April 17, 2013 China: Healthcare Equity Research HC corporate day takeaways: tender and sales restructuring in focus Two day event with 7 participating healthcare companies We hosted our China Healthcare corporate day in Hong Kong on April 15- RELATED RESEARCH 16, with senior management from 7 companies attending: Sino Biopharm China: Healthcare: Beijing EDL tender: price (1177.HK, Neutral), Shanghai Pharma (2607.HK, Neutral), Sihuan Pharma continues to trend down, volume in focus (April 10, 2013) (0460.HK, Neutral), Fosun Pharma (2196.HK, Not Covered), Tasly (600535.SS, Neutral), Yuyue Medical (002223.SZ, CL-Buy) and CR Sanjiu China: Healthcare: 2012 EDL: Newly included exclusive products the key focus (March 18, 2013) (000999.SZ, Coverage Suspended). Key takeaways follow. China: Healthcare: Policy impact priced in; refresh valuations; upgrade Mindray to Buy (January 11, More positive tone on top-line growth 2013) Most of the companies see pricing trending down during the upcoming China: Healthcare: We expect impact of new round tender, although many expect a sequential improvement in 1Q and 2Q as of drug price cuts to be moderate (January 8, 2013) they believe the price impact is unlikely to substantially impact 2013 earnings. China: Healthcare: 2013 Outlook: Crucial juncture, Top-line growth should continue to be driven by rising ex-manufacturing quality to the fore; Huahai up to Buy (December 13, price and volume expansion due to the new EDL inclusion as well as by sales 2012) channel restructuring (increasing hospital coverage, implementing a direct China: Healthcare: New round of drug price cut in sales channel and expanding the sales force). With a newly expanded EDL, line with our expectations (September 19, 2012) TCM may experience more pricing pressure than in the past. Earnings growth hinges on the EBIT margin Earnings visibility remains weak as sales channel restructuring may continue to push up operating costs, leading to a lower EBIT margin. We believe restructuring remains the dominant sector theme and companies will have to focus on cost control in order to achieve stable earnings growth. Companies capable of improving gross margin by optimizing their product mix are likely to deliver stronger earnings growth, in our view. We believe companies unable to accelerate top-line growth will likely see earnings downside during the restructuring process. Mixed outlook on the price impact of the upcoming tender The companies differed in their outlook on the magnitude of price impact in this year’s upcoming tender. Some companies believe price erosion is likely to hit earnings, i.e., the management of Sino Biopharma was more cautious, while management from Shanghai Pharm, Tasly and Sanjiu downplayed the potential impact of the price cut, as they believe it is already reflected in consensus numbers. Yuyue and Fosun maintained a neutral view, as their businesses have limited exposure to the price cuts. The companies believe product expansion is the key driver of long-term growth. Wei Du, Ph.D +86(21)2401-8928 [email protected] Beijing Gao Hua Securities Company Limited Goldman Sachs does and seeks to do business with Li Yu companies covered in its research reports. As a result, +86(21)2401-8932 [email protected] Beijing Gao Hua Securities Company Limited investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research April 17, 2013 China: Healthcare GS Healthcare corporate day summary: companies We hosted our China Healthcare corporate day in Hong Kong from April 15-16 with 7 companies attending. Below are some key highlights from the group meetings we attended during the two day event. Sino Biopharm (1177.HK, Neutral, HK$5.31) Management turned more cautious on the sustainability of strong growth momentum due to concerns over pricing pressure and lack of new product launches. According to management: Several products, such as Kaifen, Runzhong, Mingzheng, Tiance and Tianqingyitai etc., may face price erosion between 5-50% in the upcoming regional tender. They expect labor costs to go up by 15% this year vs. the historical average of about 10%. The revenue growth rate may slow as the impact of the price cuts are fully factored into the relatively higher base. Management attributes robust top-line growth of about 40%, over the past two years, to signification volume growth of all products included in the RDL in 2009. Higher capex (about Rmb500 in 2013) may further pressure earnings growth. Management continues to believe in the strong growth potential of Tanqingganmei, Runzhong, Tuotuo, Beiqian, Kaifen, New Ossified Estriol Capsule, Xin HaiNeng and Zhiruo, with the possibility of 30% yoy growth in 2013. We have a Neutral rating on Sino Biopharm and 12-month