28x 40x
Source: Company data, HSBC
39 EQUITIES ● HEALTHCARE March 2017
Table 17. Comparison table
CAGR EPS PEG 2016e/ PB ROE _____ PE (x) ______EPS ______(%) CAGR (x) (x) (%) Target Upside/ Mkt Cap Price T/O Wind Code Company Rating Price (lcy) Downside (%) (USDm) (lcy) (USDm) 2016e 2017e 2018e 2016e 2017e 2018e 2016-18e 2016e 2016e A-shares (RMB) 600196.SH Fosun Pharma - A Buy 29.0 13% 8869.0 25.7 30.8 20.5 17.6 15.4 1.3 1.5 1.7 15.2 1.3 2.6 14.9 600998.SH Jointown Hold 23.1 14% 4822.4 20.2 9.9 38.0 31.3 26.3 0.5 0.6 0.8 20.0 1.9 3.4 8.3 600276.SH Hengrui Buy 60.0 20% 16947.4 49.8 35.1 44.6 36.5 29.7 0.9 1.1 1.4 22.3 2.0 9.4 24.2 600521.SH Huahai Pharma Buy 26.5 25% 3201.1 21.2 16.9 44.4 34.6 23.6 0.5 0.6 0.9 37.0 1.2 5.7 12.4 600557.SH Kanion Buy 20.1 11% 1615.5 18.1 11.7 27.8 23.7 19.9 0.7 0.8 0.9 18.2 1.5 3.5 12.5 600535.SH Tasly Buy 53.8 41% 5994.5 38.3 25.6 28.4 23.4 19.7 1.3 1.6 1.9 20.1 1.4 4.9 18.2 600079.SH Humanwell Buy 25.0 23% 3786.6 20.3 23.5 34.1 26.7 22.9 0.6 0.8 0.9 22.0 1.6 3.0 9.3 002262.SZ Nhwa Hold 20.5 -8% 2029.6 22.2 10.0 43.3 33.8 26.8 0.5 0.6 0.8 27.2 1.6 6.7 16.2 002038.SZ SL Pharm Buy 40.7 45% 2779.1 28.0 13.2 40.7 23.2 15.7 0.7 1.2 1.8 61.2 0.7 4.9 12.4 600518.SH Kangmei Not Rated 12498.9 17.4 41.6 25.5 20.9 17.7 0.7 0.8 1.0 20.1 1.3 2.9 11.0 000538.SZ Yunnan Baiyao Not Rated 11525.0 76.4 61.0 25.7 22.4 19.6 3.0 3.4 3.9 14.4 1.8 4.9 19.9 600085.SH Tongrengtang Not Rated 6077.1 30.6 35.6 42.3 36.5 33.7 0.7 0.8 0.9 12.1 3.5 5.4 13.5 002294.SZ Salubris Not Rated 4249.9 28.0 13.4 20.2 16.9 14.1 1.4 1.7 2.0 19.8 1.0 5.5 28.1 000513.SZ Livzon Not Rated 3085.2 54.4 15.7 30.0 24.3 20.1 1.8 2.2 2.7 22.1 1.4 4.0 14.6 000963.SZ Huadong Medicine Not Rated 5494.0 78.0 18.6 27.3 22.2 18.1 2.9 3.5 4.3 22.8 1.2 5.9 24.3 000028.SZ Sinopharm Accord Not Rated 4179.9 71.3 10.9 35.3 28.2 22.9 2.0 2.5 3.1 24.1 1.5 3.5 13.1 Average 32.0 25.6 21.0 1.2 1.5 1.8 23.4 1.5 4.6 15.5 H-shares (HKD) 2196.HK Fosun Pharma - H Buy 32.0 20% 8867.8 26.6 4.7 18.9 16.2 14.2 1.3 1.5 1.7 15.2 1.2 2.7 14.9 6826.HK Haohai Buy 50.0 34% 771.9 37.5 0.2 17.3 15.0 13.1 1.9 2.2 2.5 15.0 1.2 2.1 11.0 0963.HK Bloomage Buy 18.3 64% 521.8 11.2 0.6 14.4 11.7 9.7 0.7 0.8 1.0 21.5 0.7 2.8 21.3 1099.HK Sinopharm Hold 40.0 13% 12597.6 35.4 19.2 20.1 17.2 15.2 1.6 1.9 2.1 14.6 1.4 1.1 13.1 1177.HK Sino Biopharm Buy 7.9 21% 6243.1 6.5 14.0 24.6 22.2 19.1 0.2 0.3 0.3 11.8 2.1 5.3 23.9 1093.HK CSPC Buy 11.2 19% 7350.6 9.4 16.0 27.0 22.0 17.4 0.4 0.4 0.5 24.2 1.1 5.5 22.4 867.HK CMS Buy 15.6 21% 4113.0 12.8 6.1 21.5 18.3 14.9 0.5 0.6 0.8 20.1 1.1 5.2 23.9 2186.HK Luye Buy 6.5 33% 2095.8 4.9 7.9 17.2 14.1 12.6 0.3 0.3 0.4 17.0 1.0 2.5 14.0 3320.HK CR Pharma Hold 8.9 5% 6863.4 8.5 4.3 17.8 15.0 12.7 0.5 0.6 0.7 18.4 1.0 1.3 9.7 874.HK Baiyunshan Not Rated 6122.8 21.7 3.3 19.8 19.2 18.4 1.0 1.0 1.0 3.6 5.5 2.1 12.3 1513.HK Livzon Not Rated 3085.2 46.7 1.3 22.4 18.9 16.1 1.9 2.2 2.6 18.0 1.2 2.9 14.2 1530.HK 3sBio Not Rated 3000.4 9.2 5.0 27.8 21.4 17.3 0.3 0.4 0.5 26.8 1.0 3.3 12.0 3933.HK United Lab Not Rated 1056.0 5.0 3.4 74.1 20.3 16.2 0.1 0.2 0.3 113.9 0.7 1.2 1.7 460.HK Sihuan Not Rated 3480.5 2.8 8.1 14.9 13.9 12.9 0.2 0.2 0.2 7.5 2.0 2.1 13.7 Average 23.4 17.1 14.7 0.8 0.9 1.1 22.9 1.5 2.8 14.6 Source: Wind, Bloomberg, HSBC estimates for covered companies. Priced as of 3 March 2017.
40 EQUITIES ● HEALTHCARE March 2017
Valuation and risks
Valuation Risks
Current price: Our new target price of HKD7.90 is based on a 26x 2017e PE Upside catalysts: better-than-expected new product Sino Biopharm HKD6.50 (previously at a 21x 2017e PE). with a 1.5x PEG (2017e PE/2017- launches of Anlotinib and Tenofovir. Key downside risks: 1177 HK Target price: 19e CAGR), slightly above the historical average of a 1.4x PEG higher-than-expected price cuts during drug tenders; slower-
HKD7.90 and a 24x PE, and at a 35% premium to its peers’ 20x 2017e PE than-expected launches of new products. average, due to product launches and strong R&D and sales Buy Up/downside: capacities. We maintain our Buy rating. 22%
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our new target price of HKD11.20 (from HKD9.80) is based on a Upside catalysts: better-than-expected 2H16 results and CSPC HKD9.40 26x 2017e PE (previously at a 28x 2016e PE), with a 1.3x PEG new product launches. Key downside risks: higher-than-
1093 HK Target price: (2016e PE/2016-18e CAGR; same as previously), slightly above expected price cuts as a result of the tender process; CSPC’s historical average of a 1.2x PEG, and at a 40% premium Oulaining listed in more adjuvant drug lists. HKD11.20 to its peers’ 20x 2017e PE average, due to its strong growth profile
Buy Up/downside: and high percentage of exclusive products. We maintain our Buy 19% rating due to well-positioned in line products and strong sales
capability. Zhijie Zhao | [email protected] | +852 2996 6591
Current price: We are rolling over our target multiple to 2017e (from 2016e) and Upside catalysts: stronger-than-expected Plendil sales and CMS HKD12.80 raise our target price to RMB15.60 (from RMB14.10) based on a the introduction of new products. Key downside risks: lower- 867 HK Target price: 21x 2017e PE (from a 21x 2016e PE), 24% above its peers’ 17x than-expected patient growth, higher-than expected price
2017e PE average. The premium is based on its leading position in cuts; lower-than-expected ramp-up of Plendil sales. HKD15.60 acquiring products and sales. We maintain our Buy rating.
