China Healthcare Sector 2019 Outlook...1 China Healthcare Sector 2019 Outlook 7 January, 2019 After...

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China Healthcare Sector 2019 Outlook

7 January, 2019

After the correction in 2H2018, the healthcare sector valuation has reached a three-year low as a

result of a series of policies calling for ASP cuts and consolidation. Given more policy uncertainties

ahead in 2019, we strongly recommend investors pick stocks from a bottom-up perspective and

embrace earnings visibility. Our top picks are Shanghai Pharm [2607.HK; BUY]; CTCM [570.HK; BUY]

and SinoPharm [1099.HK; BUY].

Healthcare sector correction since 2H2018 due to policy risks. In 1H2018 the healthcare sector

was significantly re-rated following strong momentum in 2017. The sector began to correct in June.

Apart from macro factors, such as the trade war and RMB depreciation, major de-rating factors in the

sector included 1) the Group Purchasing Organization’s (GPO) progress in expanding nationwide and

to more drugs accelerated and the ASP cut was much more severe than expected; 2) drug terminal

growth pressure from medical insurance cost control; and 3) a rapid increase in the selling expenses of

drug companies.

Medical reform storm to continue in 2019. Looking ahead to 2019, we expect medical reforms to

continue to deepen, mainly including a review of upstream drugs and approval reforms, generics’

consistency evaluation, the GPO, hierarchy diagnosis and treatment, and medical insurance payment

reforms. Through these reforms, the authorities’ key goals are to 1) introduce clinically indispensable

drugs to the market as soon as possible to benefit patients; 2) encourage domestic manufacturers to

research and develop innovative drugs; 3) call for generics consolidation and ASP cuts (e.g. the GPO)

and improve generics quality (e.g. generics consistency evaluation); 4) cut drug prices to a more

affordable level (e.g. tendering price cuts); 5) alleviate the national medical insurance reimbursement

fund burden by optimizing insurance coverage and its payment structure; and 6) make good use of

limited medical resources (e.g. hierarchy diagnosis and treatment).

Earnings visibility the key; buy distributors and CTM in 2019. The authorities’ determination to

pursue medical reforms will continue to create policy uncertainties in 2019. While the overall market

will remain volatile in the near term, we prefer stocks with lower policy risk (i.e. higher earnings

visibility) and attractive valuations. Drug manufacturers will confront a tough year in 2019 because of

fierce ASP pressure under the GPO. On the other hand, Concentrated Chinese Medicine Granules

(CCMG) will continue to deliver solid growth because of top-level support for Traditional Chinese

Medicine (TCM) and CCMG’s oligopolistic market nature. 2019 should be a continuing recovery year

for distributors, as the two invoice system’s short-term negative impact on internal sales to distributor

business faded. We expect downstream hospitals to continue to underperform, since they are still in a

transition period, during which their other profit sources from higher medical services fees, government

subsidies, lowering operating cost, etc., cannot yet make up for the shortfall from the drugs zero price

mark-up.

2019 conviction calls

Our top 2019 recommendations are companies with high earnings visibility, low exposure to policy

risks, especially the GPO, and undemanding valuations, as follows:

Shanghai Pharm [2607.HK; Initiate with BUY]: Limited exposure to the GPO for its

pharmaceutical manufacturing segment, earnings recovery by its associates and JVs, distribution

sector recovery, and high earnings visibility with an attractive valuation.

CTCM [570.HK; BUY]: Strong and secure earnings growth of CCMG, Yang Bin's stake has

been offloaded, not exposed to the GPO, and an appealing valuation.

SinoPharm [1099.HK; BUY]: A leader in the pharmaceutical distribution business, recovery

of the distribution business to continue in 2019, limited exposure to the GPO, and rapid

development of retail business and medical devices distribution business, with an undemanding

valuation.

Harry He—Analyst

(852) 3698-6320

[email protected]

Wong Chi Man, CFA—Head of Research

(852) 3698-6317

[email protected]

Liz Li—Analyst

(852) 3698-6297

[email protected]

2

Medical insurance fund raised to keep it at >10% growth in 2019

From a macro perspective, medical insurance is the principal payment body in China’s healthcare

industry, accounting for >50% of total terminal payments. We expect the overall medical insurance

funds raised (i.e. medical insurance for urban workers + medical insurance for urban and rural

residents and private insurance) to remain at >10% growth (despite a slowdown from >20% in

previous years because of rapid coverage expansion) in the next few years. For medical insurance

for urban workers, fund growth will be driven by an increase in disposable income (accounting for 6

–7ppts) and an increase in the number of workers (accounting for 3–4ppts). Medical insurance for

urban and rural residents, for which 75–80% of the funding comes from government subsidies, is

expected to continue to grow by 8–9% YoY. Private insurance growth is expected to be >20% YoY

p.a. over the next few years.

Because of increasing pressure to balance fund growth and increase expenditure, we expect a

structural change for drug coverage and payments for medical insurance. We expect the medical

fund to be spent more on clinically indispensable drugs than on supplementary drugs. According to

IMS data, in 8M2018 the hospital drug sales growth rate was as low as 2.8%, squeezing the bub-

bles (i.e. drug use control) for supplementary drugs, antibiotics, CTM injections, etc. With limited

medical insurance resources, the government intends to provide the best quality pharmaceutical

products at the lowest possible prices; that is, the coverage and payment structure of the medical

insurance fund is the key. In summary, the expected >10% growth in the medical insurance fund

will provide room for structural change in the medical insurance payment structure, involving more

innovative and clinically indispensable drugs and removing supplementary drugs, antibiotics, CTM

injections etc.

NMPA reforms to secure the execution of 2019 medical reforms

In March 2018, the State Council combined 1) the responsibilities of the State Administration for

Industry and Commerce; 2) the responsibilities of the State Administration for Quality Supervision;

3) the responsibilities of the Chinese Food and Drugs Administration; and 4) the price supervision,

inspection and anti-monopoly law enforcement responsibilities of the National Development and

Reform Commission under the new State Administration of Market Supervision and Administration,

which is a direct subordinate of the State Council.

Considering the importance of drug supervision, the National Medical Products Administration

(NMPA) was set up separately and is administered directly by the State Administration of Market

Supervision and Administration. Market. Supervision of the NMPA is managed at different levels as

follows:

The national level NMPA is responsible mainly for product registration and formulation of the

regulatory system: it is responsible for formulating the regulatory system for drugs, medical

devices and cosmetics, and for licensing and inspecting the development of drugs, medical

devices and cosmetics.

The provincial level NMPA is responsible mainly for production supervision: it is responsible

for licensing, inspection and enforcement for pharmaceutical, medical devices and cosmetics

production, as well as drug wholesale licensing and retail chain headquarters licensing, etc.

The municipal and county level NMPA are responsible for product management and supervi-

sion: they are responsible for the licensing, inspection and enforcement for drug retailing and

medical device operation, as well as the quality inspection and enforcement of cosmetics op-

erations, and the use of drugs and medical devices.

We expect the restructuring of the healthcare industry top-level authorities to facilitate and secure

the execution of medical reforms in 2019 and promote the healthy long-term development of Chi-

na’s pharmaceutical industry.

The State Administration of Mar-

ket Supervision and Administra-

tion was set up in March 2018.

Re-structuring of the top-level

authorities will promote the

healthy long-term development of

China’s pharmaceutical industry.

The expected >10% medical

insurance fund growth rate will

provide room for medical insur-

ance payment structure changes

involving more innovative and

clinically indispensable drugs and

the removal of supplementary

drugs, antibiotics, CTM injec-

tions, etc.

3

Innovative drugs: reforms, reforms and more reforms!

2019 will begin to harvest the benefits of drug review and approval reforms

In past years, China’s pharmaceutical industry was driven by generic drugs, not innovative

drugs. Many obstacles have hindered the healthy development of the pharmaceutical industry:

1) backlogged drug applications; 2) a much slower new drug launch process compared to that of

the U.S.; 3) a lack of innovation capability and motivation for domestic manufacturers; 4) overly

duplicated application of generics; and 5) poor quality generics. In 2015, to solve these prob-

lems, the State Council issued the document “Opinions on Reforming the Reviewing and Ap-

proval system of Drugs and Medical Devices”, putting forward an enormous number of

measures, including 1) expanding the personnel of the Center for Drug Evaluation (CDE); 2)

calling for clinical trial data reviews; 3) stimulating priority review of drugs and applications for

green pathways; 4) pushing generics consistency evaluation; 5) launching the Marketing Author-

ization Holder (MAH); 6) joining the International Council for Harmonization (ICH); and 7) reform-

ing the chemical drugs registration and classification. So far, the new drug registration and clas-

sification system has been introduced, and the backlogged drug applications have been alleviat-

ed. We expect the drug review and approval reforms to bring about structural development op-

portunities in many subdivisions of the healthcare sector in 2019. With the completion of the

drug review and approval reforms, the launch process for innovative drugs will be condensed,

and clinically indispensable drugs will have a faster marketing channel to patients in China.

Domestic manufacturers will be forced to innovate in 2019

The authorities have put forward many specific measures for speeding up bringing foreign inno-

vative drugs into China. First, in July 2018, the National Medical Products Administration

(NMPA) published “Adjustment of the Procedures for Review and Approval of Drug Clinical Tri-

als”, which states that “if an applicant does not receive a negative or doubtful opinion from the

CDE within 60 days from the date of acceptance and payment of the application, it may carry on

clinical trials in accordance with the submitted trial design”. Although the 60-day review period is

still longer than the U.S. FDA’s practice of 30 days, we believe the Chinese CDE has made a big

step compared with the past, when manufacturers had to wait sometimes for over a year to get

clinical trial approval (i.e. manufacturers had to get a “YES” from the CDE, while now, as long as

CDE does not say “NO” within 60 days, they can start clinical trials). Second, for clinically urgent

drugs, as long as human race trials can demonstrate bioequivalence in different human races,

foreign clinical trial data can be accepted by the CDE. We believe supporting foreign innovative

drugs will put pressure on domestic manufacturers and push them to put more effort into innova-

tion (we have seen that in recent years in some specific areas, such as PD-1 or CAR-T, some

Chinese pharmaceutical manufacturers have reached tier-1 level worldwide). Of course, one

thing we need to point out is that supporting innovative drugs alone is not enough; supplemen-

tary policies which reduce the unreasonable profits of generics (such as the GPO, tender price

cuts, and national oncology drug price negotiations) are also critical for pushing domestic inno-

vations.

China’s healthcare industry has

been facing many long-existing

problems, and the authorities

have initiated a series of reforms

since 2015

The CDE is now 60 days vs. the

U.S. FDA’s 30 days for clinical

trial application review, a big step

for the Chinese CDE

4

Generics: landscape about to undergo restructuring

China’s generics face three major problems

The healthy development of generics is crucial for the pharmaceutical industry to substitute origi-

nal drugs to reduce the burden on the medical fund and secure the overall drug supply. Howev-

er, there are three major obstacles hindering the development of generics: 1) overly duplicated

applications for low value-added generics, especially in the anti-virus and metabolic area; 2) in-

consistency of quality and efficiency of generics compared with the original drugs because many

small manufacturers have limited R&D capability, and don’t have the expertise to set up research

projects based on sufficient due diligence (i.e. they just struggle to survive at first by producing

generics); and 3) the relatively high profit margin of generics reduced the incentive for manufac-

turers to research and develop innovative drugs.

So the government’s targets are clear: 1) to consolidate the generics industry to avoid inefficient

and duplicated competition; 2) to call for a generics ASP cut and lower the profitability of gener-

ics to motivate manufacturers to focus on innovative drugs; and 3) to secure the quality of gener-

ics. Generics consistency evaluation is put forward under these circumstances to comply with

target 3 via streamlining the safety and efficiency of generics with original drugs. Together with

stringent regulation of clinical trail data checks and generics’ quality, safety and efficiency can be

secured to the highest level.

Generics consistency evaluation progress slow

As at end-September 2018, the CDE had accepted up to 350 applications for consistency evalu-

ation, involving 151 drugs. Starting from July 2017, manufacturers began to apply one after an-

other, 16 applications a month on average. The progress has accelerated since May 2018

(Figure 1 below), indicating that more and more manufacturers realize the importance of con-

sistency evaluation, and the CDE’s review progress began to accelerate.

Because of a limited number of qualified clinical trial centers (only >100 hospitals are qualified to

perform clinical trial phase I), the progress of the Bioequivalence (BE) test for the “289 Essen-

tial Drug List (EDL)” drugs has been seriously delayed. According to Centre for Drug Evaluation

(CDE), as at end-September 2018, only 18 drugs had completed the consistency evaluation vs.

the target of 289 drugs completed by end-2018. Slow progress in consistency evaluation may

hinder the progress of the GPO expanding to more drugs.

Consistency evaluation and

the GPO are the two most

important keys for the healthy

development of generic drugs

over the next few years

8

1813

19

43

59

36

62

19

0

10

20

30

40

50

60

70

2018.1 2018.2 2018.3 2018.4 2018.5 2018.6 2018.7 2018.8 2018.9

CDE application numbers

Figure 1: CDE consistency evaluation applications

Source: CDE, CGIS research

5

Generics: top level support for generics development

On April 3, 2018, the State Council announced “Opinions on Reforming and Perfecting the Policy

of Supply Guarantee and Use of Generic Pharmaceuticals”. It clearly stated support for the

whole supply chain of chemical generics in four major ways:

Generics R&D (supporting the R&D of generics of clinical indispensable drugs with definite

curative effects);

Improving generics’ efficiency and accelerating the consistency evaluation process;

Terminals support (generics that pass the consistency evaluation will be included in the pro-

curement list in a timely manner, and they will be recommended as substitutes for original

drugs via doctors medication education and clearly stated in drug labels, drugs procurement

support, medical reimbursement list support, medication recommendations, etc.). Some

provinces have published detailed policies to push generics consistency evaluation imple-

mentation. Sichuan, Hubei, Guangxi, Shaanxi etc. have claimed to have categorized gener-

ics that passed the evaluation in the same quality classification as the original drugs. Shang-

hai announced that generics passing the evaluation will go direct to the online procurement

process rather than tendering. We believe these local policies will secure the implementa-

tion of the consistency policy and stimulate manufacturers’ motivation to choose premium

candidates to pass the consistency evaluation, eventually benefiting patients and medical

funds with cheaper alternatives that are equivalent to the original drugs; and

Tax reductions of up to 15% for generics manufacturers.

Overall, we believe this Opinion will stimulate the development of domestic generics as substi-

tutes for original/imported drugs, securing good generics for patients.

6

The Group Purchasing Organization (GPO)

Our understanding of the GPO is that its basic mission is to bring about price reductions

for generics and consolidation (as an ideal supplement, the chemical consistency evalua-

tion will secure overall generics quality, while the GPO will cut ASPs). In the past, Chinese

pharmaceutical companies had relative high profitability for their generic drugs, which

was considered unhealthy, as this hindered their motivation to conduct R&D on innova-

tive drugs. The GPO’s drastic ASP cut can be seen as a way to squeeze the profitability of

generics to a normal level, thus forcing manufactures to consolidate and undertake inno-

vative R&D. More importantly, the sharp ASP cut for generics can give the medical insur-

ance fund more room to include clinically indispensable and newly launched innovative

drugs (oncology targeted drugs, PD-1/PD-L1 etc.), essentially benefiting patients. With the

announcement of the first round preliminary tender prices in December 2018, which were

much lower than expected, we are concerned that the GPO may expand nationwide faster

than we previously expected in 3 to 5 years, which may trigger volatility in the share pric-

es of generics manufacturers in 2019.

The fifth meeting of the Central Committee for deepening reform on November 14, 2018 ad-

dressed the purposes of the GPO, which are to explore and improve the group purchasing

mechanism and market-driven pricing mechanism, reduce the financial burden for medication

expenditure for patients, standardize the drug distribution system, and enhance awareness of

drug safety. The overall concepts of “national organization, alliance procurement and platform

operation” must be followed. The government and the market should work hand in hand to en-

sure drug quality and supply stability.

