19 August 2013 Sector Weekly Healthcare Sector Healthcare Sector Weekly Dose Valuation summary Company Ticker CCY Px Mkt ––––– P/E ––––– EPS CAGR –––– PEG –––– –––– P/B –––– –––– ROE –––– This weekly product is designed to provide investors with key sector cap '13E '14E '15E ('12E -'15E) '13E '14E '15E '13E '14E '15E '13E '14E '15E updates and our attempt to identify (USD) (x) (x) (x) (%) (x) (x) (x) (x) (x) (x) (%) (%) (%) stock implications and insights. Shandong Weigao Group Medical 1066 -HK HKD 8.09 1,965 24.2 19.9 16.4 22 1.1 0.9 0.7 2.9 2.6 2.3 12.1 13.2 14.3 Polymer Co. Ltd. Class H Topics this week: Bribery investigation, China Shineway Pharmaceutical 2877 -HK HKD 12.72 1,356 11.8 10.5 9.4 12 1.0 0.9 0.8 1.8 1.7 1.5 16.0 16.3 16.5 H7N9 resurfacing, NDRC might adjust Group Limited originator drug px, June ’13 hospital United Laboratories International 3933 -HK HKD 2.92 613 18.3 13.0 10.6 26 0.7 0.5 0.4 0.7 0.7 0.7 3.8 5.2 6.1 patient traffic data Holdings Ltd. Sinovac Biotech Ltd. SVA -US USD 4.61 254 -26.3 -43.9 46.1 2.3 2.6 2.7 -8.7 -6.0 5.9 Companies mentioned: Weigao (1066-HK), Shineway (2877.HK) and The China Nepstar Chain Drugstore NPD -US USD 1.58 156 21.3 Ltd. Sponsored ADR United Labs (3933.HK), Sinovac (SVA.O) and Nepstar (NPD.N) Source: Factset/Bloomberg SAIC anti-bribery investigation to begin: The State Administration for Industry and Commerce (SAIC) has initiated a round of bribery investigation that is expected to last 3 months until November ‘13. The goal is to crack down on bribery during Christopher Lui tender activities between drug manufacturers and hospitals. Our worst case scenario for this anti-bribery activity could mean -7% to earnings and the duration [email protected] Tel: (852) 2977 9203 could last for three quarters. H7N9 resurfacing : Experts from the recently held international symposium on the prevention and treatment of new types of influenza indicated since the avian H7N9 virus does not kill poultries, it is hard to estimate the embedded risk of poultries carrying the viral strand. Experts believe there could be more H7N9 cases later this autumn/winter. Stock implications: Companies that could benefit from the marketing expense slowdown include: 1) Weigao (1066.HK) – Doctors could increase tests and services to increase revenues, involving the usage of more medical consumables; 2) Shineway (2877.HK) – Its drugs are low-priced and hospital sales only account for 20% of total sales; and 3) The United Labs (3933.HK) – Doctors may prescribe more TUL’s antibiotics given they are of decent quality and are priced higher than generics, as well as to avoid prescribing too many MNC drugs. Two companies could benefit from H7N9 scare: 1) Sinovac (SVA.O) – Developing H7N9 vaccines for China, and 2) Nepstar (NPD.N) – patients may want to visit drugstores instead of going to hospitals for minor illnesses to avoid H7N9 exposure. NDRC may adjust prices of originator drugs: Media reported the NDRC could adjust pricing methodologies for originator drugs. Options NDRC is considering are: 1) removal of the retail ceiling price, 2) usage of drug reference pricing, and 3) review of independent pricing statuses for originator drugs. June ’13 hospital patient traffic data highlights: 1) 2Q13 growth accelerated vs. 1Q13, 2) June grew 5% YoY, though slower than in April and May, and 3)Class III hospitals continue to record double digit growth albeit a slowdown in pace. Download our reports from Bloomberg: BOCM 〈enter 〉 Healthcare Sector 19 August 2013 SAIC anti-bribery investigation to begin A 3-month long bribery investigation targeting tender activities: The State Administration for Industry and Commerce (SAIC) has initiated a round of bribery investigation that is expected to last 3 months until November ‘13. The goal is to crack down on bribery during tender activities between drug manufacturers and hospitals. Link to news: http://finance.sina.com.cn/world/20130814/181716447967.shtml Our comments: Recall the topic has been under the spotlight since the GSK incident. We believe this 3-month investigation is a warning to those that have conducted heavy activities related to bribery. It could also offer a preview to a more stringent environment as no company wants to make the headlines as GSK did. As tender activities will be under the microscope, we expect marketing activities from manufacturers to decline throughout 4Q13 and possibly in 1Q14. Although less marketing activities may affect top-line sales growth, we believe this may not be a bad thing because companies may be able to optimize the marketing strategies for their products under the new and fairer environment. On impact: We believe earnings impact would be -7% YoY at worst, and the duration could be three quarters or so. We attempt to quantify potential earnings impact using the data collected during the 2006 anti-bribery period. The data used and assumptions include: 1) We used the sales, operating expense and operating profit data from 70 A-share companies that have reported quarterly financials since 2004. 