Buy Up/downside: 22%
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of HKD6.50 is based on a 2.2x PEG Upside catalysts: potential earnings-accretive M&A Luye HKD4.90 (2016e PE over 2016-18e recurring EPS CAGR), in line with the transactions, and faster-than-expected second-line products 2186 HK Target price: company’s historical PEG. Our target price implies a 22x 2016e PE turnaround. Downside risks: higher-than-expected price cuts
HKD6.50 and an 18x 2017e PE, largely in line with the H-share pharma during drug tenders; slower-than-expected new product manufacturers’ average. With 33% implied upside from the current launches Buy Up/downside: share price, our Buy rating is based on increased earnings visibility 33% in 2017e and a 2018e product launch.
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our new target price of HKD7.90 is based on a 26x 2017e PE Upside catalysts: more aggressive M&A strategies and Sinopharm HKD35.40 (previously at a 21x 2017e PE). with a 1.5x PEG (2017e PE/2017- lower-than-expected interest rate. Downside risks: higher-
1099 HK Target price: 19e CAGR), slightly above the historical average of a 1.4x PEG than-expected price cuts during tenders; higher-than-
and a 24x PE, and at a 35% premium to its peers’ 20x 2017e PE expected interest rate. HKD40.00 average, due to product launches and strong R&D and sales
Hold Up/downside: capacities. We maintain our Buy rating. 13%
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of HKD50.00 is based on a 22x 2016e Upside catalysts: potential M&A in 2017 in the Haohai HKD37.50 PE, with a 2016-18e net profit CAGR of 15%. The multiple is ophthalmology area to be funded by Haohai’s IPO proceeds.
6826 HK Target price: comparable to Bloomage’s (963 HK) target price-implied valuation Key downside risks: higher-than-expected price cuts for
HKD50.00 multiple, as we expect Haohai to perform strongly in the cosmetic ortho HA injections; competition from new entrants in the surgery market. cosmetic surgery space.
Buy Up/downside: 34%
Zhijie Zhao | [email protected] | +852 2996 6591
Priced at 3 March 2017. Source: HSBC estimates
41 EQUITIES ● HEALTHCARE March 2017
Valuation and risks
Valuation Risks
Current price: Our unchanged target price of HKD18.30 is based on a 22x Upside catalysts: the rapid ramp-up of hydro-lifting Bloomage HKD11.20 2016e PE or a PEG of 1.0x (2016e PE/2016-18e CAGR). We injections and new product launches. Key downside risks: 963 HK Target price: believe Bloomage deserves to trade at a premium because: 1) it increasing competition in the HA dermal filler market;
HKD18.30 has evolved into a comprehensive dermatology provider with a margin pressure from a drop in prices of HA raw materials rich pipeline; and 2) the company generates a high ROE. and end-products. Buy Up/downside: 64%
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: We use a sum-of-the-parts (SOTP) approach to derive an equity Key upside risks: faster-than-expected industry expansion; CR Pharma HKD8.50 valuation of HKD55.8bn with an unchanged target price of less-than-expected impact from the two-invoice system for
3320 HK Target price: HKD8.88 based on the existing capital base and assuming no the inter-provincial allocation business in the short term.
HKD8.88 additional capital enlargement, implying an 18.6x/15.7x 2016-17e Key downside risks: slower-than-expected China PE. We value the manufacturing business at HKD40.1bn based healthcare industry expansion and reforms; potential price
Hold Up/downside: on an 18.3x 2016e PE, which is a 13% discount to the peer cuts in a centralised tender process; changes to products 5% average, and the distribution and retail business at HKD15.7bn that are included on the National Reimbursement Drug based on a 19.5x 2016e PE, which is a 15% premium vs the peer List and the National Essential Drug List.
average. Zhijie Zhao | [email protected] | +852 2996 6591
Current price: We are rolling over our target multiple to 2017e (from 2016e) and Upside catalysts: approval of new drugs. Key downside Hengrui RMB49.80 raise our target price to RMB60.00 (from RMB52.70) based on a risks: longer-than-expected CFDA drug review period; 600276 CH Target price: 46x 2017e PE, with a 1.8x PEG (2017e PE/2017-19e CAGR), in higher-than-expected price cuts as a result of the tender
RMB60.00 line with the historical average of 1.8x. We maintain our Buy process. rating as we expect Hengrui, which has strong R&D and sales
Buy Up/downside: capacities, to benefit strongly in the long run in a market with 20% increasing entry barriers
Zhijie Zhao | [email protected] | +852 2996 6591
FosunPharma Current price: Our unchanged target price of RMB29.00/HKD32.00 for the A- Upside catalysts: potential M&A would further expand its 600196 CH RMB25.70/HKD26.60 and H-shares is based on a sum-of-the-parts (SOTP) approach, product coverage and contribute to higher earnings implying a 24x 2016e PE. 1) pharma manufacturing business: growth; acceleration of drug tenders. Key downside risks: 2196 HK Target price:
RMB29.00/HKD32.00 22x 2016e, given 14% organic growth (2015-17e core EPS slower-than-expected drug tenders; lower number of CAGR); 2) hospital business: 45x 2016e PE, in line with the hospital beds; major failure in new drug development.
Buy Up/downside: industry average; 3) medical devices: 35x 2016e PE, given a 13%/20% CAGR of 30% in 2015-17e; 4) other businesses/investments: marked-to-market or benchmarked to comparable companies.
Our Buy rating on the A-share is due to strong M&A ability, and we apply a 10% discount to the A-share to value the H-share. Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of RMB45.40 is based on a 40x/33x Upside catalysts: completion of CDDP Stage III clinical Tasly RMB38.30 2016-17e PE, or PEG of 2.0x (2016e PE/2016-18e CAGR), in trials in the US; increasing PRDL coverage of Yiqi Fumai
600535 CH Target price: line with the sector average. Our forecasts are 3% and 2% above powder injection and Salvianolic Acid powder injection.
consensus as we are more positive on the domestic TCM market Key downside risks: potential negative CDDP clinical trial RMB53.80 in 2017-18e. We rate Tasly a Buy, given the potential strong results; higher-than-expected price cuts in drug tenders.
Buy Up/downside: catalyst of successful results of CDDP’s unblinding data. 41%
Zhijie Zhao | [email protected] | +852 2996 6591
Priced at 3 March 2017. Source: HSBC estimates
42 EQUITIES ● HEALTHCARE March 2017
Valuation and risks
Valuation Risks
Current price: Our unchanged target price of RMB23.10 is based on 2.2x PEG Upside catalysts: rapid growth in the number of online users; Jointown RMB20.20 (2016e PE/2016-18e CAGR), implying a 44x 2016e PE. The 2.2x faster-than-expected expansion of direct-to-hospital sales. 600998 CH Target price: PEG is at a 30% discount to Jointown’s historical average of a 3.2x Key downside risks: slower-than expected direct-to-hospital
RMB23.10 PEG, given that the two-invoice system is likely to hurt Jointown’s sales growth; higher-than-expected e-commerce distribution business. Our target price implies 14% upside, and we investment. Hold Up/downside: maintain a Hold rating, given the potential negative impact from the 14% two-invoice system.
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of RMB26.5 is based on a 48x 2016e Upside catalysts: approval of Valsartan; new products Huahai Pharma RMB21.20 PE, which implies a 43x 2017e PE and PEG of 1.2x (2016e launches; lower-than-expect price cuts in the new round
600521 CH Target price: PE/2016-18e CAGR), which is at a discount to the sector average drug tenders. Key downside risks: delays in ANDA
PEG of 1.5x, reflecting the uncertainty over the ANDA approvals approvals; harsher price cuts for domestic products. RMB26.50 and the tender progress. We maintain a Buy rating, given Huahai’s
Buy Up/downside: expected participation in the first wave of new generics and 25% potential FTF generics in 2018e.
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of RMB20.10 is based on a 31x PE Upside catalysts: fast ramp-up of Yousaijin. Key downside Kanion RMB18.10 applied to our 2016e EPS estimate, in line with the TCM sector risks: higher-than-expected price cuts in upcoming drug 600557 CH Target price: average, and implies 11% upside. We believe Kanion deserves to tenders, the government tightening regulations related to
RMB20.10 trade in line with its peers, given its superior R&D input (R&D TCM injections. expense at 10%+ of total revenue versus TCM peers at 2.5%). We
Buy Up/downside: have a Buy rating due to strong R&D and the exclusive TCM 11% drugs.
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of RMB40.70 is based on a PEG of Upside catalysts: final approval of Lenalidomide. Key SL Pharma RMB28.00 1.0x (2016e PE/2016-17e CAGR), implying a 60x, 34x and 23x downside risks: a longer-than expected CFDA drug review 002038 Target price: 2016-18e PE, respectively. The PEG of 1.0x is still at a 17% period; worse-than-expected Biocoen sales.