Following the fifth meeting of the Central Committee for deepening reform (Nov 14), the 11 city

GPO document was released, with 31 final GPO candidate drugs (Figure 3). The policy attitude

is very firm about pushing forward the GPO. It stated that during the GPO period (i.e. one year),

medical institutions should give priority to the drugs selected in centralized purchasing and en-

sure that the agreed purchase volume is met. We need a dynamic view to examine each gener-

ic’s specific market landscape, considering the specific drug’s consistency evaluation passing

situation, competition and original drug’s price strategy when polices lean to generics for medical

insurance cost-reduction purposes, etc. It is a complicated situation in which each player wants

to maximize its own benefits (we used Entecavir as a demonstration example on Page xxx). In

the policy, it is explicitly stated that every year there will be a review of GPO candidate drugs,

prices and manufacturers. So the key is to maintain a dynamic perspective on this, as the market

landscape for each generic may change from year to year. If a manufacturer cannot get the GPO

market (60%–70% of the quantity of the 11 cities), it can compete for the remaining 30–40%

market share.

The essence of the GPO is

calling for ASP cuts and gener-

ics consolidation

7

Shanghai GPO supplementary document

The Shanghai GPO website announced a GPO supplementary document on Nov 21. This sup-

plementary policy is critical as 1) it specified important details for the official Nov 14 GPO docu-

ment; and 2) the National Medical Insurance Bureau designated the Shanghai GPO office as

responsible for GPO execution. So the market may take this as a top-level policy and assume

that other provinces will follow with similar details (Figure 2).

This will encourage manufacturers to do the consistency evaluation, because if their

drugs do not pass, their ASP will be no greater that those in the GPO market that passed.

Also, there will be the risk of losing that drug’s GPO market (near term 4+7 cities, longer

term maybe nationwide public hospitals’ 60–70% volume) once 3 or more players pass

the consistency evaluation. Even if they do not bid for the GPO tenders, they will still

have to cut their ASP and volume will also be reduced. So now there are obvious disad-

vantages if they do not pass the consistency evaluation or do not compete for the GPO

market vs. entering the GPO market and passing the consistency evaluation. Therefore,

we expect this to trigger a fierce price war for manufacturers to compete in the GPO mar-

ket, with the whole generics manufacturing sector the losers. But the leading players may

lose less, as they are more competitive in pushing BE tests and getting GPO market

share.

Overall, we believe the GPO is one of a series of policies calling for price cuts since the 2011

Anhui “Double Envelope Tendering”. Since the GPO is aimed at pushing generics to pass the

chemical generics consistency evaluation, the slow progress of the consistency evaluation pro-

cess may hinder GPO progress in expanding nationwide and to more drugs. In fact, since the

number of qualified clinical trial centres number is limited, BE progress for the “289 EDL” drugs

has been seriously delayed (by end-September 2018 only 18 drugs had completed the con-

sistency evaluation vs. the target of 289 completing BE by end-2018). Also, more detailed sup-

port polices are needed as a nationwide GPO with one exclusive manufacturer based on the

lowest price is dangerous, as there will be drug safety concerns if only one manufacturer is re-

sponsible for a drug’s nationwide supply.

60-70% publ ic hospita ls ' las t year procurement

4+7 cities market (31 drugs)

30-40% publ ic hospita ls ' las t year procurement

Hospitals can only procure from those passed the consistency evaluation drugs

Hospitals can procure those not passed the consistency evaluation drugs, but there is a price ceiling, i .e. the GPO tendering price

For a drug not chosen in GPO, i t still needs cut ASP. The ASP cut percentage will depend on the price difference between its 2017 tendering price and the GPO tendering price. The finalized price will be higher than GPO

price, but the price premium will be in a reasonable range. The price premium is

compensated for the loss of the GPO market.

Its used volume shall not exceed those GPO drugs after adjustment for the associated

percentage of the hospitals' total

procurement.

One GPO drug can only have one dis tributor. Manufacturer choosesdis tributor, which is required to cover a l l Shanghai area in 2017 and be able to distribute the 31 GPO

l i sted drugs to a ll the social medical insurance qualified institutions in

24hrs . Benefit leading distributors

Sino Pharm [1099.hk], Shanghai Pharm [2607.hk].

Hospitals pay 50% to manufacturers

within 5 working days of

procurement; either after half a year or procurement volume reached 50% of the GPO volume, pay another 45%; pay the remaining 5% at the end of the GPO period. Benefiting manufacturers as decl ined cash pressure.

Figure 2: Shanghai GPO supplementary document details

Source: Shanghai GPO office, CGIS research

8

Generics — the GPO’s list of 31 drugs

31 drugs on the list (6 drugs were withdrawn, as highlighted in blue, so only 25 remained)

The GPO announced the preliminary tender manufacturers on Dec 6, 2018, and the ASPs were

announced on December 7, 2018. The ASP cuts for some drugs (Figure 3) were 70–95%, which

was much more severe than market expectations of 10–40%. Six drugs were withdrawn due to

failure to reach a price agreement.

Order Category 品种名 Specification Manufacturers 预中选企业

Averaged price in

last 3 year

(Minimum Size)

Bidding Price Bidding Price

(minimum Size)Change %

1 Atorvastatin Calcium Tablets 阿托伐他汀钙片 20mg*7 Jialin Pharmaceutical 北京嘉林药业 5.8 6.6 0.94 -83.74%

2 Rosuvastatin Calcium Tablets 瑞舒伐他汀钙片 10mg*28 Jingxin Pharmaceutical 浙江京新药业 4.22 21.8 0.78 -81.55%

3 Clopidogrel Bisulfate Tablets 硫酸氢氯吡格雷片 75mg*7 Salubris Pharmaceuticals 深圳信立泰药业 8.72 22.26 3.18 -63.53%

4 lrbesartan Tablets 厄贝沙坦片 75mg*28 Huahai Pharmaceutical 浙江华海药业 0.66 5.66 0.20 -69.37%

5 Amlodipine Besylate Tablets 苯磺酸氨氯地平片 5mg*28 Jingxin Pharmaceutical 浙江京新药业 0.35 4.16 0.15 -57.55%

6 Entecavir Dispersible Tablets 恩替卡韦分散片 0.5mg*28 Chia Tai-Tianqing Pharmaceutical 正大天晴药业集团 14.14 17.36 0.62 -95.62%

7 Escitalopram Oxalate Tablets 草酸艾司西酞普兰片 10mg*7 Sichuan kelun Pharmaceutical 四川科伦药业 7.42 30.94 4.42 -40.43%

8 Paroxetine Hydrochloride Tablets 盐酸帕罗西汀片 20mg*20 Huahai Pharmaceutical 浙江华海药业 3.86 33.4 1.67 -56.74%

9 Olanzapine Tablets 奥氮平片 10mg*7 Haosen Pharmaceutical 江苏豪森药业 13.85 67.51 9.64 -30.37%

10 Cefuroxime Axetil Tablets 头孢呋辛酯片 250mg*12 Beite Pharmaceutical 成都倍特药业 1.08 6.16 0.51 -52.47%

11 Risperidone Tablets 利培酮片 1mg*60 Huahai Pharmaceutical 浙江华海药业 0.6 10.02 0.17 -72.17%

12 Gefitinib Tablets 吉非替尼片 250mg*10 AstraZeneca 阿斯利康制药 315.1 547 54.70 -82.64%

13 Fosinopril Sodium Tablets 福辛普利钠片 10mg*14 Bristol-Myers Squibb 百时美施贵宝制药 2.79 11.8 0.84 -69.79%

14 Irbesartan and Hydrochlorothiazide tablets 厄贝沙坦氢氯噻嗪片(150mg+12.5

mg)*14Huahai Pharmaceutical 浙江华海药业 3.72 15.26 1.09 -70.70%

15 Lisinopril Tablets 赖诺普利片 10mg*28 Huahai Pharmaceutical 浙江华海药业 1.33 6.45 0.71 -46.62%

16 Tenofovir Disoproxil Fumarate Tablets 富马酸替诺福韦二吡呋酯片 300mg*30 Beite Pharmaceutical 成都倍特药业 15.3 17.72 0.59 -96.14%

17 Losartan Potassium Tablets 氯沙坦钾片 50mg*14 Huahai Pharmaceutical 浙江华海药业 4.26 14.7 2.10 -50.70%

18 Amoxicil l in Capsules 阿莫西林胶囊 250mg CSPC Ouyi Pharmaceutical 石药集团中诺药业 0.3

19 Azithromycin Tablets 阿奇霉素片 250mg CSPC Ouyi Pharmaceutical 石药集团欧意药业 3.77

19 Azithromycin Tablets 阿奇霉素片 500mg CSPC Ouyi Pharmaceutical 石药集团欧意药业 4.71

20 Enalapril Maleate Tablets 马来酸依那普利片 10mg*16 Yangtze River Pharmaceutical 扬子江药业集团江苏制药 1.88 8.93 0.68 -63.83%

21 Levetiracetam Tablets 左乙拉西坦片 250mg*30 Jingxin Pharmaceutical 浙江京新药业 3.3 72 2.40 -27.27%

22 Tramadol Hydrochloride Tablets 盐酸曲马多片 50mg CSPC Ouyi Pharmaceutical 石药集团欧意药业 2

23 Imatinib Mesylate Tablets 甲磺酸伊马替尼片 100mg*60 Haosen Pharmaceutical 江苏豪森药业集团 18.42 623.82 13.90 -24.54%

24 Alfacalcidol Tablets 阿法骨化醇片 0.25μg Chongqing Yaoyou Pharmacy 重庆药友制药 1.39

25 Montelukast Sodium Tablets 孟鲁司特钠片 10mg*5 Minsheng Binjiang Pharmaceuticals 杭州民生滨江制药 2.87 19.38 3.88 35.05%

26 Captopril Tablets 卡托普利片 25mg Changzhou Pharmaceutical 常州制药厂 0.81

27 Montmorillonite Powder 蒙脱石散 3g*15 Simcere Pharmaceutical 先声药业 1.13 10.2 0.68 -39.82%

注射用培美曲塞二钠 500mg Sichuan Huiyu Pharmaceutical 四川汇宇制药 9283 2776.97 2776.97 -70.09%

注射用培美曲塞二钠 100mg Sichuan Huiyu Pharmaceutical 四川汇宇制药 2459.56 810 810.00 -67.07%

29 Flurbiprofen Axetil Injection 氟比洛芬酯注射液 50mg/5ml*5 Beijing Tide Pharmaceutical 北京泰德 310.8 109.75 21.95 -92.94%

30 Dexmedetomidine Hydrochloride Injection 盐酸右美托咪定注射液 0.2mg/2ml*4 Yangtze River Pharmaceutical 扬子江药业集团 153 532 133 -13.07%

31 Azithromycin for Injection 注射用阿奇霉素 0.5g Poly Pharm 海南普利制药 153

28 Pemetrexed Disodium for Injection

Sources: Shanghai GPO office, CGIS research

Figure 3: Officially announced GPO preliminary tendering price and associated ASP cut

9

GPO dynamic market landscape demonstration

Entecavir is used for the treatment of HBV. Currently Baraclude, from Bristol-Myers Squibb

(BMS), has a ~40% market share. Sino BioPharm, by virtue of its first-mover advantage and its

sales network for its liver disease line, became the largest domestic producer, and commands a

~40% market share. Other players share the remaining ~20%.

Jiangxi Qingfeng and Sino BioPharm were the first two to pass the chemical generics consistency

evaluation. From Jiangxi Qingfeng’s perspective, as it had <5% market share in the past, it had an

incentive to sacrifice price in exchange for sales volume. In other words, Qingfeng leveraged

passing the consistency evaluation quickly to gain a huge market share. If Qingfeng did not com-

pete for the GPO, its ASP would not have been better off because according to the Shanghai sup-

plementary policy, the non-GPO market ASP must not exceed that in the GPO market. Therefore,

we think Qingfeng was highly motivated to compete for the GPO market at the expense of an ASP

cut. This is why Sino BioPharm was forced to cut its ASP by >90%. Although only 4% of its reve-

nue is affected in this round of tenders, eventually about 20% of its revenue may be affected if the

GPO becomes nationwide.

Trend: Looking ahead, with more competitors passing the Entecavir consistency evalua-

tion, we expect the Sino BioPharm Entecavir to face a further ASP cut, despite the 95% cut this

year, in the next round of GPO reviews (i.e. one year later).

10

Chinese Traditional Medicine (CTM)

From a macro perspective, CTM is supported is supported by top-level policy. Specifically, CTM

finished drugs face the same downstream drug sales percentage cap, and CTM finished drugs

have no price mark-up. Therefore, we prefer Concentrated Chinese Medicine Granules (CCMG)

and CTM decoction pieces over CTM finished drugs, as the former two can have a 25% price

mark-up, and their sales will not be included in the drug sales percentage in some provinces,

which will motivate public hospitals to set up CTM departments and push CTM decoction pieces

and CCMG business.

In the H-share market, >70% of the profit of CTCM [570.hk] comes from CCMG, and it is proac-

tively expanding its CTM decoction pieces business through M&A and collaboration with Pingan

Group. This is why it is one of our 2019 conviction calls. We continue to like CCMG in 2019 be-

cause 1) we expect it to deliver strong growth, given its oligopolistic market nature; 2) some

provinces have maintained CCMG in the medical reimbursement list and kept a price mark up of

up to 25%; and 3) whether CCMG market opens up or not, both are good for CTCM. As far as

we know, the CCMG market opening-up policy does not have clear schedule yet. Before the

market opening-up, the existing five players will continue to benefit from the oligarchic market

structure and fast CCMG market growth. When the market opens up, it will be a trade-off be-

tween sharply enlarged market volume (more hospitals will be qualified to sell CCMG) and in-

creased competition. Based on our understanding, there will be a three year transitional period

for the existing players and entry barriers for newcomers, i.e. CTCM’s CCMG growth perspective

is still visible and high-teen revenue growth can still be expected after the CCMG license opens

up to more players.

Regarding the potential risk that CCMG may be removed from the provincial reimbursement drug

lists (PRDLs) and that the 25% mark-up in some provinces may be cancelled, we expect any

such removal or cancellation to have a limited impact on CCMG growth, because without the

mark-up or PRDL inclusion, CCMG still have the advantage of convenient intake method and

dosage flexibility compared to CTM finished drugs. Thus, CTCM can still rely on its channel ex-

pansion to boost sales and replace traditional Chinese finished drugs. Since CTCM’s Grade II

Chinese Traditional Medicine (CTM) hospital coverage is still relatively low, before the CCMG

market opens up, Grade II CTM hospital expansion can boost CCMG revenue growth. When the

CCMG market opens up to allow all CTM hospitals to sell CCMG, instead of only Grade II or

above, there will be a huge additional market for CCMG to grow, making the risk of the potential

cancellation of the 25% mark-up and the removal from the PRDL even smaller.

CCMG provincial medical insurance reimbursement update

We summarize the CCMG provincial medical insurance reimbursement as follows:

Reimbursed: Beijing, Jiangsu (reimbursement eligible only for Tianjiang, Yifang,

Kangrentang and China Resources 999), Sichuan, Ningxia, Yunnan, Zhejiang, Gansu, Qing-

hai, Guizhou, Inner Mongolia, Tianjin, Shaanxi, Shandong and Jiangxi (limited to local man-

ufacturers only).

Not reimbursed: Anhui, Fujian, Heilongjiang, Shanghai, Tibet, Guangdong (exclude

Shenzhen, Guangzhou, Foshan and Zhaoqing which explicitly stated reimbursed), Henan,

Hubei, Hunan, Xinjiang, Chongqing and Liaoning.

Refer to CTM decoction pieces regulations: Guangxi, Hainan, Jilin, Shanxi.

