Please read carefully the important disclosures at the end of this report Company Update May 15, 2012 Health Care RESEARCH HOLD Guangzhou Pharmaceutical (00874.HK) Jessica LI, Ph.D SFC CE Ref: AWV098 [email protected]Overzealous on Trademark Win; Sales Windfall not Guaranteed Financial highlights (Rmb mn) 2008A 2009A 2010A 2011E 2012E Revenue 3,451 3,802 4,486 5,440 6,366 (+/-%) -72.0% 10.2% 18.0% 21.3% 17.0% Operating profit 110 102 311 183 237 (+/-%) -85.5% -7.1% 204.1% -41.1% 29.5% Net Profit 182 215 267 288 375 (+/-%) -43.2% 18.2% 24.3% 7.6% 30.4% EPS 0.2 0.3 0.3 0.4 0.5 P/E (x) 43.1 36.4 29.3 27.2 20.9 P/B (x) 2.3 2.2 2.1 1.9 1.8 EV/EBITDA (X) 16.7 15.2 9.3 11.0 9.2 ROE (%) 5.1% 6.0% 7.2% 7.4% 8.8% Dividend Yield 0.3% 0.4% 0.4% 0.5% 0.6% Net profit margin 5.0% 5.6% 6.1% 5.5% 6.1% ROA (%) 3.9% 4.8% 5.8% 5.9% 6.9% D/A 22.8% 19.9% 19.0% 20.3% 21.7% Share information A-share H-share 600332.CH Bloomberg code 0874.HK Rmb20.91 Share price HK$11.88 - Target price HK$8.00 12.88 30d avg daily turnover (mn shs) 5.20 Rmb20.9/10.9 52wk high/low HK$11.9/4.1 16,956 Market cap (mn) 9,633 591 Issued shares (mn) 220 200 Free float (mn) 220 Recent price performance % Last week 1m 3m YTD 00874.HK +34.69 +76.48 +99.16 +99.16 HSCEI -8.23 -6.35 -12.44 +0.43 CHCCI Health Care -0.28 -3.09 -7.36 +6.15 52wk performance 40 60 80 100 120 140 160 2011-May-14 2011-Aug-14 2011-Nov-14 2012-Feb-14 Relative Value (%) 0874.HK HSCEI Source: Bloomberg, company data, CICC Research What’s new On May 11, Guangzhou Pharma (GPC) announced that the China International Economic & Trade Arbitration Commission had ruled in its favor in its dispute over the Wang Lao Ji trademark. The trade body ruled that Hung To (Jia Duo Bao’s parentco) will have to cease its use of the Wang Lao Ji trademark; and, GPHL (GPC’s parent company) will resume all rights regarding the Wang Lao Ji trademark, effective immediately. GPHL indicated that it would reserve the right to ask for compensation for JDB’s infringement. According to GPHL’s Wang Lao Ji trademark loss evaluation reports, the losses are >Rmb300mn. Implications GPC H-shares surged ~50%, or a gain of ~Rmb5bn in market cap, in the past two weeks, on anticipation of the favorable trademark ruling. Trading at a forward P/E of 21x 2012e EPS, against our 3-year EPS CAGR estimate of 18%, we believe GPC’s current share price more than reflects the upside from the positive arbitration outcome. We expect the sales of green-pack Wang Lao Ji to benefit from JDB ceasing its use of the WLJ brand, as well as its expanded production capacity and increased promotional efforts. We forecast that green-pack WLJ will deliver 23% sales growth and 15% net profit CAGR over the next three years. However, we see significant hurdles for GPC to reap sales windfall considering its weak marketing ability and the long-prepared counter-attack from JDB. Valuation and recommendation We maintain our HOLD rating and 12-month TP of HK$8.0, based on a 2012 PEG of 0.8, 18% 3-yr CAGR and 2012e EPS of Rmb0.46. Risks Stiffer competition, severe drug price cuts; higher-than-expected raw material costs; faster-than-expected M&A in distribution; and, faster ramp-up in vaccine business.
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What’s new On May 11, Guangzhou Pharma (GPC) announced that the China International Economic & Trade Arbitration Commission had ruled in its favor in its dispute over the Wang Lao Ji trademark. The trade body ruled that Hung To (Jia Duo Bao’s parentco) will have to cease its use of the Wang Lao Ji trademark; and, GPHL (GPC’s parent company) will resume all rights regarding the Wang Lao Ji trademark, effective immediately.
GPHL indicated that it would reserve the right to ask for compensation for JDB’s infringement. According to GPHL’s WangLao Ji trademark loss evaluation reports, the losses are >Rmb300mn.