RMB40.70 discount to the A-share peers at 1.2x, due to the uncertainty about Lenalidomide’s promotion. Our target price implies 45% upside Buy Up/downside: from the current share price; we reiterate our Buy rating. 45%
Zhijie Zhao | [email protected] | +852 2996 6591
Current price: Our unchanged target price of RMB20.50 is based on a 40x 2016e Upside catalysts: acceleration of drug tenders; smaller price Nhwa RMB22.20 PE, in line with Nhwa’s five-year historical PE, given that the cuts than expected during the following drug tenders. Key
002262 CH Target price: resumption of drug tenders is going to benefit its new products. downside risks: higher-than-expected price cuts in upcoming
RMB20.50 Our target price of RMB20.50 implies -8% upside from the current drug tenders; slower-than-expected ramp-up of newly share price; we maintain a Hold rating on the stock, given the lack launched products.
Hold Up/downside: of new product launches in the near term. -8%
Zhijie Zhao | [email protected] | +852 2996 6591
Priced at 3 March 2017. Source: HSBC estimates
43 EQUITIES ● HEALTHCARE March 2017
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44 EQUITIES ● HEALTHCARE March 2017
Company section
45 EQUITIES ● HEALTHCARE March 2017
Hengrui (600276 CH)
We expect a 23% net profit CAGR in 2016-18e More products expected to contribute from 2018e and beyond Maintain Buy and raise target price to RMB60.00 from RMB52.70
19% revenue CAGR over the next three years
Management announced 2017 revenue growth guidance of 18-20% y-o-y, slightly below the previous outlook of over 20%. The downward revision is mainly due to the lower-than-expected growth of the overseas business. We still expect revenue growth of 20% in 2017e and a 23% net profit CAGR over next three years due to solid domestic generics growth and new product launches. We expect domestic generics, patent (apatinib) and overseas sales to grow 14%, 89% and 10% in 2017e, respectively.
The launch of new products The tighter CFDA inspection regime has caused industry-wide delays of new product launches. Hengrui is no exception. We expect the resubmission of 19k (a white blood cell stimulator) in 1Q17e. The un-blinding of Apatinib liver cancer, Pyrotinib and Fahmitinib is likely to happen in 3Q17e and 4Q17e, in our view. As a result, we may see the company’s R&D efforts come to fruition in 2018e, with the possible launch of several new products, including the potential ‘super’ blockbuster Pyrotinib. The contribution of patent drugs should rise to 15% of total revenue in 2018e.
Maintain Buy, based on strong R&D and innovation We believe Hengrui has the strongest R&D capacity in China among its peers. Between 2010 and 2015, the company spent an average of 9% of revenue on R&D, far above the 3-4% of domestic peers. According to the current pipeline, we expect Hengrui to receive 2-3 patent drug approvals on an annual basis in the next 3-5 years. Although higher pharma industry standards have created problems for many manufacturers, we believe R&D-driven companies should win in the long term.
Based on the new company guidance, we lower our 2016-18e net profit estimates by 3%, 8% and 11%, respectively, based on: 1) a 5% fall in overseas revenue in 2016-18e; and 2) lowering 19k’s revenue to 0 in 2017e due to the delayed product launch schedule. However, we still expect earnings growth of 23% and a 24% CAGR in 2016-18e and 2017-19e, respectively. We are rolling over our target multiple to 2017e and raise our target price to RMB60.00 (from RMB52.70) based on a 46x 2017e PE (previously a 46x 2016 PE), with a 1.8x PEG (2017e PE/2017-19e CAGR). We maintain our Buy rating. Key downside risks include a longer-than- expected CFDA drug review period and higher-than-expected price cuts as a result of the tender process.
46 EQUITIES ● HEALTHCARE March 2017
Figure 42. Key events in 2017e
Source: Company data, HSBC estimates
Table 18. Key estimate changes RMBm 2016e 2017e 2018e Old revenue estimate 11,528 14,271 17,727 New revenue estimate 11,207 13,444 15,942 Change -2.8% -5.8% -10.1%
Old net profit estimate 2,701 3,489 4,421 New net profit estimate 2,621 3,222 3,950 Change -3.0% -7.6% -10.7%
Consensus Revenue 11,339 13,667 16,395 HSBC estimate vs. Consensus -1.2% -1.6% -2.8% Net profit 2,689 3,308 4,028 HSBC estimate vs. Consensus -2.5% -2.6% -1.9% Source: Company data, Wind, HSBC estimates
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Table 19. Key business revenue growth RMBm 2015 2016e 2017e 2018e 2019e Domestic generic 8,758 9,940 11,365 13,222 15,475 y-o-y 18% 13% 14% 16% 17% % of total 93% 88% 84% 82% 80% Patent (Apatinib; begins in 2019) 250 900 1,700 2,310 3,252 y-o-y 260% 89% 36% 41% % of total 3% 8% 13% 14% 17% Overseas 400 480 528 607 698 y-o-y 700% 20% 10% 15% 15% % of total 4% 4% 4% 4% 4% Total 9,408 11,320 13,593 16,139 19,425 y-o-y 26% 20% 20% 19% 20% Source: Company data, HSBC estimates
Table 20. Hengrui’s major pipeline for domestic market Year of Generic name (EN) Generic name (CN) TA Status approval Type PEG-rhG-CSF (19k) 聚乙二醇重组人粒细胞 White blood stimulator Supplementary 2018 FTM 刺激因子 clinical data DPP-4 Retagliptin 瑞格列汀 Type II diabetes Clinical III 2018 Patent Apatinib 阿帕替尼 Liver cancer Clinical III 2017-18 Patent Fahmitinib 法米替尼片 Colorectal cancer Clinical III 2017-18 Patent Azoletinib 吡咯替尼 Breast and lung cancer Clinical II 2018-19 Patent Hengaliflozin 脯氨酸恒格列净 Type II diabetes Clinical II 2018-19 Patent HAO-472 HAO-472 Acute myeloid leukaemia Clinical I 2019+ Patent Vismodegib-analogue 环咪德吉 Basal cell carcinoma Clinical I 2019+ Patent SHR3680 SHR3680 Prostate cancer Clinical I 2019+ Patent SHR6390 SHR6390 Breast cancer Clinical I 2019+ Patent Eltrombopag-analogue 海曲泊帕 Thrombopenia Clinical I 2019+ Patent M6G M6G Cancer pain Clinical I 2019+ Patent Fasiglifam 呋格列泛 Type II diabetes Clinical I 2019+ Patent SHR0302 SHR0302 Osteoarthritis Clinical I 2019+ Patent SHR4640 SHR4640 Gout Clinical I 2019+ Patent Cabazitaxel 卡巴他赛注射液 Prostate cancer Application for CT 2020+ FTM Rebamipide eye drop 瑞巴派特滴眼液 Xerophthalmia Application for CT 2020+ FTM Ketorolac tromethamine 酮咯酸氨丁三醇鼻喷剂 Relieve pain Application for CT 2020+ FTM nasal spray Bepotastine besilate eye 苯磺贝他斯汀滴眼液 Allergic conjunctivitis Application for CT 2020+ FTM drop Source: Company data, HSBC. Notes: CT stands for clinical trial. FTM stands for first-to-market.
Table 21. Hengrui’s existing ANDA products Generic name (EN) Generic name (CN) TA Approval date Irinotecan Hydrochloride for Injection 注射用盐酸伊立替康 Colorectal cancer December 2011 Letrozole Tablets 来曲唑片 Oestrogen deficiency symptoms May 2013 Oxaliplatin for Injection 注射用奥沙利铂 Cancer June 2014 Cyclophosphamide for Injection 注射用环磷酰胺 Cancer October 2014 Sevoflurane 七氟烷 Surgery anaesthesia November 2015 Cisatracurium Besilate for Injection 苯磺顺阿曲库铵注射液 Surgery anaesthesia February 2017 Gabapentin Capsules 加巴喷丁胶囊 Epilepsy NA Source: Company data, HSBC. NA – Not Applicable.