11

Distributors: high visibility in vulnerable 2019

Distributors are in the middle of the supply chain in the healthcare industry. Their primary value is

to provide logistics services for drug distribution and facilitate purchases by downstream users

(hospitals, clinics, medical institutions, retail drug stores, etc). We prefer distributors in 2019 for

the following main reasons:

With the nationwide implementation of the two invoice system by 2018, which calls for fewer

distribution layers and more distribution consolidation, we expect the short-term negative

impact on leading distributors’ internal transfer business to fade further in 2019. We saw an

increasing percentage of direct sales to hospitals for leading distributors in 2018 (raised to

80% for Sino Pharm and 70% for Shanghai Pharm as of Q3 2018). We have also seen earn-

ings recovery of the leading distributors since Q2 2018.

Some new growth engines have emerged: Leading distributors have put effort into the retail

business (prescription outsourcing opportunities), the high-margin medical device distribution

business, and SOE reforms (such as employee stock option plans).

Benefiting from GPO: One GPO drug can only have one distributor. According to the Shang-

hai GPO supplementary document, eligible distributors are required to cover the entire

Shanghai area in 2017 and should be able to distribute the 31 GPO listed drugs to all social

medical insurance qualified institutions within 24 hours. We believe the leading players will

have an advantage, and we note that SinoPharm and Shanghai Pharm alone share the

whole Shanghai GPO distribution market.

749.3

1291.3

1860.1

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2011 2015 2020

China distribution market

RMBbn

Sources: Frost & Sullivan

Note: In 2015, there were ~11,000 distributors (2012: ~13,700), with the top three players having

a combined 40% market share and the biggest 100 players having a 70% market share. We ex-

pect to see fewer small companies with no upstream or downstream sales network survive. The

most promising way out for small- to medium-size companies with certain resources is to seek

coordination with the leading distributors or be acquired by big players. This basically offers plen-

ty of M&A opportunities for the leading players with the acquisition cost as low as 5–8x PER.

The pharmaceutical distribution market is driven mainly by 1) the aging population; 2) extended

healthcare commercial insurance coverage; and 3) upstream drug manufacturing development.

Figure 4: China distribution market size

Consolidation is a long-term

trend in China’s distribution

industry, despite some short-

term pain (e.g. internal transfer

business is affected for the

leaders).

12

Distributors: Benefiting from the GPO

According to the Shanghai GPO office, the Shanghai 4+7 GPO distributors’ results were pub-

lished on December 7, 2018. We see clearly that the two leading players shared the whole

Shanghai GPO distribution market, which further confirms our logic that the leading distributors

will benefit from the GPO, based on their strong channel capability and the GPO’s requirement re

distributor eligibility; that is, from the manufactures’ perspective, as GPO drugs will involve rela-

tively large volume, they will be inclined to choose the leading distributors.

We believe 2019 is good tim-

ing to build up long-term posi-

tions in the leading distributors,

as they likely hit bottom in

2018.

Figure 5: Shanghai GPO drugs distribution market shared by two leaders

Sources: Shanghai GPO office, CGIS research

Order Category 品种名 Specification Manufacturers 预中选企业 Distributor

1 Atorvastatin Calcium Tablets 阿托伐他汀钙片 20mg*7 Jialin Pharmaceutical 北京嘉林药业 SinoPharm

2 Rosuvastatin Calcium Tablets 瑞舒伐他汀钙片 10mg*28 Jingxin Pharmaceutical 浙江京新药业 ShanghaiPharm

3 Clopidogrel Bisulfate Tablets 硫酸氢氯吡格雷片 75mg*7 Salubris Pharmaceuticals 深圳信立泰药业 ShanghaiPharm

4 lrbesartan Tablets 厄贝沙坦片 75mg*28 Huahai Pharmaceutical 浙江华海药业 ShanghaiPharm

5 Amlodipine Besylate Tablets 苯磺酸氨氯地平片 5mg*28 Jingxin Pharmaceutical 浙江京新药业 ShanghaiPharm

6 Entecavir Dispersible Tablets 恩替卡韦分散片 0.5mg*28 Chia Tai-Tianqing Pharmaceutical 正大天晴药业集团 ShanghaiPharm

7 Escitalopram Oxalate Tablets 草酸艾司西酞普兰片 10mg*7 Sichuan kelun Pharmaceutical 四川科伦药业 SinoPharm

8 Paroxetine Hydrochloride Tablets 盐酸帕罗西汀片 20mg*20 Huahai Pharmaceutical 浙江华海药业 SinoPharm

9 Olanzapine Tablets 奥氮平片 10mg*7 Haosen Pharmaceutical 江苏豪森药业 ShanghaiPharm

10 Cefuroxime Axetil Tablets 头孢呋辛酯片 250mg*12 Beite Pharmaceutical 成都倍特药业 ShanghaiPharm

11 Risperidone Tablets 利培酮片 1mg*60 Huahai Pharmaceutical 浙江华海药业 SinoPharm

12 Gefitinib Tablets 吉非替尼片 250mg*10 AstraZeneca 阿斯利康制药 ShanghaiPharm

13 Fosinopril Sodium Tablets 福辛普利钠片 10mg*14 Bristol-Myers Squibb 百时美施贵宝制药 SinoPharm

14 Irbesartan and Hydrochlorothiazide tablets 厄贝沙坦氢氯噻嗪片(150mg+12.5

mg)*14Huahai Pharmaceutical 浙江华海药业 ShanghaiPharm

15 Lisinopril Tablets 赖诺普利片 10mg*28 Huahai Pharmaceutical 浙江华海药业 ShanghaiPharm

16 Tenofovir Disoproxil Fumarate Tablets 富马酸替诺福韦二吡呋酯片 300mg*30 Beite Pharmaceutical 成都倍特药业 ShanghaiPharm

17 Losartan Potassium Tablets 氯沙坦钾片 50mg*14 Huahai Pharmaceutical 浙江华海药业 ShanghaiPharm

20 Enalapril Maleate Tablets 马来酸依那普利片 10mg*16 Yangtze River Pharmaceutical 扬子江药业集团江苏制药 SinoPharm

21 Levetiracetam Tablets 左乙拉西坦片 250mg*30 Jingxin Pharmaceutical 浙江京新药业 SinoPharm

23 Imatinib Mesylate Tablets 甲磺酸伊马替尼片 100mg*60 Haosen Pharmaceutical 江苏豪森药业集团 SinoPharm

25 Montelukast Sodium Tablets 孟鲁司特钠片 10mg*5 Minsheng Binjiang Pharmaceuticals 杭州民生滨江制药 SinoPharm

27 Montmorillonite Powder 蒙脱石散 3g*15 Simcere Pharmaceutical 先声药业 SinoPharm

注射用培美曲塞二钠 500mg Sichuan Huiyu Pharmaceutical 四川汇宇制药 SinoPharm

注射用培美曲塞二钠 100mg Sichuan Huiyu Pharmaceutical 四川汇宇制药 SinoPharm

29 Flurbiprofen Axetil Injection 氟比洛芬酯注射液 50mg/5ml*5 Beijing Tide Pharmaceutical 北京泰德 ShanghaiPharm

30 Dexmedetomidine Hydrochloride Injection 盐酸右美托咪定注射液 0.2mg/2ml*4 Yangtze River Pharmaceutical 扬子江药业集团 SinoPharm

28 Pemetrexed Disodium for Injection

13

Downstream: continuing to push hierarchy diagnosis and treatment

One of the key problems in China’s current medical system is that there is no hierarchical diag-

nosis, so premium medical resources (such as famous doctors in Grade III hospitals) are preoc-

cupied with minor diseases.

In 2018, the National Health Committee continued to promote hierarchy diagnosis and treatment,

emphasized inducing patient flow from high-tier hospitals to lower-tiers ones. The authorities put

forward the following:

Accelerating the construction of the Medical Federation, including establishing an Urban

Medical Group and a County Medical Community, setting up a Major Diseases and Medical

Resource Shortages Specialist Alliance, and constructing a Telemedicine Collaborative Net-

work to introduce high-quality medical resources to lower-tier cities.

Constructing regional medical centers to provide medical resources for critical patients.

Upgrading county-level hospitals’ medical treatment capabilities.

We believe the promotion of hierarchy diagnosis and treatment will make better use of premium

medical resources and improve the overall efficiency of the healthcare sector.

Besides hierarchy diagnosis and treatment, other major measures are indispensable for public

hospital reform (such as appraisal reforms for hospital administrators, drugs zero price mark-up,

drugs sales percentage cap and updating the National Essential Drugs List (EDL)). The ultimate

winners of hospital reform will be the medical reimbursement fund and patients, as their money

will be spent on necessary treatment rather than on overtreatment or unreasonably high drug

prices. Physicians will also benefit, as their value to patients will be more easily identified (i.e.

much higher physician service fees), and this will eventually be reflected in more competitive

compensation packages. For hospitals, in the short term, public hospital reform calls for a reve-

nue structure change from the original “drug sales + government subsidy + medical services” to

the targeted “higher medical services charges + government subsidy”. But higher medical ser-

vices charges currently don't have a clear time schedule. We previously expected 2–3 years for

the reforms to be fully implemented, but first-line practitioners expect an even longer time. Over-

all, the reforms mean short-term pain for long-term gain for hospitals. We expect hospitals to

continue to underperform in 2019.

We believe the promotion of

hierarchy diagnosis and treat-

ment will make better use of

premium medical resources

and improve the overall effi-

ciency of the healthcare sec-

tor.

14

The 2018 version of EDL

The National Health Commission released the 2018 edition of the National Essential Drugs List

(EDL) on October 25, 2018. The new EDL came into effect on November 1, 2018. We are ex-

pecting the new EDL to help optimize the medical institutions’ medication structure.

The 2018 edition of the EDL was revised on the basis of the 2012 edition. Overall, the 2018 edi-

tion EDL has the following characteristics: 1) the number of drugs has been increased from 520

to 685, of which 417 are Western medicines and 268 are Chinese finished drugs (including eth-

nical medicines), which can better serve different classes of medical institutions and stimulate

the deployment and preferential use of essential drugs; 2) it optimized the drug catalogue struc-

ture, focusing on the basic drugs needed for common diseases and chronic diseases, and the

heavy burden of fatal diseases and public health, and emphasizing children’s and other special

groups’ medication needs by adding 12 types of cancer drugs and 22 kinds of clinically urgently

needed children’s drugs; 3) it further standardized dosage, forms and specifications. The 685

drugs have more than 1,110 dosage forms and 1,810 specifications; 4) it continued to empha-

size both Chinese and Western medicines simultaneously; and 5) it strengthened clinical neces-

sity. Of the 165 newly added drugs, 11 are not covered by medical insurance, such as the direct

HCV drugs Sophobovir and Verapamil.

Specifically, we note that the authorities put many inspiring clinically indispensable drugs in the

2018 EDL, including six targeted oncology drugs: Gefitinib, Imatinib, Icotinib, Rituximab,

Trastuzumab and Pemetrexed. Also, Sofosbuvir and Velpatasvir, from Gilead, for the treatment

of HCV, is included. In the antivirus field, Entecavir’s inclusion is exciting too. For diabetes, we

note that GLP-1 Liraglutide and 3rd generation insulin Glargine were included. In summary, the

2018 edition EDL addition confirmed the authorities’ efficiency and determination to support clini-

cally indispensable drugs within a shorter period of time.

The 2018 version of the EDL

covers the major clinical diseas-

es, is better adapted to basic

medical and health needs, pro-

vides basic support to further

improve the basic drug system,

and meets the people's basic

drug needs for disease preven-

tion and control with high quality.

No. in l ist Chinese name English name Form and specifications Related l isted companies Remarks

Chemical and Bio drugs

49 恩替卡韦 Entecavir 片剂：0.5mg、1.0mg,分散片：0.5mg、1.0mg, 胶囊：0.5mg SinoBio Pharm

48 奥司他韦 Oseltamivir 胶囊：30mg、45mg、75mg, 颗粒剂：15mg、25mg HEC

87 苯溴马隆 Benzbromarone 片剂：50mg, 胶囊：50mg HEC

92 溴隐亭 Bromocriptine 片剂：2.5mg CMS

169 非洛地平 Felodipine 片剂：2.5mg、5mg,缓释片：2.5mg、5mg CMS

171 左氨氯地平 levamlodipine （苯磺酸盐、马来酸盐）片剂：2.5mg CSPC

244 右旋糖酐铁 Iron dextran 口服溶液剂：5ml:25mg（Fe）、10ml:50mg（Fe） Consun

250 重组人促红素（CHO 细胞） Recombinant Human Erythropoietin (CHO Cell) 注射液：2000IU、3000IU、10000IU 3SBio

277 甘精胰岛素 Insulin Glargine 注射液：3ml:300 单位（预填充）、3ml:300 单位（笔芯） TUL

288 吡格列酮 Pioglitazone 片剂：15mg、30mg, 胶囊：15mg、30mg Luye, CSPC, CMS

283 格列齐特 Gliclazide 片剂（Ⅱ）：80mg Baiyunshan

50 利巴韦林 Ribavirin 片剂、胶囊：0.1g Ascletics Negative impact

51 索磷布韦维帕他韦 Sofosbuvir and Velpatasvir 片剂：每片含400mg 索磷布韦和100mg 维帕他韦 Ascletics Negative impact

53 重组人干扰素 Recombinant Human Interferon Ascletics Negative impact

Chinese Traditional drugs

58 清开灵颗粒软胶囊 Shineway

248 滑膜炎颗粒颗粒 Shineway

11 金叶败毒颗粒颗粒剂：每袋装10g CTCM

111 鳖甲煎丸丸剂 CTCM

Figure 6: EDL-related HK-listed companies

Source: CGIS research

15

Implications of the 2018 EDL version

The new version EDL covers the major clinical diseases, is better adapted to basic medi-

cal and health needs, provide support to further improve the essential drug system, and

meets the people's basic drug needs with high quality drugs. The key is how to secure

the supply and use of the EDL drugs in medical institutions.

The State has mandatory requirements. The earliest requirement was that EDL drugs should be

used in all primary medical institutions. The proportion of EDL drugs used in Grade II hospitals

should reach 40%–50%, and that in Grade III hospitals should reach 25%–30%. In fact, the pro-

portion of EDL drugs used in hospitals at all levels is difficult to achieve. Current documents re-

quire only that "the proportion of essential drugs used in public medical institutions should be

clearly defined in provincial units", "the bidders of EDL drugs should be responsible for prompt-

ing medical institutions to give priority to procure EDL drugs and doctors to give priority to use

EDL drugs". On November 5, 2018, the Liaoning Health and Planning Commission issued the

“Notice on Implementing the 2018 Edition of the National Essential Drug Catalogue”. Liaoning

became the first province to explicitly state that EDL drugs will not be counted for drugs sales

percentage. The policy has greatly supported EDL drugs through 1) reiterating the dominant role

of EDL drugs in medical institutions’ drugs usage; 2) calling for improved EDL drug quality; 3)

increasing the EDL drug usage percentage; and 4) requiring medical institutions to procure at

least a certain percentage of EDL drugs in their drug procurement (for community level clinics

and other Grade I or below medical institutions, the EDL drug procurement percentage should

be at least 60%. For Grade III general hospitals and Chinese Traditional Medicine hospitals, the

EDL drug procurement percentage should exceed 35% and 20%, respectively. Specialty hospi-

tals' EDL drug procurement percentage should be higher than 25%).

In 2019, we expect local authorities to push forward detailed plans on securing EDL drug use,

following Liaoning.

16

Valuation

Source: WIND, CGIS research

To access the valuation after the 2H2018 correction in the healthcare sector, we plotted the fol-

lowing TTM valuation charts for the past three years for the chemical, TCM, biology, distributors

and medical device sub-sectors. Figure 8 is a close-up glance, excluding the biology sub-sector

TTM, whose TTM is exceptionally high, which compressed the graph.

We note that the chemicals, TCM, distributors and medical device sub-sectors are at a three

year low TTM valuation.

