EQUITIES HEALTHCARE March 2017 By: Zhijie Zhao https://www.research.hsbc.com China Pharmaceuticals China 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 // Equities of opportunities We raise our target prices between 11% and 25%; we prefer Hengrui, Sino Biopharm and CMS, all rated Buy March 2017 March 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 2 EQUITIES ● HEALTHCARE March 2017 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.