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Table 22. Hengrui’s major ANDA pipeline Generic name (CN) TA Application date SHR-1316 注射液 Oncology 2016 注射用 SHR-A1403 Oncology 2016 地氟烷 Surgery anaesthesia 2014 磺达肝癸钠 Blood system 2013 托伐普坦 Blood system 2013 环磷酰胺 Oncology 2012 盐酸右美托咪定 Surgery anaesthesia 2012 顺苯磺阿曲库铵 Surgery anaesthesia 2011 来曲唑 Oncology 2010 多西他赛 Oncology 2010 加巴喷丁 Anti-epileptic 2008 奥沙利铂 Oncology 2007 盐酸伊立替康 Oncology 2007 Source: Company data, HSBC
Figure 42. Hengrui five-year PE band
70 Max 60
50 +1 SD 40 Mea -n1 SD 30 Min 20 10 0 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Hengrui 21x 23x 29x 34x 45x
Source: Wind, HSBC
Figure 43. Hengrui five-year PEG band
3.50 3.00 Max 2.50 +1 SD 2.00 Mean 1.50 -1 SD 1.00 Min 0.50 - Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Hengrui PEG 1.0x 1.3x 1.8x 2.3x 3.2x
Source: Wind, HSBC
49 EQUITIES ● HEALTHCARE March 2017
Table 23. Comparison table of MNCs: Innovative players enjoy higher PEG multiples ______PE (x) ______EPS ______CAGR PEG EPS Ticker Name Rating Mkt Cap Price (Lcy) T/O (USDm) 2016e 2017e 2018e 2016e 2017e 2018e 2016-18e 2016e/CAGR (USDm) (%) (x) JNJ.US Johnson & Johnson Not Rated 323,362.4 118.9 (USD) 826.3 16.9 16.1 15.2 6.7 7.0 7.4 4.9 3.4 ROG.VX Roche Hold 209,978.1 243.5 (CHF) 358.5 15.7 14.5 13.8 14.7 15.6 16.8 6.9 2.3 PFE.US Pfizer Not Rated 204,018.1 33.6 (USD) 868.6 13.2 12.1 11.7 2.4 2.6 2.8 7.4 1.8 NOVN.VX Novartis Not Rated 201,803.5 77.0 (CHF) 416.2 16.1 14.4 13.2 4.7 4.8 5.3 6.1 2.6 UNH.US UnitedHealth Not Rated 149,922.7 157.6 (USD) 615.0 16.6 14.8 13.1 8.0 9.5 10.6 15.2 1.1 AMGN.US Amgen Not Rated 127,619.9 173.3 (USD) 603.9 14.1 13.6 12.9 11.5 12.3 12.8 5.2 2.7 GSK.US GSK Buy 101,497.8 41.3 (USD) 154.0 14.9 14.5 13.9 2.0 2.2 2.3 6.5 2.3 GILD.US Gilead Not Rated 91,503.5 69.9 (USD) 767.9 8.0 8.6 8.6 11.4 8.8 8.1 -15.8 -0.5 BMY.US Bristol-Myers Not Rated 91,232.4 54.6 (USD) 653.4 19.6 17.6 14.6 2.9 2.8 3.1 4.3 4.6 Squibb NOVOB.DC Novo Nordisk Hold 89,938.7 247.0 (CHF) 152.7 16.1 14.6 13.6 15.1 15.3 16.9 5.9 2.7
Average 15.1 14.1 13.1 8.0 8.1 8.6 4.7 2.3 Source: Thomson Reuters Datastream, Bloomberg. HSBC estimates for rated companies. Priced as of 3 March 2017.
The PEG of Hengrui has been correlated to the performance of patent drugs. The contribution of patent drugs has risen sharply since the launch of Aatinib in 2014. Revenue from this blockbuster drug may account for 8% of Hengrui’s total sales in 2016e, in our view. We expect the revenue share of patent products to climb to 20% in 2020e and over 50% in 2030e, thanks to the launch of pyrotinib and other innovative drugs. We believe that the PEG of Hengrui will hold firm due to its strong R&D ability. Major multinational drug companies with a strong presence in the patent drug market have higher PEG multiples than their peers.
50 EQUITIES ● HEALTHCARE March 2017
Financials & valuation: Jiangsu Hengrui Medicine Buy
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (RMBm) EV/sales 12.0 9.9 8.1 6.7 Revenue 9,316 11,207 13,444 15,942 EV/EBITDA 43.8 34.7 27.9 22.6 EBITDA 2,549 3,200 3,899 4,736 EV/IC 21.6 15.9 14.4 11.3 Depreciation & amortisation -135 -159 -165 -167 PE* 53.8 44.8 36.4 29.7 Operating profit/EBIT 2,414 3,040 3,734 4,569 PB 11.8 9.5 7.6 6.2 Net interest 148 81 105 136 FCF yield (%) 1.6 1.1 3.5 2.0 PBT 2,562 3,122 3,838 4,705 Dividend yield (%) 0.2 0.2 0.3 0.3 HSBC PBT 2,562 3,122 3,838 4,705 * Based on HSBC EPS (diluted) Taxation -338 -446 -545 -669 Net profit 2,172 2,610 3,214 3,939 HSBC net profit 2,172 2,610 3,214 3,939 Issuer information Cash flow summary (RMBm) Share price (RMB) 49.80 Free float 100% Cash flow from operations 2,277 1,485 3,349 3,658 Target price (RMB) 60.00 Sector Pharmaceuticals Capex -622 -393 -547 -556 Reuters (Equity) 600276.SS Country China Cash flow from investment -470 -393 -547 -556 Bloomberg (Equity) 600276 CH Analyst Zhijie Zhao Dividends -215 -265 -323 -397 Market cap (USDm) 16,949 Contact +852 2996 6591 Change in net debt -1,684 -630 -2,406 -1,765
FCF equity 1,856 1,269 4,038 2,339 Balance sheet summary (RMBm) Price relative Intangible fixed assets 196 235 282 338 Tangible fixed assets 1,770 2,186 2,501 2,812 56.00 56.00 Current assets 9,378 11,162 14,289 17,437 Cash & others 5,133 5,763 8,169 9,935 51.00 51.00 Total assets 11,497 13,736 17,225 20,739 46.00 46.00 Operating liabilities 1,043 857 1,363 1,222 41.00 41.00 Gross debt 10 10 10 10 36.00 36.00 Net debt -5,123 -5,753 -8,159 -9,925 Shareholders' funds 9,931 12,344 15,289 18,902 31.00 31.00 Invested capital 5,168 6,964 7,540 9,430 26.00 26.00 21.00 21.00 2015 2016 2017 Ratio, growth and per share analysis Jiangsu Hengrui Medicine Rel to CSI 300 Index
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 03 Mar 2017 Revenue 25.0 20.3 20.0 18.6 EBITDA 37.4 25.5 21.9 21.5 Operating profit 40.4 26.0 22.8 22.4 PBT 42.4 21.9 23.0 22.6 HSBC EPS 43.3 20.2 23.1 22.6 Ratios (%) Revenue/IC (x) 1.9 1.8 1.9 1.9 ROIC 41.9 43.1 44.3 46.3 ROE 24.3 23.4 23.3 23.0 ROA 20.4 20.7 20.7 20.6 EBITDA margin 27.4 28.6 29.0 29.7 Operating profit margin 25.9 27.1 27.8 28.7 EBITDA/net interest (x) Net debt/equity -49.5 -44.8 -51.4 -50.7 Net debt/EBITDA (x) -2.0 -1.8 -2.1 -2.1 CF from operations/net debt Per share data (RMB) EPS Rep (diluted) 0.93 1.11 1.37 1.68 HSBC EPS (diluted) 0.93 1.11 1.37 1.68 DPS 0.09 0.11 0.14 0.17 Book value 4.23 5.26 6.51 8.05
51 EQUITIES ● HEALTHCARE March 2017
Sino Biopharm (1177 HK)
Cancer drug Anlotinib set to become a potential super blockbuster Generics expected to gain market share from MNCs Maintain Buy and raise target price to HKD7.90 from HKD6.30
Anlotinib: RMB30bn potential market size
The value of China’s non-small cell lung cancer market is close to RMB10bn, according to our calculations. Our key assumptions are: 1) 130,000 patients are the target group of Anlotinib, based on a 0.39‰ morbidity rate and a 20-30% third-line treatment ratio; 2) the PFS and medication cycle of the drug is around five months for the treatment of non-small cell lung cancer; and 3) we estimate monthly treatment fees for Anlotinib of RMB15,000, the median of the RMB10,000-20,000 price range. The cost of Anlotinib’s rival products – Gefitinib, Erlotinib, Icotinib and Aptinib – is RMB6,000-18,000. Anlotinib, in our view, deserves a slight premium due to its high efficacy and drug tolerance.
Meanwhile, Anlotinib is undergoing Phase II clinical trials for six types of cancers, including renal cell carcinoma, gastric cancer, and colorectal cancer. The morbidity rate of these three cancers is 0.38‰, 0.25‰ and 0.20‰, respectively. With a PFS significantly higher than five months, the market value will likely exceed RMB20bn, pushing the total market size of Anlotinib beyond RMB30bn. We believe the theoretical peak value of Anlotinib may reach RMB3-6bn based on a 10-20% penetration rate.
Gaining market share from MNCs In the latest drug tender, only eight out of 31 provinces still separate original and generic drugs qualified for BE tests. We believe that most of Sino Biopharm’s generic drugs, including Entecavir, will pass the BE test in 2017e. As one of the leading generic drug manufacturers in China, Sino Biopharm should benefit from the retreat of MNCs and should expand its market share in the next round of drug tenders, plus the new additions to the NRDL (such as Tianqingganmei and Dasatinib) We are optimistic about the long-term growth potential of the company.