Specifically, the chemicals sub-sector faces the risk of the GPO expanding nationwide faster

than expected and a larger-than-expected ASP cut, which may suppress the sub-sector re-

rating or even trigger a further de-rating in 2019. For the TCM and distributors sub-sectors,

we don’t see significant downside risks from a TTM valuation perspective or from the policy

side. Therefore, our conviction calls come from these two sub-sectors. When considering

high earnings visibility and low exposure to policy risks, especially to the GPO, our top picks

are Shanghai Pharm [2607.HK], CTCM [570.HK] and SinoPharm [1099.HK]. The biology sub

-sector’s TTM valuation may be biased, as our proxy stocks include Genscript [1558.hk],

whose PER is exceptionally high because the market gives value to its CAR-T. We are con-

cerned that investors may not prefer their relative low earnings visibility in the vulnerable

2019 market conditions.

0

20

40

60

80

100

120

140

160

180

200

Chemicals TCM Biology H-market Distributors Medical device

TTM(x)

Figure 7: TTM PER of the Hong Kong-listed healthcare sub-sectors

Notes:

1. We use H shares + red chips to represents the Hong Kong-listed market average valuation.

2. Our statistical analysis focuses on data post-Stock Connect, since the relative valuation relationship may

have been changed by the Stock Connect.

17

Valuation

Source: WIND, CGIS research

0

5

10

15

20

25

30

35

40

Chemicals TCM H-market Distributors Medical device

TTM(x)

Figure 8: PER of the Hong Kong-listed healthcare sub-sectors (excluding the biology sub-sector)

Figure 9: Valuation table for major healthcare companies (data as at Jan 4, 2019)

Source: Capital IQ

Price Mkt cap

Company Ticker HK$ HK$m 2018E 2019E 2020E 2018E 2019E 2020E 2018E 2019E 2020E 2018E 2019E 2020E

CSPC PHARMACEUTI* 1093 11.08 69,095 17.7 13.9 10.9 3.6 3.0 2.5 22.6 24.1 25.7 10.9 8.5 6.4

Sino Biopharmaceutical Limited 1177 5.02 63,252 18.6 16.7 14.3 3.7 3.1 2.6 25.8 23.4 22.4 13.8 10.5 8.9

3SBio Inc. * 1530 9.10 23,150 17.7 14.5 12.1 2.3 2.1 1.8 14.5 15.5 16.2 16.6 13.9 11.9

Luye Pharma Group Ltd. 2186 5.24 17,161 11.8 10.0 9.0 1.8 1.5 1.3 16.5 16.3 15.5 11.1 9.9 8.7

Livzon Pharmaceutical Group Inc. 1513 21.45 15,423 12.0 10.8 9.2 1.3 1.1 1.0 10.2 10.9 11.7 9.6 8.1 6.9

YiChang HEC ChangJiang Pharmaceutical Co., Ltd.* 1558 26.95 12,181 13.1 14.0 11.6 3.0 2.4 2.0 25.4 19.1 19.1 6.6 5.8 4.2

The United Laboratories International Holdings Limited 3933 4.22 6,921 9.6 7.7 6.5 1.1 0.9 0.8 10.2 12.6 12.6 5.7 4.9 4.1

Lee's Pharmaceutical Holdings Limited 950 5.59 3,309 12.4 11.2 9.5 1.6 1.5 1.3 14.6 14.2 14.6 7.8 6.7 5.7

Essex Bio-Technology Limited 1061 3.98 2,304 10.5 8.7 7.2 n.a n.a n.a n.a n.a n.a n.a n.a n.a

Simple average 13.7 11.9 10.0 2.3 1.9 1.7 17.5 17.0 17.2 10.3 8.6 7.1

Median 12.4 11.2 9.5 2.0 1.8 1.6 15.5 15.9 15.8 10.2 8.3 6.7

China Traditional Chinese Medicine Holdings Co. Limited* 570 4.51 22,712 12.5 10.8 9.1 1.0 0.9 0.8 10.4 10.4 11.1 5.6 4.0 2.9

Tong Ren Tang Technologies Co. Ltd. 1666 9.99 12,797 15.2 14.0 12.9 1.8 1.6 1.6 11.9 11.3 11.9 7.7 7.7 6.2

China Shineway Pharmaceutical Group Limited 2877 7.79 6,442 9.8 8.2 6.8 0.9 0.9 0.8 9.6 11.2 13.0 5.7 4.9 4.2

Consun Pharmaceutical Group Limited 1681 4.70 4,113 7.8 6.8 5.8 1.7 1.4 1.2 23.3 23.3 22.5 n.a n.a n.a

Simple average 11.3 9.9 8.7 1.3 1.2 1.1 13.8 14.1 14.6 6.4 5.6 4.4

Median 11.1 9.5 7.9 1.3 1.2 1.0 11.2 11.3 12.5 5.7 4.9 4.2

Sinopharm Group Co. Ltd.* 1099 31.10 92,429 13.5 11.9 10.3 2.0 1.8 1.6 15.5 15.7 16.2 7.7 7.1 6.4

China Resources Pharmaceutical Group Limited 3320 9.93 62,410 15.0 12.7 10.7 1.3 1.2 1.1 9.1 9.8 10.2 7.2 11.2 6.0

Shanghai Pharmaceuticals Holding Co., Ltd. * 2607 15.56 44,222 9.6 8.4 7.3 1.0 0.9 0.8 11.0 11.2 11.7 6.6 5.7 4.9

China Medical System Holdings Limited 867 7.01 17,385 7.9 7.1 6.3 1.8 1.5 1.3 24.3 23.3 22.9 8.6 6.6 5.5

Simple average 11.5 10.0 8.6 1.5 1.4 1.2 15.0 15.0 15.2 7.5 7.7 5.7

Median 11.6 10.2 8.8 1.5 1.4 1.2 13.3 13.5 14.0 7.5 6.9 5.8

PER(x) PBR(x) ROE(%) EV/EBITDA (x)

1

BUY (Initiation coverage)

Close: HK$15.56 (Jan 04, 2019)

Target Price: HK$22.3 (+43.3%)

Price Performance

Market Cap US$5,692m

Shares Outstanding 2842.1m

Auditor PWC

Free Float 64%

52W range HK$15.32-24.25

3M average daily T/O US$0.45m

Major Shareholding Shanghai SASAC

(23.5%)

Sources: Company, Bloomberg

Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]

Liz Li —Analyst

(852) 3698 6297

[email protected]

The key investment themes for Shanghai Pharm (SPH) are 1) continued mid-teen revenue growth

momentum expected for the pharmaceutical segment for existing key products after marketing

and sales reforms; (2) Techpool’s ramp-up after being integrated into SPH’s sales network; 3) the

recovery of the profitability of its associates and JVs in 2019; and 4) the recovery of the distribu-

tion business with the impact from the two-invoice system on the internal distribution business

fading and synergies with the Cardinal China business emerging. Overall, we expect SPH’s EPS

growth to rebound from 9.4% in 2018E to 14.4% in 2019E. We value SPH at 12x 2019 PER

(multiple corresponds to its expected 13% EPS CAGR in 2017–2020E, lower than distributors’

TTM average of ~13x after considering weak market sentiment), which translates into a target

price of HK$22.3. We initiate our coverage with a BUY recommendation and make it one of our

2019 top picks because of its high earnings visibility and the limited impact of policy uncertainties

(especially the GPO).

Investment thesis

Manufacturing segment becoming an important growth driver: Going forward, we expect

SPH’s manufacturing segment to contribute 51%/52%/53% of total gross profit in

2018/19/20E, respectively, due to 1) the consolidation of Techpool (SPH acquired another

26.34% stake in May 2018, changing it from an associate to a subsidiary with a total stake of

67.14%; the deal was closed in August 2018). Two major Techpool products will enrich

SPH’s key product portfolio: linastatin for injection, for acute and chronic pancreatitis and

acute circulatory failure (shock), and Kailikang, suitable for mild to moderate acute thrombotic

cerebral infarction. Also, SPH can leverage its sales channels to boost its Techpool products,

which have relatively high coverage in Grade III hospitals, into lower-tier hospitals; 2) ex-

pected strong growth momentum of existing key products after marketing and sales reforms;

3) SPH’s leading progress in chemical consistency evaluation (it has already initiated 70

products; half are in the clinical trial stage, and two have already completed the trials and

applied to the CFDA: Fluoxitine Hydrochloride Capsules and Captopril Tablets).

Limited impact of the GPO: Almost half of the manufacturing segment are CTMs, which

have very little exposure to GPO risks. Also, most of SPH’s chemical generics are in the low-

cost drug catalogue, which are also largely immune from the GPO. Overall, we expect the

GPO to have <3% earnings impact on SPH, making SPH a good defensive play in 2019.

Recovery in the distribution segment: Looking ahead, we believe the short-term impact

of the two-invoice system on the sales-to-distributor business has been gradually fading

since Q2 2018, when the implementation of the policy expanded nationwide. In the long run,

the policy will benefit the distribution leaders due to consolidation. Moreover, we expect SPH

to create synergy with Cardinal China regarding advanced logistics management, channel

expansion, imported product distribution, and Direct-to-Pharmacy (DTP) business. Cardinal

China is expected to break even in 2018 (after deducting all M&A-related one-off costs), and

we project SPH to double Cardinal China’s net margin from ~0.5% currently to ~1% in three

years, i.e. contributing 5–6% of total profit in 2020E.

Sources: Company, CGIS Research estimates

0

5

10

15

20

25

30

35

40

5

10

15

20

25

30

Volume(RHS) Price(LHS)

HK$ HK$m

Y/E Dec 31 2016A 2017A 2018E 2019E 2020E

Revenue (RMBm) 120,765 130,847 141,996 154,401 167,798

Core net profit (RMBm) 3,163 3,513 4,073 4,657 5,314

YoY 11.1% 10.1% 15.9% 14.4% 14.1%

Core net margin (%) 2.6 2.7 2.9 3.0 3.2

Core EPS (RMB) 1.18 1.31 1.43 1.64 1.87

YoY 11.1% 10.1% 9.4% 14.4% 14.1%

PER (x) 11.6 10.5 9.6 8.4 7.3

PBR (x) 1.2 1.1 1.0 0.9 0.8

ROE(%) 10.1 10.7 11.0 11.2 11.7

EV/EBITDA (x) 8.1 7.8 6.6 5.7 4.9

2

Source: Company, CGIS Research estimates

Balance Sheet Profit and Loss

Year ended Dec 31 2016A 2017A 2018E 2019E 2020E Year ended Dec 31 2016A 2017A 2018E 2019E 2020E

(RMBm) (RMBm)

Cash & cash equivalents 11,967 14,842 25,925 29,910 34,195 Maunfacturing 10,334 12,476 14,472 16,643 18,973

Inventories 16,416 17,270 19,371 20,319 22,701 Distribution 104,865 112,265 120,685 130,098 140,246

Trade & note receivables 31,880 36,530 37,386 42,987 44,360 Retail 5,113 5,604 6,277 7,030 7,874

Others 4 1 1 1 1 Others 453 502 562 629 705

Current assets 60,267 68,642 82,683 93,217 101,256 Revenue 120,765 130,847 141,996 154,401 167,798

PP&E 7,201 9,386 9,464 9,538 9,609 Cost of goods sold (106,873) (114,661) (123,832) (134,138) (145,391)

Intangible assets 7,284 8,092 8,304 8,510 8,712 Gross profit 13,892 16,187 18,164 20,263 22,406

Others 7,992 8,224 8,515 8,821 9,155 Selling expense (6,067) (7,411) (7,824) (8,646) (9,397)

Non-current assets 22,476 25,702 26,282 26,869 27,476 Admin & other expenses (4,045) (4,098) (4,544) (4,941) (5,370)

Share profit of JV - 212 254 303 361

Total assets 82,743 94,344 108,965 120,087 128,731 Share profit of associates 528 339 453 430 425

Operating profit 4,308 5,229 6,504 7,408 8,426

Trade and bills payables 31,130 35,115 36,131 41,045 42,605 Other income 294 198 213 232 252

Other payables 341 722 722 722 722 Other gains/losses 137 239 0 0 0

ST borrowings 9,641 13,792 20,326 22,078 24,076 Disposal of JV/associates 0 207 0 0 0

Others 1 2 2 2 2 Finance cost (525) (668) (837) (888) (949)

Current liabilities 41,113 49,632 57,182 63,848 67,406 Pretax income 4,639 5,205 5,880 6,752 7,728

Income taxes (809) (1,147) (1,190) (1,384) (1,597)

LT borrowings 2,836 2,959 3,587 3,896 4,249 MI 633 537 618 710 817

Others 1,959 2,078 2,078 2,078 2,078 Net profit 3,196 3,521 4,073 4,657 5,314

Long-term liabilities 4,795 5,037 5,665 5,974 6,327 Core net profit 3,163 3,513 4,073 4,657 5,314

Total liabilities 45,908 54,669 62,847 69,822 73,733 EBITDA 5,851 6,361 7,375 8,306 9,351

Basic EPS (RMB) 1.189 1.309 1.433 1.639 1.870

Shareholders' equity 17,484 17,453 20,226 20,226 20,226 Fully diluted EPS (RMB) 1.189 1.309 1.433 1.639 1.870

Reserves 14,138 16,578 19,629 23,065 26,982 Basic core EPS (RMB) 1.176 1.306 1.433 1.639 1.870

Minority interests 5,212 5,645 6,263 6,973 7,790 Fully diluted core EPS (RMB) 1.176 1.306 1.433 1.639 1.870

Total equity 36,834 39,676 46,118 50,264 54,998 Dividend (RMB) 0.360 0.380 0.430 0.492 0.561

Payout 30.6% 29.1% 30.0% 30.0% 30.0%

Cash Flow

Year ended Dec 31 2016A 2017E 2018E 2019E 2020E Key Ratios

(RMBm) Year ended Dec 31 2016A 2017A 2018E 2019E 2020E

Profit before tax 4,639 5,205 5,880 6,752 7,728

Depreciation & amortization 824 934 659 666 674 Growth (% YoY)

Change in working cap. (2,488) (2,547) (1,942) (1,635) (2,194) Sales 14.5 8.3 8.5 8.7 8.7

Income tax paid (1,008) (904) (1,190) (1,384) (1,597) Operating profit 11.4 10.5 24.4 13.9 13.7

Others (749) (1,047) (708) (733) (786) EBITDA 9.4 8.7 15.9 12.6 12.6

Operating cash flow 1,218 1,641 2,699 3,666 3,826 Core net profit 10.0 11.0 15.9 14.4 14.1

Basic EPS 11.1 10.1 9.4 14.4 14.1

CAPEX (1,452) (515) (900) (900) (900) Core EPS 11.1 10.1 9.4 14.4 14.1

Change in other assets (1,265) (1,679) 369 379 405 Profitability (%)

Investment cash flow (2,718) (2,194) (531) (521) (495) Gross margin 11.50 12.37 12.79 13.12 13.35

Operating margin 3.6 4.0 4.6 4.8 5.0

Net change in debt 906 22 0 0 0 EBITDA margin 4.8 4.9 5.2 5.4 5.6

Others 298 3,139 8,915 840 953 Core net profit margin 2.6 2.7 2.9 3.0 3.2

Financing cash flow 1,204 3,161 8,915 840 953 ROA 3.8 4.0 4.0 4.1 4.3

ROE 10.1 10.7 11.0 11.2 11.7

Net change in cash (295) 2,608 11,083 3,985 4,284 Balance sheet ratios

Cash at beginning of the year 11,278 10,980 13,569 24,653 28,638 Current ratio (X) 1.47 1.38 1.45 1.46 1.50

Effect from foreign exchange (3) (19) 0 0 0 Quick ratio (X) 1.07 1.04 1.11 1.14 1.17

Cash at the end of the year 10,980 13,569 24,653 28,638 32,922 Cash ratio (X) 0.29 0.30 0.45 0.47 0.51

Trade & bill receivables days 95 95 95 95 95

Trade & bill payable days 105 105 105 105 105

Inventory turnover days 55 54 54 54 54

Total debt to equity ratio (%) 9.0 8.7 9.0 9.0 9.0

Net debt to equity ratio (%) 2.9 10.9 Net cash Net cash Net cash

3

SPH: A leading drug manufacturer and distributor

SPH is an A+H listed company, which has vertically integrated segments of pharmaceutical R&D,

manufacturing, distribution, and retail. Founded in 1994, this industry-leading giant has been pro-

ducing more than 800 drugs across therapeutical areas of the digestive system & metabolism,

cardiovascular system, systemic anti-infection, psychoneural and anti-tumor. SPH acquired anoth-

er two pharmaceutical giants, Takeda Chromo Beteiligungs AG and Vitaco Holding, in the past

two years to further consolidate its vertical supply chain.