Implications GPC H-shares surged ~50%, or a gain of ~Rmb5bn in market cap, in the past two weeks, on anticipation of the favorable trademark ruling. Trading at a forward P/E of 21x 2012e EPS, against our 3-year EPS CAGR estimate of 18%, we believe GPC’s current share price more than reflects the upside from the positive arbitration outcome. We expect the sales of green-pack Wang Lao Ji to benefit from JDB ceasing its use of the WLJ brand, as well as its expandedproduction capacity and increased promotional efforts. We forecast that green-pack WLJ will deliver 23% sales growth and 15% net profit CAGR over the next three years. However, we see significant hurdles for GPC to reap sales windfall considering its weak marketing ability and the long-prepared counter-attack from JDB.
Valuation and recommendation We maintain our HOLD rating and 12-month TP of HK$8.0, based on a 2012 PEG of 0.8, 18% 3-yr CAGR and 2012e EPS of Rmb0.46.
Risks Stiffer competition, severe drug price cuts; higher-than-expected raw material costs; faster-than-expected M&A in distribution; and, faster ramp-up in vaccine business.
CICC Research: May 15, 2012
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GPC regaining WLJ brand does not necessarily mean a revenue windfall After its victory in the arbitration case, we believe that GPHL will most likely transfer the “Wang Lao Ji” trademark to GPC as intangible assets. We expect that sales of green-pack WLJ will benefit from JDB ceasing to use the WLJ brand, in conjunction with its expanded production capacity and increased promotional efforts. Two new production lines will be put into use next month with total capability of >5mn TEU/year. GPC’s newly established Wang Lao Ji Healthcare Company has also recruited 3,000 persons to prepare for the production of red-can Wang Lao Ji herbal drink. Wang Lao Ji Pharma, GPC’s subsidiary manufacturing green-pack Wang Lao Ji herbal tea, has raised its 2012 sales target. But, GPC will find it difficult to hit a tremendous high, considering its weak marketing ability and JDB’s long-prepared counter-attack.
Green-pack sales to benefit We expect that regaining the rights to the red-can “Wang Lao Ji” trademark and increased sales and promotional efforts will sustain solid growth for green-pack sales. As the green-pack now becomes the only WLJ herbal tea available on the market, it will soon take over the niche created by the absence of red-can WLJ. Wang Lao Ji Pharma contributed ~18%/~23% to GPC’s net profit in 2010/2011. We expect the contribution to further increase to 24% in 2012. We forecast Wang Lao Ji to drive sales and net profit CAGR of 23% and 15%, respectively, in 2011~2014.
Wang Lao Ji Pharma is a joint venture formed by GPC and Tong Hing Pharma in February 2005 to promote Wang Lao Ji herbal tea (Green Box) and other smaller products. GPC holds ~48% of equity interest in Wang Lao Ji Pharma.
Figure 1: Sales and net profit of Wang Lao Ji Pharma in 2002~2012e
Source: Company data; CICC Research
Red-can success is not guaranteed We deem the success of the red-can WLJ a pay-off of JDB’s potent and continuing marketing efforts, rather than the color of the can or the time-honored brand itself. Derived from its insight that a market niche existed for a functional herbal drink, JDB successfully repositioned WLJ from a TCM herbal tea into a popular drink capable of reducing “pathogenic fire” (降火) in the early-2000s. Being an innovator in the market, JDB enjoys a high margin, which then coverts to ~25% in marketing campaign annually. Its continuing, formidable advertising dynamics and charity marketing in the hard-to-find timing are very difficult to be replicated by competitors.
GPC does not have a strong marketing background. It may have the exclusive rights to the use of the red-can WLJ brand, but GPC lacks the marketing savvy to eat up the market share which was occupied by the JDB-marketed WLJ. In order to catch up, GPC has to divert its energy into the marketing of fast-moving consumer goods, which it is not good at. Despite the output of the marketing campaign, the skyrocketing marketing costs will result in a low margin and harm the company’s short-term performance. GPC will also have to deal with the potential cannibalization of the green-pack WLJ if it decides to launch the red-can itself.
Intensive competition from the rebranding of “Jia Duo Bao” herbal tea
We anticipate fierce competition from Jia Duo Bao given JDB’s strong marketing capabilities and distribution channel in the herbal drink area. JDB has switched from the “Wang Lao Ji” red-can herbal drink to the “Jia Duo Bao” trademark. JDB has been preparing for a potential adverse verdict for a long time. Since late-2011, it has been in the process of diluting the WLJ brand on both its production packages and on its marketing campaigns. This transition has been made in smooth, gradual
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steps and the market response has been mild. Its nationwide slogan, “怕上火喝王老吉”, which used to be for WLJ has been rebranded “怕上火喝正宗凉茶 加多宝出品” to totally eliminate the effects of losing the WLJ brand. JDB’s advertisement costs reached Rmb400mn in just April alone, 2.4x that of Wang Lao Ji Pharma’s monthly revenue in FY11. We believe that JDB Group is creating its own brand of “Jia Duo Bao” herbal drink with the help of its powerful distribution network. And, while it could take GPC months to ramp up, assuming the company will launch red-can, JDB has enough time to enjoy the market initiative and to reinforce its current leading status.