Maintain Buy We expect Anlotinib to contribute RMB300m in 2018e and RMB1bn in 2019e. Our new target price of HKD7.90 is based on a 26x 2017e PE (previously a 21x 2017e PE). with a 1.5x PEG (2017e PE/2017-19e CAGR), slightly above the historical average of a 1.4x PEG and a 24x PE, and at a 30% premium to its peers’ average 20x 2017e PE, due to new product launches, strong R&D and sales capacity. We maintain our Buy rating. Key downside risks include a slower-than-expected CFDA drug review, higher-than-expected price cuts, and the impact of the anti-corruption campaign on hospitals.
52 EQUITIES ● HEALTHCARE March 2017
Figure 44. Key events in 2017e
Source: Company data, HSBC estimates
Table 24. Estimated Anlotinib market size for NSCLC NSCLC third-line drugs Morbidity rate: 0.39‰ % of third-line treatment 20%-30% Population: 1.3bn Incident number: 1.3bn x 0.4‰ x 25% = 130,000 Dosage: 12mg/day Expected monthly price: cRMB15,000 Expected median of treatment cycle (expect PFS c5): c5 months Potential market size 130,000 x 15,000 x 5 = RMB9.75bn Source: NCBI, HSBC estimates
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Table 25. Key estimate changes HKDm 2016e 2017e 2018e Old revenue estimate 15,840 17,567 20,528 New revenue estimate 15,840 17,598 20,692 Change 0.0% 0.2% 0.8%
Old net profit estimate 2,018 2,235 2,590 New net profit estimate 2,018 2,239 2,609 Change 0.0% 0.2% 0.7%
Consensus Revenue 15,923 17,347 19,343 HSBC estimates vs. Consensus -0.5% 1.4% 7.0% Net profit 2,017 2,201 2,501 HSBC estimates vs. Consensus 0.0% 1.7% 4.3% Source: Company data, Wind, HSBC estimates
Figure 45. Sino Biopharm five-year PE band
12.0
10.0 Max
8.0 +1 SD 6.0 Mean
4.0 -1 SD
2.0 Min
0.0 Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 Nov-15 Jun-16 Jan-17 Sino biopharm 9x 15x 20x 24x 33x
Source: Wind, HSBC
Figure 46. Sino Biopharm five-year PEG band
3.0 Max 2.5
2.0 +1 SD
1.5 Mean
1.0 -1 SD
0.5 Min
0.0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 Sino biopharm PEG .6x .9x 1.4x 1.9x 2.7x
Source: Wind, HSBC
54 EQUITIES ● HEALTHCARE March 2017
Financials & valuation: Sino Biopharmaceutical Buy
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (HKDm) EV/sales 3.7 3.4 3.1 2.6 Revenue 14,550 15,840 17,598 20,692 EV/EBITDA 17.2 15.9 14.1 12.0 EBITDA 3,136 3,390 3,815 4,434 EV/IC 4.1 3.7 3.4 3.1 Depreciation & amortisation -329 -380 -436 -503 PE* 27.3 24.0 21.7 18.6 Operating profit/EBIT 2,807 3,010 3,379 3,931 PB 6.3 5.3 4.6 4.0 Net interest -80 -69 -70 -70 FCF yield (%) 4.0 3.2 4.4 5.9 PBT 3,444 3,711 4,114 4,794 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT 3,444 3,711 4,114 4,794 * Based on HSBC EPS (diluted) Taxation -533 -607 -670 -780 Net profit 1,779 2,018 2,239 2,609 HSBC net profit 1,779 2,018 2,239 2,609 Issuer information Cash flow summary (HKDm) Share price (HKD) 6.54 Free float 100% Cash flow from operations 2,291 2,651 3,327 4,267 Target price (HKD) 7.90 Sector Pharmaceuticals Capex -214 -927 -990 -1,101 Reuters (Equity) 1177.HK Country China Cash flow from investment -1,833 -956 -1,022 -1,137 Bloomberg (Equity) 1177 HK Analyst Zhijie Zhao Dividends -296 -447 -596 -683 Market cap (USDm) 6,244 Contact +852 2996 6591 Change in net debt 3,420 -512 -419 -1,172
FCF equity 2,032 1,648 2,263 3,088 Balance sheet summary (HKDm) Price relative Intangible fixed assets 2,864 2,913 2,961 3,030 Tangible fixed assets 3,682 4,105 4,561 5,106 10.90 10.90 Current assets 9,936 11,256 13,261 15,625 9.90 9.90 Cash & others 2,711 3,346 4,427 6,247 Total assets 16,483 18,274 20,783 23,760 8.90 8.90 Operating liabilities 516 529 529 529 7.90 7.90 Gross debt 5,524 5,647 6,309 6,957 6.90 6.90 Net debt 2,813 2,301 1,882 710 5.90 5.90 Shareholders' funds 7,756 9,096 10,477 12,222 Invested capital 13,256 14,399 15,827 16,984 4.90 4.90 3.90 3.90 2015 2016 2017 Ratio, growth and per share analysis Sino Biopharmaceutical Rel to HSCEI
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 03 Mar 2017 Revenue 17.5 8.9 11.1 17.6 EBITDA 26.8 8.1 12.5 16.2 Operating profit 26.8 7.2 12.3 16.4 PBT 22.9 7.8 10.8 16.5 HSBC EPS 17.5 13.5 10.9 16.5 Ratios (%) Revenue/IC (x) 1.4 1.1 1.2 1.3 ROIC 22.2 18.3 18.8 20.1 ROE 24.8 23.9 22.9 23.0 ROA 19.4 18.2 17.9 18.3 EBITDA margin 21.6 21.4 21.7 21.4 Operating profit margin 19.3 19.0 19.2 19.0 EBITDA/net interest (x) 39.3 48.9 54.8 63.7 Net debt/equity 26.9 19.0 13.5 4.4 Net debt/EBITDA (x) 0.9 0.7 0.5 0.2 CF from operations/net debt 81.4 115.2 176.7 600.7 Per share data (HKD) EPS Rep (diluted) 0.24 0.27 0.30 0.35 HSBC EPS (diluted) 0.24 0.27 0.30 0.35 DPS 0.00 0.00 0.00 0.00 Book value 1.05 1.23 1.41 1.65
55 EQUITIES ● HEALTHCARE March 2017
CMS (867 HK)
Expect Plendil and other new products to drive growth The new MNCs strategy creates more product acquisition choices Maintain Buy and raise target price to RMB15.60 from RMB14.10
New product acquisitions to deliver growth
While CMS made headlines by purchasing the hypertension or high blood pressure drug Plendil in 2016, the company has been enriching its product pipeline since 2014. Over the past three years, CMS has purchased seven new drugs in the Chinese market, mainly in the areas of cardiovascular (CVS) and central nervous system (CNS). We expect the revenue contribution from these products to materialise soon due to the company’s well-educated sales team, drug tenders and the phasing out of old drugs in downstream channels. We think Plendil will contribute RMB1.4bn in 2017e and RMB1.7bn in 2018e, and four major new products (Nuodikang, Danshentong, Hirudoid, and Combizyn) will contribute RMB720m in 2017e and RMB1.3bn in 2018e.
Retreat of MNC from the generic drug market creates opportunities MNCs are struggling in China’s off-patent drug market due to unfavourable tender policies and stricter compliance requirements. In tenders for 23 out of 31 provinces, original drugs and generic drugs are either in the same bidding group or receive the same drug quality scores. To improve profitability, MNCs are gradually transferring their off-patent products to domestic companies with strong sales resources. As discussed earlier, major international pharma giants, including AZ, Novartis, GSK and Johnson & Johnson, have been closing their non-core drug lines in China. In 2016, some blockbuster drugs were added to that list. AZ’s Plendil and Imdur, Novo Nordisk’s GLP-1 and Lilly’s Cefaclor were all transferred to local companies. We believe the trend will strengthen, indicating that more product transfers are on the horizon. Given CMS’s acquisition experience and good reputation, we believe that it is well-placed to benefit from this trend.
Maintain Buy, based on strong sales capacity We believe CMS has one of the strongest sales teams and is also experienced in acquiring products in China. We expect CMS to acquire 1-2 new products every year in the next 3-5 years. Meanwhile, the new tender policy in Guangdong has created problems for Deanxit, a drug to treat depression. As a result, we lower our 2016-18e net profit estimates by 5%, 8% and 7%, respectively. However, we still expect CMS to show a 20% earnings CAGR in 2016-18e. We are rolling over our target multiple to 2017e and raise our target price to RMB15.60 (from RMB14.10), based on a 21x 2017e PE (previously a 21x 2016e PE), slightly above its peers’ average 20x 2017e PE. The premium is based on its leading position in acquiring products and a strong sales team. We maintain our Buy rating. Key downside risks include a longer-than-expected new products launch and higher-than-expected price cuts as a result of the tender process.