Figure 1: SPH M&As milestones

Source: Company

Figure 3: SPH performance of key subsidiaries (RMB m)

RMBm

Principal subsidiaries Business Nature Shareholding % 2015 2016 2017 YoY % 2017 revenue 2015 2016 2017 YoY % 2017 profit

Shanghai Pharma Co., Ltd Sales of drugs 100% 63,432 75,130 81,555 8.6% 62.3% 1,024 1,225 1,325 8.2% 37.6%

SPH Keyuan Xinhai Pharmaceutical Co., Ltd. Sales of drugs 100% 24,207 27,736 29,270 5.5% 22.4% 271 237 679 186.8% 19.3%

SPH Sine Pharmaceutical Factory Co., Ltd. Production and sales of drugs 100% 2,937 3,192 3,574 12.0% 2.7% 182 187 267 42.4% 7.6%

SPH No. 1 Biochemical & Pharmaceutical Co., Ltd. Production and sales of drugs 100% 1,192 1,002 1,313 31.1% 1.0% 370 260 298 14.6% 8.5%

SPH New Asia Pharmaceutical Co., Ltd. Production and sales of drugs 97% 2,027 1,980 1,997 0.9% 1.5% 41 61 34 -44.0% 0.9%

Shanghai TCM Co., Ltd. Production and sales of drugs 100% 4,473 4,785 5,052 5.6% 3.9% 212 525 334 -36.3% 9.5%

SPH Chiatai Qingchunbao Pharmaceutical Co., Ltd. Production and sales of drugs 75% 1,203 1,239 1,277 3.1% 1.0% 136 164 184 12.1% 3.9%

SPH Changzhou Pharmaceutical Co., Ltd. Production and sales of drugs 76% 4,935 5,277 5,762 9.2% 4.4% 160 152 196 29.1% 4.2%

SPH Zhongxi Sunve Pharmaceutical Co., Ltd. Production and sales of drugs 100% 882 812 908 11.8% 0.7% 315 302 339 12.2% 9.6%

Revenue Net profit

Source: Company, CGIS research

Figure 2: SPH major products sales in the pharmaceutical industry segment (RMB m)

RMBm

Prodcuts Therapeutic area 2015 2016 2017 YoY(15-16) YoY(16-17)

丹參酮ⅡA磺酸鈉注射液 Cardiovascular System 401 330 412 -17.7% 24.8%

硫酸羥氯喹片 Antineoplastic drug and immunomodulator 417 486 551 16.6% 13.4%

雙歧桿菌三聯活菌 Digestive and Metabolism 382 349 475 -8.8% 36.3%

注射用鹽酸頭孢替安 Systemic Anti-infection 302 326 418 7.8% 28.1%

Revenue

Source: Company, CGIS research

4

Major growth drivers

1) Manufacturing segment to deliver mid-teen revenue growth in the next few years

SPH produces over 800 varieties of drugs and 20 dosage forms regularly, with ~60% of revenue

concentrated in 60 key products. Up to 28 products generate revenue >RMB100m/year. SPH

covers most hospital terminals and retail terminals all over China through its own and dealer/

agent marketing channels. Overall, we expect drug manufacturing business revenue to deliver

mid-teen top-line growth on the basis of the Techpool consolidation and sales team reform.

We expect the manufacturing segment to have ~15%/15% of top-line growth in 2019/20E, respec-

tively, following >20% growth in 2018E. The slowdown in the pace of growth takes into considera-

tion overall ASP pressure for generics and downstream medical insurance cost control.

2) Recovery of the distribution business

The distribution industry-wide impact of the “two-invoice-system” policy has negatively affected

distributor-to-distributor sales. Half of the destocking process (caused by the policy) of the sales-

to-distributor business of SPH has been completed so far, leaving RMB6–7bn. Looking ahead, we

expect the short-term impact of the two-invoice system on the sales-to-distributor business to

gradually fade starting in 2H2018, when the implementation of the policy was completed nation-

wide. In the long run, the policy will benefit the distribution leaders due to consolidation, as Chi-

na’s distribution market is highly fragmented. We expect SPH’s distribution business to deliver

7.5%/7.8%/7.8% top-line growth in 2018/19/20E, respectively. The acceleration in 2019E reflects

1) the fading impact of the two-invoice system; 2) synergies from Cardinal China; and 3) benefits

to leading distributors from the GPO (as we discuss in the GPO part in the industry section of this

report).

3) Gross margin to gradually ramp up

We are projecting SPH’s gross margin to gradually increase, as its high-margin manufacturing

business is growing much faster then other segments. We estimate SPH’s overall gross margin to

be 12.9%/13.1%/13.3% in 2018/19/20E, respectively, up from 12.4% in 2017.

4) Steady growth of JVs and associates

We are forecasting SPH’s major JVs and associates to deliver increasing profitability (for details,

please refer to the “JVs and Associates” part of this report on the next page).

Maunfacturing

10%

Distribution 85%

Retail5%

Others0%

Figure 4: SPH 2018E revenue breakdown

Source: CGIS research estimate

Figure 5: SPH 2018E gross profit breakdown

Source: CGIS research estimate

Maunfacturing 51%

Distribution 42%

Retail6%

Others1%

5

SPH’s major associates and JVs are Shanghai Hutchison Pharmaceutical Co., Ltd. (in which SPH

indirectly holds a 50% stake), Shanghai Roche Pharmaceutical Co., Ltd. (indirectly holding a 30%

stake) and Sino-American Shanghai Squibb Pharmaceuticals Ltd. (directly holding a 30% stake).

Techpool Bio-Pharma Co., Ltd. became a subsidiary after SPH acquired another 26.34% stake,

which increased SPH’s stake from 40.8% to 67.14% in May 2018 (transaction closed in August

2018).

Shanghai Hutchison Pharmaceuticals

Shanghai Hutchison Pharmaceuticals produces 74 well-known traditional Chinese medicines

(TCMs), including Heart-protecting musk pills, Danning tablets and Shengmai injections. Its main

product, Heart-protecting musk pills, is an exclusive secret product that is highly effective in treat-

ing coronary heart disease. Heart-protecting musk pills have become a nationally well-known

TCM, with the highest production and sales volume in the form of pills, generating annual revenue

of more than RMB1.5bn. The Company moved its factory to Fengxian District in 2016 and got

land compensation for its old site, which boosted its profit in 2017 to RMB800m. Its 2017 net profit

shows a stable growth rate when the effect of the land compensation is disregarded. We expect

the Company to maintain stable and rapid growth in its future performance as a result of the new

factory's increased production capacity.

Shanghai Roche Pharmaceuticals

Roche operates as Shanghai Roche Pharmaceuticals in China. In 2017, Shanghai Roche Phar-

maceuticals had operating income of RMB10.45bn, a YOY decline of 5.38%, and net profit of

RMB399m, a YOY decline of 16.71%. We believe these declines were mainly due to price reduc-

tions for the drugs listed on the National Reimbursement Drug List (NRDL). In June 2017, the

catalogue for national drug price negotiations was released and Roche had four products

(trastuzumab, bevacizumab, rituximab and Erlotinib) listed, with price reductions from 30% to

66%, effective in Q3 2017, which had a negative impact on the Company’s performance in 2017.

With the execution of national medical insurance reforms, we expect the Company’s 2018 perfor-

mance to recover and grow as a result of a volume boost after the price reductions.

Sino-American Shanghai Squibb Pharmaceuticals

Sino-American Shanghai Squibb Pharmaceuticals (SASS) is Bristol-Myers Squibb’s (BMS) drug

import agent in China. In 2017, SASS’s operating income was RMB5.1bn, for YoY growth of

8.54%, while its net profit was RMB284m, a YoY decline of 54.34%. The main reasons for the

decline were 1) high marketing expense to launch its new drug for HCV treatment – Daclatasvir- –

which was approved by the CFDA in May 2017; and 2) a dramatic increase in marketing expens-

es to build a new cancer drug sales team, following submission of its new blockbuster anti-PD-1

drug Opvido to the CFDA. We believe that with the increasing sales of Daclatasvir and the release

of Opvido, Squibb’s performance will improve rapidly in the Chinese market.

JVs and Associates

6

SPH competitive edges

Figure 6: SPH innovative drugs R&D pipeline

The key competitive edges of SPH are 1) vertical integration. SPH is vertically integrated, with a

rich product portfolio and strong sales channels; 2) solid R&D capabilities. SPH’s leading progress

in chemical consistency evaluation (it has already initiated 70 products; half are in the clinical trial

stage, and two have already completed the trials and applied to the CFDA, Fluoxitine Hydrochlo-

ride Capsules and Captopril Tablets) can put SPH in the first tier in capturing market restructuring

opportunities in the generics market. As for R&D in innovative drugs, SPH is developing primarily

15 Bio-antibody/Novel drugs in its current pipeline; and 3) SPH’s sole distribution rights for Keytru-

da and Nivolumab.

Strong R&D pipeline

SPH invested RMB756m in 9M2018 in its R&D departments in mainland China, Hong Kong and

U.S., chiefly developing 15 Bio-antibody/Novel drugs in the current pipeline, including Lei Teng

Shu, which targets chronic abnormal immune activation in AIDS infections, and SPH3127, a type

of Renin inhibitor to lower blood pressure. Its R&D expense to manufacturing revenue percentage

was 5% in 9M2018, which still has further room to increase compared to the domestic pharma-

ceutical manufacturer average 4–12%. We are expecting SPH’s R&D ratio to gradually increase,

with SPH spending more and more on innovative drugs.

PD-1/PD-L1 inhibitors’ distribution – great potential

The Company operates four pharmaceutical research centres in the US, HK and Shanghai (from

a combination of acquisitions and organic builds) to boost its R&D capabilities, as well as gaining

rights to various drug pipelines. This partial acquisition strategy has led to a more balanced pipe-

line complementing the Company’s own internal strengths.

Two out of the four National Medical Products Administration (NMPA) approved PD-1/PD-L1 in-

hibitors are solely imported and distributed by Shanghai Pharm in the China market. The

Nivolumab drug, the first PD-1 drug in China generated RMB160m in sales as at the end of 3Q18

after being in the market for only about one month. We expect Keytruda and Nivolumab to under-

go explosive sales growth in China in 2019, providing huge opportunities for SPH.



Figure 7: PD-1/PD-L1

7

Valuation

Figure 8: SPH (H shares) PER band

SPH (H shares) have historically traded at ~13x TTM PER on average, mostly ranging from 11x

to 15x TTM. Given expected weak market sentiment on healthcare stocks in 2019, we set our

SPH target price at 12x 2019E PER, i.e. HK$22.3. Currently, SPH’s valuation is at a historical low.

We believe this gives SPH a high margin of safety, together with its high earnings visibility, so we

believe investors should accumulate SPH shares at the current price level.

Source: CGIS research, Bloomberg

10

15

20

25

30

35

1/2014 6/2014 11/2014 4/2015 9/2015 2/2016 7/2016 12/2016 5/2017 10/2017 3/2018 8/2018

HK$

11.1X

16.8X

14.9X

13.0X

9.2X

8

SPH company background

SPH, previously known as Shanghai No. 4 Pharmaceutical Co., Ltd. (上海四藥股份有限公司),

was incorporated in China on 18 January 1994. The Company was listed on the Shanghai Stock

Exchange on 24 March 1994. In 1998, Shanghai Pharmaceutical (Group) Corporation, the prede-

cessor of Shanghai Pharmaceutical (Group) Co., Ltd. (“Shanghai Pharma Group”, 上海醫藥（集

團）有限公司), which was the intermediate holding company of the Company, injected certain

assets and wholly owned subsidiaries (“new assets”) into the Company. In return, the Company

issued 40,000,000 new domestic shares (“A Shares”) and disposed of all of its assets and liabili-

ties before the new asset injection to Shanghai Pharma Group. After the new asset injection, the

Company changed its name to Shanghai Pharmaceutical Co., Ltd. (上海市醫藥股份有限公司)

and was then engaged in the distribution of pharmaceutical products. In 2009, to streamline and

restructure the pharmaceutical businesses under the control of Shanghai Pharma Group and

Shanghai Industrial Investment (Holdings) Co., Ltd. (Shanghai Industrial Group, 上海實業（集

團）有限公司), the ultimate holding company of the Company, the Company entered into a se-

ries of restructuring agreements with Shanghai Pharma Group, Shanghai Industrial Group, and

their respective subsidiaries. After these restructuring transactions were completed in 2010, the

Company changed its name to Shanghai Pharmaceuticals Holding Co., Ltd. (上海醫藥集團股份有

限公司). SPH was listed on Hong Kong Stock Exchange in May 2011.

Figure 9: SPH shareholder structure

Source: Company

9

Source: Company

Figure 10: SPH management background

Name and

position

Zhou Jun(周军) , Chairman &

Non- Executive Director

Cho Man(左敏), Executive

Director & President

Li Yongzhong(李永忠),

Executive

Director & Vice

President

Shen Bo(沈波), Executive

Director, Vice President and CFO

Gender and Age Male, 49 Male, 57 Male, 48 Male 45

Education

Background

Bachelor’s degree of Arts from

Nanjing University

Master’s degree of Economics

in International Finance from

Fudan University.

Bachelor’s degree in pharmacy

from Sichuan University

Master’s degree in management

from Fudan University

EMBA degree from China

Europe International Business

School Qualified pharmacist

Bachelor’s degree in accounting

from Shanghai Institute of

Construction Materials Industry

Master’s degree in professional

accountancy from Chinese

University

of Hong Kong

Experience

Sep 16-Current: President of

Shanghai Industrial Holdings

Jun14-Current: Chairman of

Shengtai Investment and

Chairman Previous role: Chairman

of SIIC Environment Holdings Ltd

Previous role: Independent non-

executive director of Zhenjiang

Expressway

Previous role: Chairman of

Shanghai Shen-Yu Development


Shanghai Galaxy Investments Co.,

Ltd.

Jun 13- Current: Shanghai

Pharmaceuticals Holdings Ltd

Previous role: Vice chairman and

CEO of Wing Fat Printing Co., Ltd

Previous role: Vice president of

China Resources Pharmaceutical

Group Ltd.

Jun 16-Current: Shanghai

Pharmaceuticals Holdings Ltd


Xiamen Traditional Chinese Med

Previous role: Chairman of Xiamen China Resources Pharmaceutical

Traditional Chinese Med Group Ltd.

Jun 16-Current: Executive Director

Previous role: non-executive

director of Tianda Pharmaceuticals

Ltd.

Previous role: non-executive

director of Shanghai Fudan-

Zhangjia Bio- Pharmaceutical Co.,

Ltd.

Number of shares

held at the end of

year 2017

0

20,009 A-shares

0

71,700 A Shares

1


Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]


We don’t believe the management personnel change has had any impact on the earnings

visibility of CTCM. Our understanding is that new management team can enhance CTCM ’s

connection with its largest shareholder, China National Pharmaceutical Group (CNPG). We

strongly recommend investors buy on recent share price weakness caused by market reac-

tion to the management personnel change. CTCM is one of our top picks in 2019 because of

1) the limited effect of the GPO on the Company; 2) its high earnings visibility, with mid-

teens EPS growth, driven by CCMG and the fast growth of TCM decoction pieces; and 3) its

attractive valuation. We keep our target price of HK$6.5 (16x 2019E PER) and maintain our

BUY recommendation for the Company. CTCM is the only company whose valuation multi-

ple we kept in this round of target price review amid weak healthcare sector sentiment, be-

cause in our view it has the highest earnings visibility.