GPC has not demonstrated strong marketing and distribution capability
Although GPC has a valuable reserve of many time-honored TCM brands, the company’s insufficient marketing efforts have been holding its development back. Its pharmaceutical manufacturing business registered stagnant growth at a CAGR of 8% (including full contributions from Wang Lao Ji in 2008~2011) over the past 10 years, lagging far behind the industry average. Excluding Wang Lao Ji, GPC’s manufacturing business had a CAGR of 6% in 2001~2011. Slow growth was seen in all six categories, which we attribute to the limited geographic expansion, suboptimal marketing efforts, and the lack of new product introduction.
Most of GPC’s products are only able to penetrate into the South China market, where the company originated more than a century ago, and remain known to the local consumers today. About 70% of GPC’s total product sales are generated in south China and this has not changed much over the decades. While GPC’s TCM products enjoy strong brand recognition in southern China, they lack well-known national brands. Among the company’s main products, Xiao Ke Wan, a TCM to treat diabetes, is the only medicine with national recognition.
For many years, GPC has set goals to focus and strengthen its promotional efforts on products with great potential, expand its presence beyond southern China and further develop its core products. We have yet to see this strategy bear fruit.
Figure 2: GPC manufacturing sales and trend in 2001~2011
Source: Company data; CICC Research
Figure 3: GPC manufacturing revenue breakdown by regions (2010 vs.2011)
Overview of Wang Lao Ji trademark dispute A dispute over the trademark for Wang Lao Ji herbal tea, famous for its bright red cans, erupted between Jia Duo Bao (JDB) Group and Wang Lao Ji Pharma in late-2010. The JDB Group claims to have the rights to use the trademark for the herbal tea until 2020, based on the extended contract signed in 2001. However, GPC’s Wang Lao Ji Pharma believes that JDB’s rights to use the trademark should expire as early as late 2011, based on the original contract signed in the early-1990s.
Background Wang Lao Ji (also known as ‘Wong Lo Kat’ in Cantonese) is China’s best known herbal tea brand and its market leader with ~80% market share in canned beverages. In 2009, red-can Wang Lao Ji surpassed even Coca Cola with annual sales of Rmb16bn and became China’s best-selling beverage in China. The Wang Lao Ji trademark was said to be worth Rmb108bn in 2010, making it the most valuable brand in China.
The brand, originated in 1828 and is named after its inventor, became divided into two entities operating on the Mainland and outside of it after 1949. Guangzhou Pharmaceutical Holdings (GPHL), GPC’s parent company, owns the proprietary rights to the Wang Lao Ji brand in mainland China. Wong Lo Kat’s descendants established operations in Hong Kong. In 1995, GPHL signed a leasing contract with the Hong Kong–based JDB Group, granting the latter the rights to use the Wang Lao Ji trademark on canned products for a period of 15 years. As part of the agreement, Wang Lao Ji Pharma was authorized to independently produce and sell the drink in green cartons. Upon signing the contract, JDB began to produce red-can Wang Lao Ji herbal tea. The red-can, based on the recipe from the Wong family which owns the brand’s proprietary rights in Hong Kong, tastes slightly different to its green carton variety. JDB put in hardly any promotional efforts until 2003, when the company repositioned the product and strengthened its marketing efforts. Quickly, the market presence of the red-can product expanded and it became a renowned national brand. Despite that success, GPHL and GPC share negligible economic interests in the product.
GPC and its partner Tong Hing Pharm produce the green tetra-pack Wang Lao Ji herbal tea. In February 2005, Tong Hing and GPC formed a new joint venture, Wang Lao Ji Pharma, as Tong Hing increased its equity interest to 48%. In subsequent years, Wang Lao Ji Pharma intensified the promotional efforts behind green-box Wang Lao Ji. Leveraging on the nationwide popularity of red-can Wang Lao Ji, the green box product enjoyed significant sales growth, although sales level is about one tenth of that of the red-can.
The dispute over the trademark of Wang Lao Ji herbal tea, famous for its bright red cans, has intensified between Jia Duo Bao (JDB) Group and Wang Lao Ji Pharma since late 2010. The JDB Group claims to have the rights to use the trademark for the herbal tea until 2020, based on the extended contract signed in 2001. However, GPC’s Wang Lao Ji Pharma believes that JDB’s right to use the trademark should expire as early as late 2011 based on the original contract signed in the early-1990s.
The point of debate lies with the validity of the extended agreement signed by the, then, general manager of GPC after taking bribes from the parent company of JDB. The former general manager was convicted for taking bribes by the Guangzhou Intermediate People’s Court in 2005. However, the court did not deem the extended contract invalid.
Figure 4: Historical P/E bands
Source: Company data, CICC Research
CICC Research: May 15, 2012
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