56 EQUITIES ● HEALTHCARE March 2017
Figure 47. Key events in 2017e
Source: Company data, HSBC estimates
Table 26. Key estimate changes RMBm 2016e 2017e 2018e Old revenue estimate 5,145 6,415 7,767 New revenue estimate 4,875 5,913 7,221 Change -5.2% -7.8% -7.0%
Old net profit estimate 1,364 1,651 2,010 New net profit estimate 1,294 1,520 1,868 Change -5.1% -7.9% -7.1%
Consensus Revenue 4,969 6,008 7,037 HSBC estimate vs. Consensus -1.9% -1.6% 2.6% Net profit 1,333 1,613 1,900 HSBC estimate vs. Consensus -3.0% -5.8% -1.7% Source: Company data, Wind, HSBC estimates
Table 27. New products acquired in 2014-15 Drug Manufacturer Category Indications NuoDikang Tibet Pharma (PRC) CCV Activating blood circulation Danshentong Xili Pharma (PRC) Dermatology Anti-inflammation agent for the treatment of acne, tonsillitis, otitis external, boils, carbuncles, among others Lamisil Novartis (Switzerland) Dermatology Skin and hair dermatophytes Parlodel Novartis (Switzerland) Endocrinology Hyperprolactinemia MOVICOL Norgine (Netherlands) Digestive system Chronic constipation and faecal impaction Combizym DKSH (Switzerland) Digestive system Dyspepsia Hirudoid DKSH (Switzerland) Wound management Phlebitis, soft tissue injuries Source: HSBC
57 EQUITIES ● HEALTHCARE March 2017
Table 28. Major existing products Brand name (EN) Generic name Manufacturer Therapeutic area Local players NRDL/PRDL Direct academic promotion product Plendil Felodipine Tablets AstraZeneca Hypertension 6 B Deanxit Flupentixol and Melitracen Tablets Lundbeck Depression and anxiety 5 B Ursofalk Ursodeoxycholic Acid Capsules Dr. Falk Cholecystitis and 3 A cholangitis XinHuoSu Lyophilized Recombinant Human Tibet Pharma ADHF 1 NA Brain Natriuretic Peptide Salofalk Mesalazine Enteric-coated Tablets Dr. Falk UC and Crohn’s 6 B disease Bioflur Saccharomvces Boulardii Sachets BIOCODEX Diarrhoea 1 B Stulln Esculin and Digitalisglycosides Eye Stulln Macular degeneration 1 1 Drops DanShenTong Tanshinone Xili Pharma Anti-inflammation 1 B GanFuLe Ganfule Lengshuijiang Hepatitis 3 B NuoDiKang Nuodikang Tibet Pharma Chest tightness and 1 B pain Hirudoid Mucopolysaccharide Polysulfate Medinova Phlebitis 1 4 Cream Combizym Oryz-Aspergillus Enzyme and Medinova Dyspepsia 1 B Pancreatin Tablets Source: HSBC. NA – Not Applicable
Figure 48. CMS five-year PE band
25.0 Max 20.0 +1 SD 15.0 Mean 10.0 -1 SD Min 5.0
0.0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 CMS 13x 16x 20x 24x 31x
Source: Wind, HSBC
Figure 49. CMS five-year PEG band
2.20 2.00 Max 1.80 1.60 +1 SD 1.40 Mean 1.20 1.00 -1 SD 0.80 Min 0.60 0.40 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 CMS PEG .8x .9x 1.2x 1.5x 2.0x
Source: Wind, HSBC
58 EQUITIES ● HEALTHCARE March 2017
Financials & valuation: China Medical System Buy
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (RMBm) EV/sales 7.7 5.8 4.7 3.7 Revenue 3,553 4,875 5,913 7,221 EV/EBITDA 24.6 18.5 15.1 12.2 EBITDA 1,117 1,535 1,837 2,204 EV/IC 6.2 4.7 4.4 4.1 Depreciation & amortisation -78 -166 -163 -161 PE* 28.5 21.9 18.7 15.2 Operating profit/EBIT 1,039 1,370 1,674 2,044 PB Net interest -24 -59 -105 -115 FCF yield (%) 1.1 -1.2 4.4 6.1 PBT 1,064 1,405 1,651 2,029 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT 1,064 1,405 1,651 2,029 * Based on HSBC EPS (diluted) Taxation -68 -112 -132 -162 Net profit 996 1,294 1,520 1,868 HSBC net profit 996 1,294 1,520 1,868 Issuer information Cash flow summary (RMBm) Share price (HKD) 12.84 Free float 100% Cash flow from operations 615 1,829 1,421 1,920 Target price (HKD) 15.60 Sector Pharmaceuticals Capex -320 -2,053 -100 -100 Reuters (Equity) 0867.HK Country China Cash flow from investment -853 -2,053 -100 -100 Bloomberg (Equity) 867 HK Analyst Zhijie Zhao Dividends 0 0 0 0 Market cap (USDm) 4,114 Contact +852 2996 6591 Change in net debt -150 915 -584 -885
FCF equity 310 -337 1,180 1,660 Balance sheet summary (RMBm) Price relative Intangible fixed assets 2,436 4,271 4,146 4,030 Tangible fixed assets 526 600 671 737 18.80 18.80 Current assets 2,115 3,092 4,292 5,777 Cash & others 509 1,730 2,555 3,763 16.80 16.80 Total assets 6,398 9,314 10,497 11,980 14.80 14.80 Operating liabilities 142 146 177 217 Gross debt 903 3,040 3,281 3,605 12.80 12.80 Net debt 395 1,310 726 -158 10.80 10.80 Shareholders' funds 5,296 6,072 6,985 8,105 8.80 8.80 Invested capital 4,425 6,086 6,376 6,565 6.80 6.80 2015 2016 2017 Ratio, growth and per share analysis China Medical System Rel to HSCEI
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 03 Mar 2017 Revenue 20.7 37.2 21.3 22.1 EBITDA 22.2 37.5 19.6 20.0 Operating profit 19.2 31.8 22.2 22.1 PBT -5.8 32.1 17.5 22.9 HSBC EPS -4.8 29.9 17.5 22.9 Ratios (%) Revenue/IC (x) 0.9 0.9 0.9 1.1 ROIC 26.9 26.5 26.7 30.9 ROE 21.4 22.8 23.3 24.8 ROA 18.0 17.2 16.3 17.6 EBITDA margin 31.4 31.5 31.1 30.5 Operating profit margin 29.2 28.1 28.3 28.3 EBITDA/net interest (x) 46.3 25.9 17.5 19.2 Net debt/equity 7.4 21.4 10.3 -1.9 Net debt/EBITDA (x) 0.4 0.9 0.4 -0.1 CF from operations/net debt 155.7 139.6 195.7 Per share data (RMB) EPS Rep (diluted) 0.40 0.52 0.61 0.75 HSBC EPS (diluted) 0.40 0.52 0.61 0.75 DPS 0.00 0.00 0.00 0.00 Book value 0.00 0.00 0.00 0.00
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Sinopharm (1099 HK)
More consolidation expected in 2017e and beyond Short-term risks on non-direct sales and financing costs Maintain Hold with an unchanged target price of HKD40
Two-invoice system to drive consolidation at the county level
We expect the growth rate of Sinopharm to outperform the industry slightly in 2017e, driven by accelerating market consolidation at the county level and robust patient growth. With the implementation of a two-invoice system, small distributors with local sales networks but weak operating ability will likely be squeezed out of the market. Sinopharm can leverage this chance to consolidate its network in the county-level market by acquiring local companies. We expect the top-line CAGR to reach 13.3% in 2016-18e.
Non-direct sales and financing costs The two-invoice system will likely hurt the revenues of drug distributors by significantly shrinking the market’s transaction volume. Sinopharm generates 22% of its revenue through non-direct sales, which will be affected by the new policy. We expect the impact of the two-invoice system to peak in 2018e as the policy is implemented across the country. Sinopharm has responded by acquiring local companies in the county-level market. A stronger sales network will likely offset the impact of recent policy changes.
In the current macro environment, we believe Sinopharm will find it difficult to cut its financing costs. We see little room for further improvement of margins as financing costs are already low. We raise the effective interest rates for 2017-18e from 4% to 4.1% and from 3.9% to 4.1%, respectively.