2) We assume the worst case of this anti-bribery exercise to mirror that in 2006. Figure 1: Assuming 2006 was the worst case scenario, earnings could be hit by -7% YOY% 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q 06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 Sales 15% 12% 24% 7% -3% -7% -7% 5% 7% 18% 30% 42% 31% SG&A 12% 10% 13% -0.4% -2% -10% -7% -0.4% 2% 33% 9% 57% 29% Operating income 17% 13% 28% 10% -4% -6% -7% 7% 8% 14% 36% 37% 32% Source: Factset, BOCOM Int’l Data suggested SG&A spending decreased over five quarters (4Q05 through 4Q06) in the range of -0.4% YoY to -10% YoY. This led to three quarters of operating income decrease (1Q06 through 3Q06) and the magnitude ranged from -4% YoY to -7% YoY. On industry: We believe tender activities will re-accelerate in 4Q13 as inventories in hospital could be low after the slow 2Q13/3Q13 tender activities. If that is the case, sales could improve in 4Q13 while SG&A spending will be low. This could give an upside surprise for 4Q13. Download our reports from Bloomberg: BOCM 〈enter 〉 2 growth sales vs. growth SG&A 3: Figure growth income operating vs. growth SG&A 2: Figure Source: Factset, BOCOM Int’l BOCOMInt’l Factset, Source: BOCOMInt’l Factset, Source: Healthcare Download our reports from Bloomberg: BOCM -20% -10% -20% -10% 10% 20% 30% 40% 50% 60% 70% 10% 20% 30% 40% 50% 60% 70% 0% 0% 1Q05 1Q05 2Q05 2Q05 3Q05 3Q05 Sector 4Q05 4Q05 1Q06 1Q06 2Q06 2Q06 (YOY%) SG&A 3Q06 (YOY%) SG&A 3Q06 4Q06 4Q06 1Q07 1Q07 2Q07 2Q07 3Q07 3Q07 4Q07 4Q07 1Q08 1Q08 2Q08 2Q08 3Q08 3Q08 4Q08 4Q08 〈 1Q09 1Q09 enter 2Q09 2Q09 3Q09 3Q09 〉 4Q09 4Q09 1Q10 1Q10 Operatingincome(YOY%) 2Q10 2Q10 3Q10 3Q10 4Q10 Sales(YOY%) 4Q10 1Q11 1Q11 2Q11 2Q11 3Q11 3Q11 4Q11 4Q11 2013 19 August 1Q12 1Q12 2Q12 2Q12 3Q12 3Q12 4Q12 4Q12 1Q13 1Q13 3 Healthcare Sector 19 August 2013 Stock Implications: We believe the upcoming tenders will be biased towards domestic drug manufacturers with lower-priced drugs compared with the previous tenders. Therefore, we think MNCs will take a harder hit than domestic companies in the next three months, if not longer. We also believe the mix of generic drugs could go up compared with the previous quarters. Besides the three companies we introduced in last week’s issue of Weekly Dose (Lee’s Pharm, Kingworld, and China Biologics, see below) that could be immune to/less impacted by such anti-bribery activities, we are listing three more companies that may benefit from the industry slowdown in marketing activities. 1) Shandong Weigao (1066.HK) - Weigao is one of the top medical consumable companies with consumables accounting for 85% of its sales. With less revenues/incentives from drugs, doctors could increase service usage (such as diagnostics and tests) to increase hospital revenues. This could benefit consumable players such as Weigao (1066-HK). 2) China Shineway (2877.HK) – Most of the products Shineway carries are listed in the NDRL/EDL. This fits the criteria of low priced drugs. Moreover, hospital sales only account for 20% of the company’s total sales. The rest goes to second/third-tier medical institutions such as clinics (60% of sales) and OTC (20% of sales). 3) The United Labs (3933.HK) – The United Labs sells its premium priced antibiotics to hospitals. We believe doctors may use more of TUL’s antibiotics vs. MNCs’ given TUL’s quality is decent and is priced higher than other generic versions. Doctors can also avoid the heat from prescribing too much MNC drugs. Other stocks we mentioned in last week’s issue: 4) Kingworld Medicines (1110.HK) - Kingworld is an OTC drug/supplement promoter. Over 90% of its sales come from drugstores. Since it is a player with low exposure to hospitals, the company should not be affected. 5) Lee’s Pharm (0950.HK) – Lee’s is an R&D-driven drug manufacturer and also a drug promoter for foreign small/mid-sized drug manufacturers. Its ‘original producer’ drugs are not MNC drugs and have only 10-20% premium to other generics. Therefore, they should not be targets for the government. 6) China Biologic Products (CBPO) – CBPO is a Chinese plasma-based biotech company listed in the US.