Investment thesis

Management personnel change: We believe management personnel change will have

no impact on the earnings visibility of CTCM, considering 1) Wang Xiaochun still holds the

Executive Director position; 2) the previous management team will still be retained in the

group with different positions; and 3) there will be a stronger connection with CNPG. There-

fore, we believe market correction on CTCM regarding the management change may have

been an overreaction.

We expect CCMG to deliver robust growth: Going forward, we expect CCMG to contin-

ue to achieve >25% sales growth because of 1) the existing hospital market for replacing

CTM decoction pieces; 2) enhanced academic promotion with new hospitals; and 3) the

expected fast growth of sales via medicine dispensing machines, whose sales percentage

has increased from 30% in 2017 to the current ~44%.

CTM finished drugs expected to recover: We project that CTM finished drugs will de-

liver stable high single-digit growth, driven by finished OTC products, such as Biyankang

and Fengliaoxing, because of enhanced retail channels.

CTM decoction pieces another growth driver: In the next few years, CTCM will focus

on CTM decoction pieces, because developing CTM decoction pieces will benefit it from a

vertical integration perspective, and CTM decoction pieces can create synergy with CCMG

by sharing sales channels. We expect CTM decoction pieces to contribute >10% of total

revenue, reaching ~RMB1.4bn in sales in 2018E, and further ramping up to RMB2.5bn in

2019E and RMB3bn in 2020E (vs. CTM decoction pieces leader Kangmei (600518.CH) with

>RMB6bn in sales), leveraging 1) the improving utilization rate of Fengliaoxing and Shang-

hai Tongjitang; and 2) more M&A. Also, its margins are expected to gradually ramp up on

economies of scale and synergies.

BUY (Unchanged)

Close: HK$4.51 (Jan 4, 2019)


Price Performance

Market Cap US$2893m


Auditor KPMG

Free Float 55.6%

52W range HK$4.21-7.57


Major Shareholding China National Pharma-

ceutical Group Corpora-

tion (36%)

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120

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160

180

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7

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HK$ HK$m

Y/E Dec 31 2016A 2017A 2018E 2019E 2020E

Turnover (RMBm) 6,533 8,338 11,489 14,612 17,326

Net profit (RMBm) 967 1,170 1,505 1,817 2,161

Core net profit (RMBm) 974 1,170 1,505 1,817 2,161

Core net margin (%) 14.9 14.0 13.1 12.4 12.5

Core EPS (RMB) 0.22 0.26 0.31 0.36 0.43

YoY(%) 51.3 20.2 17.9 15.9 18.9

PER (x) 18.1 15.0 12.5 10.8 9.1

PBR (x) 1.5 1.4 1.0 0.9 0.8

ROE(%) 8.6 9.7 10.4 10.4 11.1

EV/EBITDA (x) 10.4 8.1 5.6 4.0 2.9

2



As at Dec 31 Year ended Dec 31

(RMBm) (RMBm)

Cash & cash equivalents 3,423 4,788 8,150 9,038 10,335 CCMG 4,359 5,500 7,370 9,212 11,239

Inventories 1,894 3,552 2,172 2,701 2,963 TCM finished drugs 2,174 2,381 2,619 2,750 2,888

Accounts receivable 2,716 3,024 4,971 6,156 7,433 TCM decoction pieces - 399 1,400 2,500 3,000

Others 37 20 20 20 20 TCM healthcare complex - 58 100 150 200

Current assets 8,070 11,384 15,314 17,915 20,751 Revenue 6,533 8,338 11,489 14,612 17,326

Property, plant and equipment 2,356 2,740 3,237 3,860 4,400 Cost of goods sold (2,745) (3,686) (5,430) (7,109) (8,465)

Intangible assets 6,764 6,704 6,773 6,841 6,906 Gross profit 3,788 4,652 6,059 7,503 8,861

Goodw ill 3,456 3,486 3,486 3,486 3,486 Other gains / (losses) 82 120 64 76 87

Others 390 571 571 572 573 Marketing expenses (1,968) (2,437) (3,136) (4,018) (4,765)

Non-current assets 12,966 13,501 14,068 14,759 15,366 Admin & other expenses (517) (552) (747) (950) (1,126)


Total assets 21,037 24,885 29,382 32,675 36,117 Net interest income / (expense) (73) (221) (218) (162) (136)

Non-operating items 0 2 1 1 1

Accounts payable 2,304 3,857 4,073 5,332 6,349 Pretax income 1,304 1,567 2,022 2,450 2,921

ST borrow ings 1,001 639 600 600 600 Income taxes (217) (256) (344) (417) (497)

Others 202 200 200 200 200 Non-controlling interests (120) (141) (173) (216) (264)

Current liabilities 3,507 4,695 4,872 6,132 7,149 Net profit 967 1,170 1,505 1,817 2,161

Long-term debts 2,909 4,515 4,482 4,482 4,482 Core net profit 974 1,170 1,505 1,817 2,161

Others 1,866 1,860 1,860 1,860 1,860

Long-term liabilities 4,774 6,375 6,342 6,342 6,342 EBIT 1,264 1,647 2,067 2,395 2,793

EBITDA 1,714 2,210 2,573 3,021 3,551

Total liabilities 8,281 11,070 11,215 12,474 13,491

EPS (RMB) 0.218 0.264 0.311 0.361 0.429

Shareholders' equity 11,588 12,437 16,616 18,433 20,594 Core EPS (RMB) 0.220 0.264 0.311 0.361 0.429

Minority interests 1,168 1,378 1,552 1,768 2,032 DPS (HK$) 0.100 0.106 0.093 0.108 0.129

Total equity 12,756 13,815 18,168 20,201 22,626 Payout ratio 40.2% 40.0% 30.0% 30.0% 30.0%

Cash Flow Key Ratios

Year ended Dec 31 Year ended Dec 31 2016A 2017A 2018E 2019E 2020E

(RMBm) Growth (% YoY)

Profit before tax 1,304 1,567 2,022 2,450 2,921 Sales 76.1 27.6 37.8 27.2 18.6

Depr & amortization 337 423 333 410 494 Operating profit 80.9 29.8 25.4 16.6 17.1

Change in w orking cap. (349) (413) (351) (455) (521) EBITDA 86.0 29.0 16.4 17.4 17.5

Income tax paid (204) (293) (344) (417) (497) Core net profit 81.8 20.2 28.6 20.7 18.9

Others 378 (49) 217 161 135 Core EPS 51.3 20.2 17.9 15.9 18.9

Operating cash flow 1,465 1,236 1,878 2,149 2,533 Profitability (%)

Gross margin 58.0 55.8 52.7 51.3 51.1

Capex (760) (711) (900) (1,100) (1,100) Operating margin 21.1 21.4 19.5 17.9 17.6

Cash for acquisition of subsidiaries (742) 0 0 0 0 EBITDA margin 26.2 26.5 22.4 20.7 20.5

Change in other assets (998) 1,104 0 0 0 Core net profit margin 14.9 14.0 13.1 12.4 12.5

Investment cash flow (2,500) 393 (900) (1,100) (1,100) ROA 4.8 5.1 5.5 5.9 6.3

ROE 8.6 9.7 10.4 10.4 11.1

Net change in debt 1,460 1,244 (72) 0 0 Balance sheet ratios

Proceeds from new shares 0 0 2,674 0 0 Current ratio (X) 2.3 2.4 3.1 2.9 2.9

Others (332) (458) (218) (162) (136) Quick ratio (X) 1.0 1.1 1.7 1.5 1.5

Financing cash flow 1,128 786 2,384 (162) (136) Cash ratio (X) 0.7 1.1 1.7 1.5 1.5


Net change in cash 92 2,414 3,362 888 1,297 Trade & bill payable days 53 34 64 47 46

Cash at beginning of the year 2,102 2,373 4,788 8,150 9,038 Inventory turnover days 208 220 158 125 122

Effect from foreign exchange (47) (31) 0 0 0 Total debt to equity ratio (%) 24.2 42.2 32.8 21.9 16.5

Cash at the end of the year 2,373 4,788 8,150 9,038 10,335 Net debt to equity ratio (%) 4.2 2.9 Net cash Net cash Net cash

2020E2020E

2020E

2019E

2018E

2018E 2019E

2019E

2018E2016A 2017A

2016A 2017A

2016A 2017A

3


Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]


Going forward, regarding the top line, SinoPharm’s distribution business is expected to

maintain above industry-average growth, and its retail business revenue growth is also

expected to remain strong. The bottom line will grow faster, with a stabilized gross margin

and stringent cost control. With the negative impact of the two invoice system gradually

fading, we believe SinoPharm will have relatively high earnings visibility going forward. We

cut our target price from HK$43.1 (16x 2019E PER) to HK$38.1 (14x 2019E PER; the 14x

multiple is lower than its historical TTM average, reflecting the lower risk appetite of inves-

tors after the sharp market correction). We give a valuation premium to SinoPharm (14x)

over SPH (12x 2019 PER), given 1) SinoPharm’s leading position in the distribution busi-

ness and 2) its higher gross margin and better cost control. Maintain BUY. It is one of our

2019 top picks because of its high earnings visibility and limited impact from the GPO.

Investment thesis

Gross margin expected to be stable: Going forward, we expect the gross margin

of the Company to stay at 8.8%–8.9%, considering 1) currently SinoPharm’s direct

sales (i.e., distribution direct to hospitals) accounts for 89% of its distribution revenue,

and we don’t think there is much room for further upside because drug distribution in

some remote areas cannot be handled with just two invoices; three invoices are need-

ed and the policy allows this; 2) we expect the positive impact of product portfolio opti-

mization from more sales of high-margin medical devices to be offset by indirect pres-

sure from the ASP decline from the GPO.

Distributor bottoming-out story remains intact: As distribution (drugs + medical

devices) accounts for ~90% of SinoPharm’s profit, we reiterate that we expect Si-

noPharm’s strong bottoming-out since Q4 2017 to continue in Q4 2018 and 2019, with

the negative impact of the two invoice system on internal transfers fading (this policy

had a total impact of ~RMB13bn on the top line, which was largely digested by

9M2018) and more M&A involving lower-tier distributors. Also, its retail business (~4%

of total profit) is expected to remain robust at >20% revenue growth, given opportuni-

ties from prescriptions flowing from hospital to hospital using nearby drug stores under

the drug zero price mark-up policy and medical insurance cost control in hospitals.

Along with SinoPharm’s stringent cost control on SG&A and financial expenses and

manageable AR days, we believe SinoPharm will have relative high earnings visibility

going forward.

Benefiting from the GPO: Because each GPO drug can have only one distribu-

tor, the manufacturers designated a distributor to cover the whole Shanghai area in

2017, which can distribute the 31 GPO-listed drugs to all the social medical insurance-

covered institutions within 24 hours. We believe the stringent requirements on distribu-

tors will benefit the leading players, and the top two have shared the Shanghai GPO

distribution market.

BUY (Unchanged)

Close: HK$31.1 (Jan 04, 2019)


Price Performance



Auditor E&Y

Free Float 40%

52W range HK$29.35-45.65

3M average daily T/O US$27m

Major Shareholding CNGPC(56.8%)

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HK$ HK$m

Y/E Dec 31 2016A 2017A 2018E 2019E 2020E

Revenue (RMBm) 258,388 277,717 303,478 332,971 366,972

Core net profit (RMBm) 4,647 5,283 5,811 6,620 7,657

Core net margin (%) 1.8 1.9 1.9 2.0 2.1

Core EPS (RMB) 1.68 1.91 2.10 2.39 2.77

YoY 23.2% 13.7% 10.0% 13.9% 15.7%

PER (x) 16.3 14.4 13.5 11.9 10.3

PBR (x) 2.4 2.1 2.0 1.8 1.6

ROE(%) 15.0 15.7 15.5 15.7 16.2

EV/EBITDA (x) 9.0 8.0 7.7 7.1 6.4

4



Year ended Dec 31 2016A 2017A 2018E 2019E 2020E Year ended Dec 31 2016A 2017A 2018E 2019E 2020E

(RMBm) (RMBm)

Cash & cash equivalents 30,590 33,870 43,498 40,617 44,206 Pharmaceutical distribution 243,883 261,636 283,937 309,625 339,409

Inventories 25,760 26,769 32,377 35,807 41,130 Retail 10,202 12,342 15,427 18,821 22,585

Trade & note receivables 69,245 75,529 90,760 100,812 110,322 Other business 4,303 3,740 4,113 4,525 4,977

Others 7,164 8,676 9,182 10,534 12,208 Revenue 258,388 277,717 303,478 332,971 366,972

Current assets 132,760 144,843 175,818 187,771 207,867 Cost of goods sold (237,717) (254,640) (276,772) (303,503) (334,311)

PP&E 6,752 7,796 9,434 10,917 12,258 Gross profit 20,671 23,077 26,706 29,468 32,660

Intangible assets 6,283 6,674 6,838 6,996 7,148 Other income 272 400 334 366 404

Others 11,917 10,226 10,816 11,334 11,888 Selling expense (6,619) (7,383) (8,649) (8,990) (9,908)

Non-current assets 24,952 24,696 27,088 29,246 31,294 Admin & other expenses (4,110) (4,187) (4,552) (4,995) (5,505)


Other gains-net 411 359 0 0 0

Total assets 157,712 169,539 202,905 217,017 239,161 Finance cost-net (1,932) (2,534) (3,349) (3,878) (3,757)

Share of JV - 10 18 22 26

Trade and bills payables 66,746 66,613 78,977 80,674 95,183 Share of Associates 232 431 695 769 841

Other payables 9,680 13,160 11,105 15,503 13,806 Pretax income 8,925 10,173 11,203 12,762 14,762

ST borrowings 22,363 30,163 50,000 50,000 50,000 Income taxes (2,033) (2,305) (2,465) (2,808) (3,248)

Others 949 941 941 941 941 MI 2,244 2,585 2,927 3,335 3,857

Current liabilities 99,737 110,876 141,023 147,119 159,929 Net profit 4,647 5,283 5,811 6,620 7,657

Core net profit 4,647 5,283 5,811 6,620 7,657

LT borrowings 11,135 5,441 1,500 1,300 1,100

Others 2,306 1,952 1,952 1,952 1,952 EBITDA 11,281 12,921 14,994 17,166 19,114

Long-term liabilities 13,442 7,393 3,452 3,252 3,052 Basic EPS (RMB) 1.680 1.909 2.100 2.392 2.767

Fully diluted EPS (RMB) 1.675 1.904 2.095 2.386 2.760

Total liabilities 113,179 118,269 144,474 150,370 162,981 Basic core EPS (RMB) 1.680 1.909 2.100 2.392 2.767

Fully diluted core EPS (RMB) 1.675 1.904 2.095 2.386 2.760

Shareholders' equity 31,811 35,451 39,684 44,565 50,241 Dividend (RMB) 0.500 0.570 0.628 0.716 0.828

Treasure stock - (193.00) (193.00) (193.00) (193.00) Payout 29.8% 29.9% 30.0% 30.0% 30.0%

Minority interests 12,722 16,012 18,939 22,274 26,131

Total equity 44,532 51,270 58,431 66,647 76,180

Key Ratios

Cash Flow Year ended Dec 31 2016A 2017A 2018E 2019E 2020E

Year ended Dec 31 2016A 2017E 2018E 2019E 2020E

(RMBm) Growth (% YoY)


Depreciation & amortization 1,068 1,017 1,155 1,316 1,462 Operating profit 10.7 16.6 16.2 14.5 11.4

Change in working cap. (128) (1,674) (11,036) (8,739) (3,696) EBITDA 10.3 14.7 16.1 14.5 11.4