Maintain Hold We lower our 2016-18e EPS estimates by 0.6%, 1.9% and 2.5%, respectively, based on higher- than-expected finance costs. Our unchanged target price of HKD40 is based on a 19x 2017e PE (previously a 21x 2016e PE), slightly below its five-year average PE of 22x. We maintain our Hold rating on Sinopharm because we believe the earnings upside is limited and non-direct sales may be affected by the two-invoice system. Key downside risks are higher-than-expected price cuts during tenders and higher-than-expected interest rates. Key upside risks are more aggressive M&A strategies and lower-than-expected interest rates.
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Figure 50. Key events in 2017e
Source: Company data, HSBC estimates
Table 29. Key estimate changes RMBm 2016e 2017e 2018e Old net profit estimate 4,901 5,309 6,043 New net profit estimate 4,873 5,210 5,895 Change -0.6% -1.9% -2.5%
Old recurring net profit estimate 4,421 5,239 5,962 New recurring net profit estimate 4,393 5,140 5,813 Change -0.6% -1.9% -2.5%
Consensus Net profit 4,681 5,269 6,041 HSBC estimates vs. Consensus 4.1% -1.1% -2.4% Source: Company data, Wind, HSBC estimates
Figure 51. Sinopharm distribution network
Heilongjiang
Jilin
Liaoning Xinjiang Inner Mongolia Beijing Tianjin Hebei Shanxi Ningxia Shandong Qinghai Gansu Jiangsu Shaanxi Henan Xizang (Tibet) Anhui Shanghai Hubei Sichuan Chongqing Zhejiang
Hunan Jiangxi Guizhou Fujian
Yunnan Taiwan Guangdong Guangxi
Hong Kong
Hainan Source: Company data, HSBC
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Figure 52. 29 provinces have announced two-invoice policies; Beijing and Guangxi are expected to follow soon
Heilongjiang
Jilin
Liaonin Xinjian g g Inner Mongolia Beijing Tianjin Hebei Shan Ningxi xi Shandong Qinghai a Gansu Jiangsu Shaanxi Henan Xizang (Tibet) Anhui Shanghai Hubei Sichuan Chongqing Zhejian g Hunan Jiangxi Guizhou Fujian
Full implementation Yunnan Taiwan Guangxi Guangdon Expected to implement in 2017 g Expected to implement by the end of 2018 Hong Kong No related policies have been announced
Hainan
Source: HSBC
Figure 53. Sinopharm five-year PE band
140.0 120.0 Max 100.0 80.0 +1 SD 60.0 Mean
40.0 -1 SD 20.0 Min 0.0 Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 Nov-15 Jun-16 Jan-17 Sinopharm 13x 13x 22x 30x 52x
Source: Wind, HSBC
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Figure 54. Sinopharm five-year PEG band
1.80
1.60 Max
1.40 +1 SD 1.20 Mean 1.00 -1 SD 0.80 Min 0.60 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Sinopharm PEG .8x .9x 1.1x 1.3x 1.6x
Source: Wind, HSBC
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Financials & valuation: Sinopharm Group Hold
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (RMBm) EV/sales 0.8 0.7 0.6 0.5 Revenue 227,069 259,464 298,148 345,147 EV/EBITDA 16.9 14.6 13.5 12.2 EBITDA 10,175 11,583 13,217 15,140 EV/IC 1.5 1.4 1.3 1.2 Depreciation & amortisation -1,005 -1,036 -1,039 -1,041 PE* 23.5 19.8 16.9 15.0 Operating profit/EBIT 9,169 10,547 12,179 14,099 PB 1.2 1.0 0.8 0.7 Net interest -1,987 -1,807 -1,972 -2,272 FCF yield (%) 10.3 4.2 3.5 7.6 PBT 7,410 9,420 10,477 12,109 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT 7,410 9,420 10,477 12,109 * Based on HSBC EPS (diluted) Taxation -1,713 -2,167 -2,410 -2,785 Net profit 3,761 4,873 5,210 5,895 HSBC net profit 3,698 4,393 5,140 5,813 Issuer information Cash flow summary (RMBm) Share price (HKD) 35.35 Free float 100% Cash flow from operations 13,560 7,597 7,074 11,342 Target price (HKD) 40.00 Sector Health Care Providers Capex -1,596 -1,557 -1,557 -1,557 Reuters (Equity) 1099.HK Country China Cash flow from investment -1,596 -1,557 -1,557 -1,557 Bloomberg (Equity) 1099 HK Analyst Zhijie Zhao Dividends 0 0 0 0 Market cap (USDm) 12,599 Contact +852 2996 6591 Change in net debt 3,975 -2,921 8,527 6,665
FCF equity 10,034 4,065 3,455 7,374 Balance sheet summary (RMBm) Price relative Intangible fixed assets 11,990 12,132 12,195 12,309 Tangible fixed assets 9,525 9,668 9,808 9,945 Current assets 116,752 138,566 162,430 189,975 52.00 52.00 Cash & others 19,919 29,110 36,484 48,140 47.00 47.00 Total assets 138,267 160,366 184,433 212,228 Operating liabilities 2,929 11,504 11,603 11,754 42.00 42.00 Gross debt 94,682 100,952 116,853 135,174 37.00 37.00 Net debt 74,763 71,842 80,369 87,034 32.00 32.00 Shareholders' funds 30,052 37,305 45,373 54,696 Invested capital 115,419 119,751 136,346 152,335 27.00 27.00 22.00 22.00 2015 2016 2017 Ratio, growth and per share analysis Sinopharm Group Rel to HSCEI
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 03 Mar 2017 Revenue 13.5 14.3 14.9 15.8 EBITDA 17.0 13.8 14.1 14.5 Operating profit 16.6 15.0 15.5 15.8 PBT 24.9 27.1 11.2 15.6 HSBC EPS 30.4 18.8 17.0 13.1 Ratios (%) Revenue/IC (x) 2.0 2.2 2.3 2.4 ROIC 6.5 7.1 7.5 7.7 ROE 12.9 13.0 12.4 11.6 ROA 4.3 4.9 4.7 4.7 EBITDA margin 4.5 4.5 4.4 4.4 Operating profit margin 4.0 4.1 4.1 4.1 EBITDA/net interest (x) 5.1 6.4 6.7 6.7 Net debt/equity 183.9 150.0 143.6 133.3 Net debt/EBITDA (x) 7.3 6.2 6.1 5.7 CF from operations/net debt 18.1 10.6 8.8 13.0 Per share data (RMB) EPS Rep (diluted) 1.36 1.76 1.88 2.13 HSBC EPS (diluted) 1.34 1.59 1.86 2.10 DPS 0.00 0.00 0.00 0.00 Book value 25.19 31.28 38.04 45.86
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CSPC (1093 HK)
Sales of NBP injections could double in the next three years New product launches will likely be the next catalyst Maintain Buy and raise target price to HKD11.20 from HKD9.80
Raise sales estimates, based on NBP injection growth
We revise our model to reflect the robust sales growth of NBP injections to treat strokes, as this product has been added to the new NRDL list. Medical coverage of the drug will be expanded from seven provinces to 31 provinces. In addition, NBP injections have entered drug tenders in 14 provinces. Boosted by these catalysts, sales volume growth could double in the next three years. We estimate NBP sales growth of 51.6% and 56.6% in 2017e and 2018e, respectively.
Positive catalysts According to our estimates, CSPC has four potential blockbuster products set to launch in 1H17e – Bortezomib injections, Iloperidone tablets, Dronedarone hydrochloride tablets, and Paclitaxelalbumin injections. Management stated that the potential peak sales of these products are RMB700-800m, RMB300-500m, RMB400-500m and RMB1-2bn, respectively. At the same time, CSPC’s Clopidogrel bisulfate received ANDA approval in the US on 2 February 2017. We expect domestic approval to be accelerated as a result. The market size of Clopidogrel Bisulfate is RMB10bn in China. We expect CSPS to launch the product in 2018e and share the channel with NBP.
Maintain Buy We adjust our 2016-18e EPS estimates by 0%, 3.1% and 8.0%, respectively, based on faster NBP growth. Our new target price of HKD11.20 is based on a 26x 2017e PE (previously a 28x 2016e PE), with a 1.3 PEG (2016e PE/2016-18e CAGR; unchanged). This is higher than CSPC’s historical average at a 1.2x PEG, and at a 30% premium to its peers’ average 2017e PE of 20x, due to a strong growth profile and a high percentage of exclusive products. We maintain our Buy rating. Catalysts are better-than-expected 2017e results and new product launches. Key downside risks are higher-than-expected price cuts during tenders and Oulaining being listed in more adjuvant drug lists.