Director’s Cut-based target price of HK$4.60. Risks: Upside: Faster-than-expected pipeline rollout; Downside: operating deleverage, slower-than-expected revenue growth. Shanghai Pharma (2607.HK, Neutral, HK$16.52) Management is confident that it can maintain stable top-line growth and accelerate the growth of its manufacturing business. According to management: They expect top-line growth to exceed the industry’s average of 20%, with manufacturing revenue growing at a double-digit rate (vs. the historical single- digit rate), driven by EDL expansion and an increased focus on core product sales. Manufacturing business gross margin could improve, driven by an increasing contribution from core product sales, which offers a roughly 65% gross margin. Sales of EDL products should contribute around 30% of total manufacturing revenue due to the expanded EDL list. The impact to segment profit hinges on the sales volume growth of the 8 newly included exclusive products against other commoditized generics. Management expects to maintain EBIT margin stability for the manufacturing business, as it believes discontinuing Shandong Ruiyin’s API (incurred a Rmb80m lose in 2012) and completing the consolidation of Kangli in 2013 should help improve profitability. The distribution margin continues to face pressure, although potential further price erosion from the local tender may be partially offset by the rising contribution Goldman Sachs Global Investment Research 2 April 17, 2013 China: Healthcare from new business such as the distribution of vaccines and high-end consumables and managing the pharmacy in some newly built hospitals. Management also reiterated its high-dividend payout policy, as it believes this is beneficial to all shareholders, including Shanghai Pharma Group, which owns 30% of listco. We have a Neutral rating on Shanghai Pharma and 12-month Director’s Cut-based target price of HK$15.00. Risks: Downside: price cut, Upside: potential M&A and better operating leverage. Sihuan (0460.HK, Neutral, HK$4.28) Management viewed 2012 as its most challenging year with a slowdown in key product sales attributable to inventory destocking, internal sales restructuring of acquired companies, e.g., Dupromise, and a realignment of sales for its key products Kelinao/Anjieli which experienced a 2012 sales volume decline of about 6% yoy. Management expects single-digit Kelinao growth in the near- to medium-term and expects Oudimei growth to continue trending up (exceeding 25% yoy in 2H12) following the integration of Dupromise sales channel and a lift in the drug sales ban in two more provinces this year. 2012 organic growth registered a 24.5% gain, excluding the higher ASP due to changes in its sales model. The company is less dependent on Kelinao so new products are becoming the revenue drivers. In 2012, no single product accounted for more than 25% of sales. Management expects 2012-2014 capex to total Rmb1.5 bn, driven by a major capacity expansion (which should accommodate 8 years of growth), with maintenance capex expected to be approximately Rmb100m annually after 2014. Management expects to maintain its gross margin at 75-78%. We have a Neutral rating on Sihuan and 12-month Director’s Cut-based target price of HK$3.18. Risks: Opex and restriction on clinical use of key products are key swing factors. Tasly (600535.SS, Neutral, Rmb66.86) Management remains positive on its strong growth momentum, guiding to about 30% manufacturing revenue growth in 2013, after 43% growth yoy in 2012, primarily driven by sustainable growth of the Dantnic Pill and strong growth of second-tier products. Sales of 7 products exceeded Rmb100 mn in 2012: Dantonic pill (Rmb2 bn), Yangxueqingnao Granule (+Rmb500 mn); Yiqifumai injection, Shuilinjia (for hepatitis) and Qishenyiqi pill all booked sales of over Rmb200 mn, while Huoxiangzhengqi pill and Jinghuaweikang pill each tallied over Rmb100 mn. We believe completion of the pending 100% equity acquisition of Jiangsu Tasly Diyi Pharma (2012 revenue/NPAT of Rmb530mn/106mn) for a consideration of Rmb1.45 bn, which implies a trailing P/E of 13.7X, should also help to boost growth as Diyi is required to achieve 25% growth for 3 years under the agreement. We have a Neutral rating on Tasly and 12-month Director’s Cut-based target price of Rmb56.50. Risks: upside: higher-than-expected R&D/promotion expense; downside: slower-than-expected Cardiotonic Pill sales on an existing high base. Goldman Sachs Global Investment Research 3 April 17, 2013 China: Healthcare Yuyue (002223.SZ, CL-Buy, Rmb16.34) Management expects about 20% annual top-line growth, but is uncertain about earnings growth due to potential cost fluctuations as a result of new product launches in 2013.