Income tax paid (2,046) (2,305) (2,465) (2,808) (3,248) Core net profit 23.2 13.7 10.0 13.9 15.7

Others 1,439 (5,544) (695) (769) (841) Basic EPS 23.2 13.7 10.0 13.9 15.7

Operating cash flow 9,258 1,667 (1,838) 1,763 8,440 Core EPS 22.9 13.7 10.0 13.9 15.7

Profitability (%)

CAPEX (1,414) (2,563) (2,900) (2,900) (2,900) Gross margin 8.00 8.31 8.80 8.85 8.90

Change in other assets (192) 16 58 195 230 Operating margin 4.0 4.3 4.6 4.8 4.8

Investment cash flow (1,606) (2,547) (2,842) (2,705) (2,670) EBITDA margin 4.4 4.7 4.9 5.2 5.2

Core net profit margin 1.8 1.9 1.9 2.0 2.1

Net change in debt 26,885 2,107 15,896 (200) (200) ROA 3.1 3.2 3.1 3.2 3.4

Others (28,912) 2,196 (1,577) (1,739) (1,981) ROE 15.0 15.7 15.5 15.7 16.2

Financing cash flow (2,027) 4,302 14,318 (1,939) (2,181) Balance sheet ratios

Current ratio (X) 1.33 1.31 1.25 1.28 1.30

Net change in cash 5,625 3,422 9,638 (2,881) 3,589 Quick ratio (X) 1.07 1.06 1.02 1.03 1.04

Cash at beginning of the year 19,966 25,573 29,011 38,649 35,768 Cash ratio (X) 0.31 0.31 0.31 0.28 0.28

Effect from foreign exchange (18) 16 0 0 0 Trade & bill receivables days 95 95 100 105 105

Cash at the end of the year 25,573 29,011 38,649 35,768 39,357 Trade & bill payable days 97 96 96 96 96



Net debt to equity ratio (%) 9.1 4.9 20.2 24.0 13.7

5


Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]


We revisited 3SBio’s fundamentals after the correction. We believe the GPO, which targets

chemical generics that passed the consistency evaluation, will have a limited impact on its

biological business. We cut our earnings forecasts for 3SBio’s existing business by

2.4%/6.2%/6.3% for 2018/19/20E, respectively, since Byetta (GLP-1) now faces pressure

from Novo Nordisk, whose Victoza has been included in the NRDL at the cost of a 48% ASP

cut. To reflect the lower risk appetite of investors after the sharp market correction, we lower

our valuation multiple and thus trim our target price from HK$17.0, which consisted of

HK$15.4 (23x 2019E PER, ~0.9x PEG) for existing business and HK$1.6 for Trastuzumab,

to HK$10.9, which consists of HK$9.8 (16x 2019E PER for existing business) plus HK$1.1

for Trastuzumab. The new valuation multiple is set at 16x, considering 1) historically the

market valued 3SBio and CSPC at almost the same level; and 2) 3SBio’s 16x is a bit higher

than the 15x of CSPC, mainly because of 3SBio’s much lower GPO risk. We believe 3SBio

may be a good shelter for investors who wish to avoid GPO risks in 2019. Maintain BUY.

Investment thesis

The growth outlook for TPIAO and Yisaipu remains intact: Competition risks exist

mainly for 3SBio’s insulin business, but TPIAO and Yisaipu are not expected to face

competition pressure in the next few years. The market is well-aware of the competitive

EPO market. Going forward, 3SBio will continue to expand its sales team, especially for

TPIAO, since it is included in the NRDL. We believe TIPAO is on track to deliver >30%

revenue growth, and the growth outlook for Yisaipu also remains intact, as top-line

growth is expected to be in the high single digits to low teens.

Insulin business may face pressure: Byetta (GLP-1) now faces pressure from Novo

Nordisk, whose Victoza was included in the NRDL at the cost of a 48% ASP cut in July

2017. We therefore cut our revenue forecast for Byetta from RMB150/165/182m to

RMB80/90/100m in 2018/19/20E, respectively. We also cut our top-line projection num-

bers for Bydureon from 15/50/100m to RMB15/35/50m in 2018/19/20E, respectively, to

reflect potentially more fierce-than-expected competition.

Market correction overdone on 3SBio: We believe the Company’s share price was

pulled down mainly by the healthcare sector rather than by Company fundamentals, as

biological drugs are not directly affected by the GPO policy. We believe this correction

will provide a re-entry opportunity for 3SBio once healthcare sector sentiment stabilizes.

Trastuzumab is worth HK$1.1: Trastuzumab is for breast cancer. 3SBio withdrew

its NDA in 2016 and re-submitted it in Q3 2018. According to China Pharmaceutical

Pipeline Monitor (CPM), the status of 3SBio’s Trastuzumab has been updated from

"production approval application submitted" to "under review" by the CDE on Septem-

ber 10. This is a big step towards its final launch. It is expected to be the first bio-

similar Trastuzumab to Roche's original drug HERCEPTIN in China.

BUY

(Unchanged)

Close: HK$9.1 (Jan 04, 2019)


Price Performance


Shares Outstanding 2,534m

Auditor E&Y

Free Float 47.2%

52W range HK$8.21-23.25


Major Shareholding CS Sunshine Investment

(28.3%)

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HK$ HK$m

Y/E Dec 31 2016A 2017A 2018E 2019E 2020E

Turnover (RMB m) 2,797 3,734 4,941 5,734 6,682

Net profit (RMB m) 713 958 1,145 1,401 1,679

Net margin (%) 25.5 25.6 23.2 24.4 25.1

EPS (RMB) 0.282 0.369 0.451 0.553 0.662

YoY change 21.0 30.7 22.4 22.4 19.8

PER (x) 28.4 21.7 17.7 14.5 12.1

PBR (x) 3.0 2.7 2.3 2.1 1.8

ROE(%) 11.6 12.8 14.5 15.5 16.2EV/EBITDA (x) 30.8 22.1 16.6 13.9 11.9

6


B alance Sheet P ro f it and Lo ss

Year ended D ec 31 Year ended D ec 31

(R M B m) (R M B m)

Cash & cash equivalents 1,040 3,103 2,627 2,750 3,365 Yisaipu 786 1,013 1,114 1,359 1,686

Inventories 262 377 532 583 645 TPIAO 765 975 1,462 1,828 2,230

Trade & note receivables 786 1,324 1,752 2,033 2,369 EPIAO 677 705 726 762 823

Others 153 472 472 472 472 SEPO 96 151 211 274 343

C urrent assets 2,241 5,276 5,384 5,838 6,852 Byetta - 131 80 90 100

PP&E 1,763 1,760 1,957 2,120 2,249 Bydureon - - 15 35 50

Intangible assets 2,289 2,254 2,274 2,294 2,369 Humulin - 197 750 788 827

Goodwill 4,126 3,924 3,924 3,924 3,924 Others 473 563 583 598 624

Others 621 540 542 543 545 R evenue 2,797 3,734 4,941 5,734 6,682

N o n-current assets 8,798 8,477 8,695 8,880 9,087 Cost o f goods so ld (402) (676) (986) (1,113) (1,269)

Gro ss pro f it 2,395 3,058 3,955 4,620 5,413

T o tal assets 11,039 13,753 14,079 14,718 15,939 Other gains / (losses) 59 56 178 78 78

Selling expense (1,017) (1,333) (1,877) (2,093) (2,439)

Trade and bills payables 59 275 394 445 508 Admin & other expenses (301) (315) (321) (355) (414)

Other payables 502 696 791 834 903 R&D expenses (243) (257) (360) (393) (469)

ST borrowings 518 1,087 1,000 600 200 Operat ing pro f it 893 1,209 1,574 1,857 2,169

Others 64 138 138 138 138 Net finance cost (124) (120) (128) (86) (45)

C urrent liabilit ies 1,144 2,196 2,323 2,017 1,749 Share of results o f JV & associates (12) (14) 2 2 2

Non-operating items 93 49 0 0 0

LT borrowings 2,541 3,319 2,500 2,200 2,200 Pretax income 850 1,124 1,448 1,773 2,125

Others 588 609 609 609 609 Income taxes (136) (178) (291) (356) (426)

Lo ng-term liabilit ies 3,129 3,928 3,109 2,809 2,809 Non-contro lling interests 2 (11) 13 16 20

Net profit 713 958 1,145 1,401 1,679

T o tal liabilit ies 4,272 6,123 5,432 4,826 4,558 C o re net pro f it 706 893 1,145 1,401 1,679

Shareholders' equity 6,522 7,397 8,401 9,630 11,099 EBITDA 1,054 1,452 1,907 2,224 2,514

M inority interests 244 233 246 262 282 Basic EPS (RM B) 0.28 0.37 0.45 0.55 0.66

T o tal equity 6,766 7,630 8,647 9,892 11,381 Fully diluted EPS (RM B) 0.28 0.35 0.41 0.51 0.61

Basic core EPS (RM B) 0.28 0.35 0.45 0.55 0.66

Fully diluted core EPS (RM B) 0.28 0.34 0.41 0.51 0.61

Dividend (RM B) 0.00 0.06 0.07 0.08 0.10

C ash F lo w

Year ended D ec 31 2016A 2017E 2018E 2019E 2020E Key R at io s

(R M B m) Year ended D ec 31 2016A 2017A 2018E 2019E 2020E

Profit before tax 850 1,102 1,448 1,773 2,125 Gro wth (% Yo Y)

Depreciation & amortization 161 244 333 367 346 Sales 67.2 33.5 32.3 16.0 16.5

Change in working cap. 468 (479) (369) (238) (266) Operating profit 102.3 32.9 32.7 17.9 16.8

Income tax paid (122) (178) (291) (356) (426) EBITDA 103.2 37.8 31.3 16.6 13.1

Others (352) 134 126 84 43 Core net profit 25.9 26.5 28.1 22.4 19.8

Operat ing cash f lo w 1,004 823 1,248 1,630 1,821 Basic EPS 21.0 30.7 22.4 22.4 19.8

Core basic EPS 12.5 25.9 28.1 22.4 19.8

CAPEX (5,186) (460) (550) (550) (550) P ro f itability (%)

Change in other assets 805 20 19 21 27 Gross margin 85.6 81.9 80.0 80.6 81.0

Investment cash f lo w (4,381) (440) (531) (529) (523) Operating margin 31.9 32.4 31.9 32.4 32.5

EBITDA margin 37.7 38.9 38.6 38.8 37.6

Issuance of shares 0 0 0 0 0 Core net profit margin 25.2 23.9 23.2 24.4 25.1

Net change in debt 2,654 1,347 (906) (700) (400) ROA 8.0 7.2 8.2 9.7 11.0

Others 56 (141) (287) (278) (282) ROE 11.6 12.8 14.5 15.5 16.2

F inancing cash f lo w 2,710 1,206 (1,193) (978) (682) B alance sheet rat io s

Current ratio (X) 2.0 2.4 2.3 2.9 3.9

N et change in cash (667) 1,588 (476) 122 616 Quick ratio (X) 0.6 1.2 0.9 1.1 1.7

Cash at beginning of the year 1,299 678 2,399 1,923 2,045 Cash ratio (X) 0.6 1.2 0.9 1.1 1.7

Effect from foreign exchange 45 133 0 0 0 Trade & bill receivables days 89 58 46 58 53

C ash at the end o f the year 678 2,399 1,923 2,045 2,661 Trade & bill payable days 32 77 82 85 86


Total debt to equity ratio (%) 47 60 42 29 22

2020E2020E2018E2016A 2017A 2019E 2019E2018E2016A 2017A

7


Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]


We believe CSPC’s earnings will still be driven by innovative drugs. However, we be-

lieve the GPO will continue to suppress its valuation in 2019, as the market is con-

cerned about overall policy risks and a worse-than-expected ASP cut. Although we

believe the actual earnings impact on CSPC from the GPO will be limited, considering

the recent market weakness, we lower our target price of CSPC from HK$15.88 (20x

2019E PER, multiple below its historical TTM average of 23x) to HK$12.0 (15x 2019E

PER, multiple 2 standard deviations below its historical average) to reflect the high poli-

cy risk of the drug manufacturing sector after the release of the disappointing prelimi-

nary GPO tender results. Maintain HOLD.

Investment thesis

Expected share performance to remain lacklustre in 2019 as its valuation is

suppressed by the GPO: Although we believe the earnings impact from the

GPO on CSPC will be limited in the near term, the overall GPO preliminary tender

results have created high policy risks going forward. Although the earnings impact

on CSPC’s 2019 results will be limited (we estimate <5%), its earnings visibility is

lowered, as its generics’ pipeline will face challenges after launch. Examples in-

clude Bortezomib (used for multiple myeloma, expected to be launched in 2H2019)

and Clopidogrel hydrochloride tablets (used for antithrombosis).

NBP growth outlook remains upbeat: We expect 2018E full-year NBP revenue

guidance of ~HK$5bn in sales (+40% YoY) as a result of expanding into lower-tier

hospitals and low current NBP channel inventory (only 2–3 weeks shipments). We

also continue to expect >30% YoY revenue growth for NBP in 2019, based on hos-

pital coverage expansion and stroke patient education.

R&D costs increase in line with guidance, expected to decline in 2020: We

expect the 2018E R&D cost target of ~HK$1.5bn to be intact, which will be spent

on chemical generics consistency evaluation, new drug clinical trials, and research

on some preclinical drug targets. We keep our forecast of R&D costs, which we

expect to remain high in 2019E and begin to decline in 2020E with the completion

of the chemical generics consistency evaluation.

Vitamin C will continue to be a cash cow: We expect the Vitamin C price to

decline slightly YoY after its peak in 2017. Vitamin C is expected to contribute ~8%

of total profit in 2019E, thus continuing to be a cash cow for the Company.