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Figure 55. Key events in 2017e
Source: Company data, HSBC estimates
Table 30. Key estimate changes HKDm 2016e 2017e 2018e Old revenue estimate 12,777 14,682 17,302 New revenue estimate 12,777 14,818 17,686 Change (%) 0.0% 0.9% 2.2%
2016e 2017e 2018e Old net profit estimate 2,113 2,556 3,185 New net profit estimate 2,113 2,588 3,278 Change (%) 0.0% 1.3% 2.9%
Consensus 2016e 2017e 2018e Revenue 12,601 14,269 16,162 HSBC estimates vs Consensus 1.4% 3.8% 9.4% Net profit 2,091 2,574 3,130 HSBC estimates vs Consensus 1.1% 0.5% 4.7% Source: Company data, Wind, HSBC estimates
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Figure 56. CSPC five-year PE band
16.0 14.0 Max 12.0 +1 SD 10.0 Mean 8.0 -1 SD 6.0 Min 4.0 2.0 0.0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 CSPC 13x 19x 22x 25x 36x
Source: Wind, HSBC
Figure 57. CSPC five-year PEG band
1.90
1.70 Max
1.50 +1 SD 1.30 Mean 1.10 -1 SD 0.90 Min 0.70 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 CSPC PEG .9x 1.1x 1.2x 1.3x 1.7x
Source: Wind, HSBC
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Financials & valuation: CSPC Pharmaceutical Group Buy
Financial statements Key forecast drivers Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (HKDm) Innovative drug 3,775 4,965 6,619 9,053 Revenue 11,394 12,777 14,818 17,686 Common generic 4,019 4,220 4,431 4,652 EBITDA 2,772 3,332 3,944 4,824 Antibiotics 1,718 1,461 1,388 1,318 Depreciation & amortisation -605 -611 -630 -647 VC 1,203 1,419 1,632 1,877 Operating profit/EBIT 2,166 2,721 3,314 4,177 Caffeine and others 679 713 748 786
Net interest -56 -59 -59 -59 PBT 2,112 2,662 3,256 4,119 HSBC PBT 2,112 2,662 3,256 4,119 Valuation data Taxation -432 -532 -651 -824 Year to 12/2015a 12/2016e 12/2017e 12/2018e Net profit 1,665 2,113 2,588 3,278 EV/sales 5.3 4.7 4.1 3.5 HSBC net profit 1,665 2,113 2,588 3,278 EV/EBITDA 21.9 18.2 15.4 12.8 Cash flow summary (HKDm) EV/IC 4.9 4.4 3.8 3.3 Cash flow from operations 2,251 2,042 2,670 3,349 PE* 34.3 27.0 22.1 17.4 Capex -837 -800 -800 -800 PB 6.4 5.5 4.7 4.0 Cash flow from investment -712 -809 -808 -808 FCF yield (%) 2.0 1.6 2.3 3.3 Dividends -591 -745 -912 -1,153 Dividend yield (%) 0.0 0.0 0.0 0.0 Change in net debt -118 -76 423 633 * Based on HSBC EPS (diluted) FCF equity 1,115 907 1,330 1,906 Balance sheet summary (HKDm) Intangible fixed assets 215 203 192 183 Issuer information Tangible fixed assets 5,611 5,812 5,994 6,156 Share price (HKD) 9.43 Free float 100% Current assets 7,648 8,767 10,713 13,334 Target price (HKD) 11.20 Sector Pharmaceuticals Cash & others 0 0 0 0 Reuters (Equity) 1093.HK Country China Total assets 13,540 14,848 16,965 19,739 Bloomberg (Equity) 1093 HK Analyst Zhijie Zhao Operating liabilities 1,243 1,243 1,243 1,243 Market cap (USDm) 7,352 Contact +852 2996 6591 Gross debt 3,484 3,408 3,832 4,464
Net debt 3,484 3,408 3,832 4,464 Shareholders' funds 8,738 10,123 11,815 13,957 Invested capital 12,446 13,742 15,847 18,613 Price relative
Ratio, growth and per share analysis 11.20 11.20 Year to 12/2015a 12/2016e 12/2017e 12/2018e 10.20 10.20 9.20 9.20 Y-o-y % change Revenue 4.0 12.1 16.0 19.4 8.20 8.20 EBITDA 21.3 20.2 18.4 22.3 7.20 7.20 Operating profit 29.4 25.6 21.8 26.0 6.20 6.20 PBT 30.3 26.1 22.3 26.5 5.20 5.20 HSBC EPS 31.3 26.9 22.4 26.7 2015 2016 2017 Ratios (%) CSPC Pharmaceutical Group Rel to HSCEI Revenue/IC (x) 0.9 1.0 1.0 1.0 ROIC 14.3 16.8 18.0 19.5 Source: HSBC ROE 19.8 22.4 23.6 25.4 Note: Priced at close of 03 Mar 2017 ROA 13.2 15.3 16.7 18.2 EBITDA margin 24.3 26.1 26.6 27.3 Operating profit margin 19.0 21.3 22.4 23.6 EBITDA/net interest (x) 49.2 56.9 67.4 82.4 Net debt/equity 39.5 33.4 32.2 31.8 Net debt/EBITDA (x) 1.3 1.0 1.0 0.9 CF from operations/net debt 64.6 59.9 69.7 75.0 Per share data (HKD) EPS Rep (diluted) 0.28 0.35 0.43 0.54 HSBC EPS (diluted) 0.28 0.35 0.43 0.54 DPS 0.00 0.00 0.00 0.00 Book value 1.48 1.71 2.00 2.36
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Disclosure appendix
Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Zhijie Zhao
Important disclosures Equities: Stock ratings and basis for financial analysis HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.
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Rating distribution for long-term investment opportunities As of 08 March 2017, the distribution of all independent ratings published by HSBC is as follows: Buy 45% ( 25% of these provided with Investment Banking Services ) Hold 40% ( 26% of these provided with Investment Banking Services ) Sell 15% ( 18% of these provided with Investment Banking Services )
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HSBC & Analyst disclosures Disclosure checklist
Company Ticker Recent price Price date Disclosure BLOOMAGE BIOTECHNOLOGY 0963.HK 11.04 07 Mar 2017 7 CHINA MEDICAL SYSTEM 0867.HK 12.84 07 Mar 2017 7 CR PHARMACEUTICAL 3320.HK 8.62 07 Mar 2017 1, 5 CSPC PHARMACEUTICAL GROUP 1093.HK 9.50 07 Mar 2017 4, 7 JIANGSU KANION PHARMA 600557.SS 18.12 07 Mar 2017 7 JIANGSU NHWA PHARMA 002262.SZ 22.75 07 Mar 2017 7 JOINTOWN PHARMACEUTICAL 600998.SS 20.35 07 Mar 2017 7 LUYE PHARMA GROUP LTD 2186.HK 4.85 07 Mar 2017 7 SHANGHAI FOSUN PHARMA 2196.HK 27.10 07 Mar 2017 6 SHANGHAI FOSUN PHARMA A 600196.SS 26.14 07 Mar 2017 6 SINOPHARM GROUP 1099.HK 35.95 07 Mar 2017 4, 12 TASLY PHARMACEUTICAL 600535.SS 37.94 07 Mar 2017 7 Source: HSBC
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 January 2017 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below.
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10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company 12 As of 02 March 2017, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. 13 As of 02 March 2017, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (including derivatives) of companies covered in HSBC Research on a principal or agency basis.
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Additional disclosures 1. This report is dated as at 08 March 2017.
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71 EQUITIES ● HEALTHCARE March 2017
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Global Healthcare Research Team
Europe Dr Stephen McGarry +44 20 7991 3164 [email protected]
Julie Mead +44 20 7991 9643 [email protected]
Jan Keppeler, CFA +49 211 910 2446 [email protected]
Richard Latz +49 211 910 1074 [email protected]
Asia Girish Bakhru, CFA +91 22 2268 1638 [email protected]
Damayanti Kerai +91 22 3396 0692 [email protected]
Zhijie Zhao +852 2996 6591 [email protected]
LatAm Ricardo N Rezende, CFA +1 212 525 5901 [email protected]
China Pharmaceuticals Equities // Healthcare March 2017 Hong Kong SAR Issuer of report: Fax: +852 2596 0200 Telephone: +852 2843 9111 Level 1 Queen’s 19, Road Central Website: www.research.hsbc.com Website: The Hongkong and Shanghai Banking Corporation Banking Shanghai and Hongkong The Limited
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations. Zhijie Zhao* Zhao* Zhijie HealthcareAnalyst, Corporation Limited Banking Shanghai and Hongkong The +852 2996 6591 | [email protected] Zhijie Zhao (Alex) joined HSBC as an Asia-Pacific healthcare a analystleading inChinese April brokerage, 2015. Prior covering to HSBC,the hesame worked space. forZhijie five yearsholds asa an bacheloranalyst London. College of withscience (honours) degree in mathematics from Imperial Main contributors