HOLD

(Unchanged)

Close: HK$11.08 (Jan 04, 2019)


Price Performance



Auditor Deloitte

Free Float 70.0%

52W range HK$9.9-26.75

3M average daily T/O US$109.5

Major Shareholding Mr. Cai Dongchen and

management (30.0%)

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HK$ HK$m

Y/E Dec 31 2016 2017 2018E 2019E 2020E

Turnover (HK$ m) 12,369 15,463 21,319 26,872 32,089

Core net profit (HK$ m) 2,101 2,771 3,793 4,810 6,181

Core net margin (%) 17.0 17.9 17.8 17.9 19.3

Core EPS (HK$) 0.352 0.458 0.626 0.794 1.020

YoY change 24.1 29.8 36.9 26.8 28.5

PER (x) 31.4 24.2 17.7 13.9 10.9

PBR (x) 6.5 4.3 3.6 3.0 2.5

ROE(%) 22.2 21.8 22.6 24.1 25.7

EV/EBITDA (x) 19.7 14.6 10.9 8.5 6.4

8



A s at D ec 31 Year ended D ec 31

(H K$ m) (H K$ m)

Cash & cash equivalents 3,238 6,557 6,801 8,182 10,926 Innovative drugs 4,774 6,582 10,603 15,396 19,926

Inventories 1,933 2,901 3,470 4,160 4,859 Generics 4,193 4,793 6,471 7,118 7,687

Accounts receivable 1,835 2,334 3,338 4,156 4,926 Bulk medicines 3,402 4,088 4,245 4,359 4,476

Others 1,422 1,842 2,778 3,446 4,020 R evenue 12,369 15,463 21,319 26,872 32,089

C urrent assets 8,428 13,635 16,387 19,943 24,731 Cost o f goods so ld (6,060) (6,117) (7,383) (8,851) (10,338)

Property, plant and equipment 5,415 6,663 7,455 8,248 8,564 Gro ss pro f it 6,309 9,346 13,936 18,021 21,751

Intangible assets 79 103 106 91 51 Other gains / (losses) 107 120 90 0 0

Others 838 1,142 1,152 1,164 1,239 M arketing expenses (2,788) (4,375) (6,865) (9,405) (11,392)

N o n-current assets 6,333 7,908 8,714 9,503 9,854 Admin expenses (554) (682) (810) (1,048) (1,219)

R&D and other expenses (424) (928) (1,556) (1,500) (1,350)

T o tal assets 14,760 21,543 25,101 29,446 34,585 Operat ing pro f it 2,649 3,482 4,795 6,067 7,790

Net interest income / (expense) (42) (27) (44) (44) (53)

Accounts payable 2,938 4,513 4,733 5,408 5,630 Share of results o f JV & associates 28 10 25 28 30

ST borrowings 898 927 769 766 928 Non-operating items 0 0 0 0 0

Others 249 319 646 740 810 Pretax income 2,635 3,465 4,776 6,051 7,767

C urrent liabilit ies 4,085 5,760 6,148 6,914 7,368 Income taxes (522) (685) (955) (1,210) (1,553)

Non-contro lling interests 12 10 28 31 33

Long-term debts 240 60 330 328 398 N et pro f it 2 ,101 2,771 3,793 4,810 6,181

Others 244 316 316 316 316 C o re net pro f it 2 ,101 2,771 3,793 4,810 6,181

Lo ng-term liabilit ies 484 375 645 644 713

EBITDA 3,233 4,195 5,647 7,076 8,945

T o tal liabilit ies 4,569 6,135 6,793 7,557 8,081

EPS (HK$) 0.352 0.458 0.626 0.794 1.020

Shareholders' equity 10,108 15,322 18,195 21,745 26,327 C o re EP S (H K$ ) 0.352 0.458 0.626 0.794 1.020

M inority interests 84 85 113 144 177 DPS (HK$) 0.120 0.156 0.213 0.270 0.347

T o tal equity 10,191 15,407 18,308 21,888 26,504

C ash F lo w Key R at io s

Year ended D ec 31 Year ended D ec 31 2016A 2017A 2018E 2019E 2020E

(H K$ m) Gro wth (% Yo Y)


Depr & amortization 510 714 852 1,008 1,155 Operating profit 22.3 31.4 37.7 26.5 28.4

Change in working cap. 110 (1,487) (1,962) (1,407) (1,752) EBITDA 21.3 16.6 29.8 34.6 25.3

Income tax paid (479) (685) (955) (1,210) (1,553) Core net profit 25.2 31.9 36.9 26.8 28.5

Others 140 (44) (57) (70) (73) Core EPS 24.1 29.8 36.9 26.8 28.5

Operat ing cash f lo w 2,916 1,963 2,654 4,373 5,545 P ro f itability (%)

Gross margin 51.0 60.4 65.4 67.1 67.8

Capex (1,106) (1,970) (1,633) (1,771) (1,416) Operating margin 21.4 22.5 22.5 22.6 24.3

Change in other assets (226) 520 32 43 (16) EBITDA margin 26.1 27.1 26.5 26.3 27.9

Investment cash f lo w (1,332) (1,450) (1,601) (1,728) (1,433) Core net profit margin 17.0 17.9 17.8 17.9 19.3

ROA 14.2 12.9 15.1 16.3 17.9

Net change in debt (325) (151) 111 (4) 231 ROE 22.2 21.8 22.6 24.1 25.7

Others (128) 1,642 (921) (1,260) (1,598) B alance sheet rat io s

F inancing cash f lo w (452) 1,491 (809) (1,264) (1,367) Current ratio (X) 2.1 2.4 2.7 2.9 3.4

Quick ratio (X) 0.8 1.0 1.0 1.1 1.5

N et change in cash 1,132 2,003 244 1,381 2,745 Cash ratio (X) 0.8 1.0 1.0 1.1 1.5

Cash at beginning of the year 2,299 3,235 5,238 5,482 6,862 Trade & bill receivables days 50.1 49.2 45.5 45.8 46.9

Effect from foreign exchange (197) 0 0 0 0 Trade & bill payable days 47.5 44.3 45.2 51.7 45.1

C ash at the end o f the year 3,235 5,238 5,482 6,862 9,607 Inventory turnover days 113.0 144.2 157.5 157.3 159.2


2016A 2017A

2020E

2020E2019E2018E2020E

2019E

2016A 2017A

2016A 2017E 2018E

2018E 2019E

9

HOLD (Downgrade from BUY)

Close: HK$26.95 (Jan 04, 2019)


Price Performance

Market Cap US$1552m

Shares Outstanding 452m

Auditor KPMG

Free Float 43.4%

52W range HK$24.9-51.6


Major Shareholding HEC Pharm Co., Ltd.

(“Parent Company”) 50.04%


Harry He—Analyst

(852) 3698-6320

[email protected]


(852) 3698-6317

[email protected]


HEC’s earnings will still be driven mainly by Kewei in the near term. But in early 2018, a flu out-

break created a high comparison base in 2H2017 and 1H2018, putting pressure on HEC’s

2H2018 and 1H2019 growth. We cut our earnings forecast by ~25.9%/32.3%/33.5% for

2018/19/20E, respectively, to reflect lower growth visibility of Kewei and to factor in its much lower

-than-expected Q3 2018 results. Its R&D pipeline is in line with expectations, but we have con-

cerns about its insulin and Yimitasvir sales outlook after launch. Also, we lowered the valuation

multiple after considering weaker market sentiment on the healthcare sector. Therefore, we cut

our target price from HK$44.7 (16x 2019E PER) to HK$28.8 (15x 2019E PER on new earnings

projections), and downgrade HEC from BUY to HOLD because of its limited earnings visibility with

potential for a 6% EPS decline in 2019E.

Investment thesis

Earnings cut and downgrade to HOLD: As Q4 2017 and 1H2018 created a high base, we

expect the Company to face challenges to deliver growth in Q4 2018 and 1H2019.

If we assume no major flu outbreak in late 2018 and early 2019, we project that Kewei’s top

line will decline by ~40% YoY in Q4 2018 and 1H2019, and thus cut our estimates by

~25.9%/32.3%/33.5% for 2018/19/20E, respectively. We also assume Blackstone will not

convert its CB in the near term, so 2019E is expected to be a weak year for HEC, because of

1) the high base in 1H2018 for Kewei; 2) high expected selling expenses; 3) CB interest; and

4) potential FX loss from RMB depreciation because of the US$400m CB. 2020E may see a

turnaround as the high base effect fades. Given its limited earnings visibility with potential for

a 6% EPS decline in 2019E, we downgrade HEC from BUY to HOLD.

Insulin business on track, but we are concerned about the insulin sales outlook after

launch: HEC listco’s 2nd generation Recombinant human insulin injection is under NDA

review, with approval expected in early 2019. Its 2nd generation Isophane protamine recom-

binant human insulin injection (pre-mixed 30R) is under clinical trial phase III patient enroll-

ment. Clinical trial phase III is expected to be completed in 2019 and launched in late 2020.

Its 3rd generation insulin glargine injection is undergoing clinical trial phase III and expected

to complete patient enrollment by 2018 and obtain approval in late 2020. Its 3rd generation

insulin aspart injection has started the phase I trial, and approval is expected by ~2021. How-

ever, we remain concerned that since diabetes is a chronic disease, the insulin habits of both

doctors and patients are hard to change, so ramping up the 2nd generation recombinant

human insulin injection and avoiding fierce competition will be challenging. Also, there is

competition from new products, especially GLP-1 (Novo Nordisk ’s GLP-1 has even been

included in the NRDL).

Small HCV market: Although HEC’s Yimitasvir can achieve close to 100% SVR12/24 ver-

sus the traditional combination of pegylated interferon on a weekly basis via injections and

ribavirin on an orally daily basis (PR48), which can only achieve 50–60% SVR12/24 for HCV,

this traditional treatment methodology is going to be replaced by pure oral DAAs in the future

as it is in the U.S. We are still concerned that HCV is a shrinking and relatively small market,

and that we will see a ceiling for Yimitasvir sales soon after its launch.

0

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12

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10

20

30

40

50

60


HK$ HK$m

Y/E Dec 31 2016A 2017A 2018E 2019E 2020E

Turnover (RMB m) 942 1,602 1,935 2,346 2,754

Reported net profit (RMB m) 381 647 816 764 925Core net profit (RMB m) 381 647 816 764 925

Core net margin (%) 40.4% 40.4% 42.2% 32.6% 33.6%

Basic EPS (RMB) 0.84 1.43 1.81 1.69 2.05

% Change 6.6% 69.6% 26.1% -6.4% 21.0%

Diluted EPS (RMB) 0.84 1.43 1.65 1.78 1.96

% Change -0.9% 69.6% 15.6% 7.4% 10.1%

PER (x) 28.1 16.6 13.1 14.0 11.6

PBR (x) 4.4 3.8 3.0 2.4 2.0

ROE(%) 16.6 24.6 25.4 19.1 19.1EV/EBITDA (x) 19.1 12.2 6.6 5.8 4.2

10



Year ended D ec 31 Year ended D ec 31

(R M B m) (R M B m)

Cash & cash equivalents 1,454 1,234 4,162 4,552 5,370 Kewei granluar 544 962 1,173 1,431 1,689

Inventories 111 88 98 122 156 Kewei Capusle 192 440 536 654 772

Trade & note receivables 337 747 697 844 991 CCV 89 96 104 112 118

Others 0 0 0 0 0 Endocrine and M etabolic 47 41 62 87 113

C urrent assets 1,901 2,069 4,956 5,519 6,517 Others 69 63 60 61 62

PP&E 496 670 1,224 1,362 1,492 R evenue 942 1,602 1,935 2,346 2,754

Prepayments for intangible assets 400 400 460 700 700 Cost o f goods so ld (214) (280) (326) (407) (519)

Others 34 637 793 855 920 Gro ss pro f it 727 1,321 1,609 1,938 2,235

N o n-current assets 930 1,707 2,477 2,916 3,111 Other gains / (losses) 16 22 48 52 61

Selling expense (181) (372) (464) (563) (702)

T o tal assets 2,831 3,776 7,433 8,435 9,628 Admin & other expenses (133) (193) (242) (293) (344)

Other expenses and losses 31 (25) 0 (136) (57)

Trade and bills payables 182 550 652 774 985 Operat ing pro f it 460 752 951 998 1,192

Other payables 28 77 115 115 115 Finance cost (7) (4) 0 (86) (87)

ST borrowings 70 10 10 0 0 Pretax income 453 748 951 913 1,105

Others 4 4 4 4 4 Income taxes (72) (122) (155) (149) (180)

C urrent liabilit ies 284 641 782 894 1,105 Net profit 381 626 796 764 925

M I - (21) (20) 0 0

LT borrowings 20 10 10 0 0 Profit to shareholders 381 647 816 764 925

Others 69 65 2,785 2,921 2,978 C o re net pro f it 381 647 816 764 925

Lo ng-term liabilit ies 89 75 2,795 2,921 2,978

EBITDA 488 778 997 1,061 1,262

T o tal liabilit ies 373 715 3,576 3,814 4,083 Basic EPS (RM B) 0.844 1.432 1.806 1.690 2.046

Fully diluted EPS (RM B) 0.844 1.432 1.655 1.777 1.957

Share capital 451 452 452 452 452 Basic core EPS (RM B) 0.844 1.433 1.806 1.690 2.046

Reserves 2,007 2,356 3,172 3,936 4,861 Fully diluted core EPS (RM B) 0.844 1.433 1.655 1.777 1.957

M I 0 253 233 233 233 Dividend (RM B) 0.300 0.600 0.722 0.676 0.818

T o tal equity 2,458 3,061 3,857 4,621 5,545

Key R at io s

C ash F lo w Year ended D ec 31 2016A 2017A 2018E 2019E 2020E

Year ended D ec 31 2016A 2017E 2018E 2019E 2020E Gro wth (% Yo Y)

(R M B m) Sales 35.9 70.1 20.8 21.2 17.4

Profit before tax 453 748 951 913 1,105 Operating profit 35.5 63.5 26.4 5.0 19.4

Depreciation & amortization 27 26 46 62 70 EBITDA 33.5 59.6 28.2 6.3 19.0

Change in working cap. (3) (20) 143 (50) 31 Core net profit 33.1 70.0 26.1 (6.4) 21.0

Income tax paid (52) (122) (134) (149) (180) Basic EPS 6.6 69.6 26.1 (6.4) 21.0

Others (29) 39 1 225 146 Core basic EPS (0.9) 69.6 26.0 (6.4) 21.0

Operat ing cash f lo w 397 671 1,007 1,000 1,172 P ro f itability (%)

Gross margin 77.2 82.5 83.2 82.6 81.2

CAPEX (63) (207) (600) (200) (200) Operating margin 48.9 47.0 49.2 42.6 43.3

Prepayment for intangible assets (110) 0 (151) (240) 0 EBITDA margin 51.8 48.6 51.5 45.2 45.8

Change in other assets (195) (638) (48) (64) (66) Core net profit margin 40.4 40.4 42.2 32.6 33.6

Investment cash f lo w (368) (845) (800) (504) (266) ROA 14.1 19.6 14.6 9.6 10.2

ROE 16.6 24.6 25.4 19.1 19.1

Issuance of shares 2 1 0 0 0 B alance sheet rat io s

Net change in debt (105) (70) 0 (20) 0 Current ratio (X) 6.7 3.2 6.3 6.2 5.9

Others (98) (4) 2,720 (86) (87) Quick ratio (X) 6.3 3.1 6.2 6.0 5.8

F inancing cash f lo w (201) (73) 2,720 (106) (87) Cash ratio (X) 5.1 1.9 5.3 5.1 4.9


N et change in cash (171) (247) 2,928 390 818 Trade & bill payable days 311 715 730 694 694

Cash at beginning of the year 1,354 1,212 887 3,815 4,205 Inventory turnover days 188 115 110 110 110

Effect from foreign exchange 30 (78) 0 0 0 Total debt to equity ratio (%) 4 1 1 0 0

C ash at the end o f the year 1,212 887 3,815 4,205 5,023 Net debt to equity ratio (%) Net cash Net cash Net cash Net cash Net cash

2020E2019E2016A 2017A 2018E2019E2016A 2017A 2018E 2020E

11

Disclaimer

This research report is not directed at, or intended for distribution to or used by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject China Galaxy International Securities (Hong Kong) Co., Limited (“Galaxy International Securities”) and/or its group companies to any registration or licensing requirement within such jurisdiction.

This report (including any information attached) is issued by Galaxy International Securities, one of the subsidiaries of the China Galaxy International Financial Holdings Limited, to the institutional clients from the information sources believed to be reliable, but no representation or warranty (expressly or implied) is made as to their accuracy, correctness and/or completeness.

This report shall not be construed as an offer, invitation or solicitation to buy or sell any securities of the company(ies) referred to herein. Past perfor-mance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regard-ing future performance. The recipient of this report should understand and comprehend the investment objectives and its related risks, and where necessary consult their own independent financial advisers prior to any investment decision.

Where any part of the information, opinions or estimates contained herein reflects the personal views and opinions of the analyst who prepared this report, such views and opinions may not correspond to the published views or investment decisions of China Galaxy International Financial Holdings Limited and any of its subsidiaries (“China Galaxy International”), directors, officers, agents and employees (“the Relevant Parties”).

All opinions and estimates reflect the judgment of the analyst on the date of this report and are subject to change without notice. China Galaxy Interna-tional and/or the Relevant Parties hereby disclaim any of their liabilities arising from the inaccuracy, incorrectness and incompleteness of this report and its attachment/s and/or any action or omission made in reliance thereof. Accordingly, this report must be read in conjunction with this disclaimer.

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The analyst who is primarily responsible for the content of this report, in whole or in part, certifies that with respect to the securities or issuer covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject, securities or issuer; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by the analyst in this report.

Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the securities covered in this research report three business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong-listed companies covered in this report; and (4) have any financial interests in the Hong Kong-listed companies cov-ered in this report.

Explanation on Equity Ratings

Copyright Reserved

No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited.

China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459

20/F, Wing On Centre, 111 Connaught Road Central, Sheung Wan, Hong Kong. General line: 3698-6888.

BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :

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