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1、 Healthcare Sector ReviewHealthcare Sector Review Wed, 08 Sep 2010 How to pick and what to pick? Equity Research Healthcare/ China . After significant adjustments in June and July, we believe many stocks with low valuations start to regain interests from investors. In 2H10, we expect price cut polic
2、ies to affect non-exclusive drugs with multiple manufacturers. This note serves as a stock pick guide in 2H10. Key Summaries Essential drug list (“EDL”, 基 本 藥 物 目 錄基 本 藥 物 目 錄 ) will only benefit pharmaceutical companies with exclusive products All county hospitals and rural clinics in PRC are oblig
3、ated to use the 307 drugs on EDL, implying a tremendous growth in volume of those 307 drugs. However, volume growth does not mean margin expansion. For non-exclusive products, margins are under risk of potential price cut and capacity expansion in industry. Only companies with exclusive products can
4、 maintain margins and enjoy volume growth from EDL. Guangzhou Pharmaceutical (874.HK, BUY, TP: HK$9.86) In long run, segment leaders will prevail through consolidations Tighter pollution and safety regulations drive smaller drug companies out of business. Increasing inter-provincial drug procurement
5、s benefits large scales drug distributors. These all lead to consolidations Segment leaders will survive and become even stronger in consolidations. Lansen (503.HK, BUY, TP: HK$4.86), Trauson (325.HK, BUY, TP: HK$4.68), Weigao (1066.HK, NR), Lijun (2005.HK, NR) and Sino Pharm (1099.HK, NR) Intermedi
6、ate and bulk drug companies are showing limited growth potential, they are either at fair value or overpriced They are making commodities, with inherited high volatility. Even worse, many intermediate and bulk drug segments are showing overcapacities, driving margins down. United Lab (3933.HK, SELL,
7、 TP: HK$9.56), China Pharm (1093.HK, NR) Invest in highly innovative firms with unique products; their products usually maintain higher margins High innovation drugs are qualified for patent protections, can enjoy “higher quality, higher price” policy of the government, and most importantly are hard
8、 to copy by competitors. Therefore, their higher margins are sustainable. Lees Pharm (950.HK, BUY, TP: HK$4.05) and Sino Biopharm (1177.HK, NR) Same quality but lower price, medical device is going to boom Quality of PRC manufactured medical devices is improved dramatically that we believe some are
9、almost equivalent to the imported devices. We see no difference in quality between domestic and imported medical devices in several years while gap in price is expected to remain wide. Traunson (325.HK, BUY, TP: HK$4.68), MingYuan (233.HK, BUY, TP: HK$0.97) and Weigao (1066.HK, NR) John Yung Orienta
10、l Patron Securities Ltd +852 2842 5871 john.yungoriental-.hk Oriental Patron Research 8 September 2010 Page 2 of 35 Table of Contents Policies, a concern but sector is optimistic in long run 3 Before the policies become substantial, panic takes over 3 Warningwe anticipate price cut in 2H10 . 3 Also
11、expecting positive policies in 2H10 3 Healthcare sector will still draw money from investors . 4 The PRC Healthcare Sector Investment Summaries 5 Companies with exclusive products on Essential Drug List (EDL) are benefited 5 Consolidation is irreversible . 6 Intermediates （中間體）and bulk drugs （原料葯） a
12、re going to fade 7 Innovative companies are going to perform . 10 Medical devices, high growth potential but with less regulatory risks . 11 The PRC Healthcare Sector, in its best era of growth 14 Unmet robust demands . 14 Medical reform, you cant stop the train . 14 Mapping the HK-listed Healthcare
13、 Sector . 16 Companies Lansen Pharmaceutical (503 HK) 19 Lees Pharmaceutical (950 HK) . 20 Trauson Holdings (325 HK) . 21 Guangzhou Pharmaceutical (874 HK) . 22 Mingyuan Medicare (233 HK) 23 The United Laboratories (3933 HK) . 24 China Pharmaceutical (1093 HK) 25 Lijun International (2005 HK) . 26 R
14、uinian International (2010 HK) 28 Shandong Weigeo (1066 HK) 29 Shineway Pharmaceutical (2877 HK) 30 Sino Biopharmaceutical (1177 HK) 31 Sinopharm (1099 HK) 32 Oriental Patron Research 8 September 2010 Page 3 of 35 Policies, a concern but sector is optimistic in long run Since late June, news about d
15、rug price regulations struck the sector. Negative market sentiments also drove medical device and drug distribution stocks down, though they are not even mentioned in the policy draft. Before the policies become substantial, panic takes over Since the National Development and Reform Commission (NDRC
16、, 發改委) showed its intention to further regulate margins and price setting mechanisms of the industries, the sector experienced significant corrections (refer to “A disaster to the industryNot yet” on 22, June, 2010). Till today, we observed the regulators had only been restating main themes of exist
17、ing policies while no details of solid tightening policies are given. Warningwe anticipate price cut in 2H10 However, we believe NDRC are serious about the price regulation on finished drugs and we expect NDRC to release policies in 2H10 with following details: 1) For non-exclusive drugs with wide p
18、rice range and multiple manufacturers, NDRC is expected to take reference from the manufacturer with the most efficient cost structure, i.e. use the existing lowest price as the new standard; higher price non-exclusive drugs will fail to compete. 2) Exclusive and innovative products are not likely t
19、o be affected. 3) Medical device makers and drug distributors are not likely to be affected. Therefore, you should A) buy companies with exclusive and innovative drugs. B) buy medical device and drug distribution sub-sector leaders. C) avoid companies with majority non-exclusive drugs. D) avoid inte
20、rmediate and bulk drug manufacturers; their downstream customers make non-exclusive drugs. Also expecting positive policies in 2H10 Equally important, we expect positive policies in “the Twelfth Five-year Plan” (十二五計劃) , hopefully in late October We believe “the Twelfth Five-year Plan” will mention
21、its supports to consolidations of the drug distribution sub-sector. The Ministry of Commerce has expressed about their future plan to develop 2-3 “national leaders” (with over RMB100bn revenue) and about 20 “regional leaders” (with over RMB10bn revenue) in the drug distribution sub-sector, eliminati
22、ng other smaller inefficient players. We also believe “the Twelfth Five-year Plan” should also substantiate beneficial policies to Oriental Patron Research 8 September 2010 Page 4 of 35 the Biotech sub-sector. In specific, we expect new tax benefits to qualified biotech companies and cash awards to
23、future biotech drug inventions. From what we heard, the government is expected to spend RMB10bn to award each “outstanding innovation drug” RMB 5-10mn. Healthcare sector will still draw money from investors At this time, we are positive to the sectors long term prospect while we can hardly argue on
24、the robust demands on drugs and medical care by the growing PRC patient population. Even we try to turn around and look at the sector from a depressive view, what is going to happen if the world economic enters recession again? The answer is no other sectors could be more attractive than this defens
25、ive sector in a yet growing country. We see in the following exhibit that, historically, healthcare sector has outpaced PRC GDP in growth. Exhibit 1: PRC GDP Growth vs Healthcare sector revenue growth 0.0% 10.0% 20.0% 30.0% 2004200520062007200820092010E GDP GrowthSector Revenue Growth Source: Nation
26、al Statistics Bureau, Wind China Oriental Patron Research 8 September 2010 Page 5 of 35 The PRC Healthcare Sector Investment Summaries Companies with exclusive products on Essential Drug List (EDL) are benefited EDL means higher reimbursements to patients, but not higher margins to companies The PRC
27、 Essential Drug List (EDL, 基本藥物目錄) was published in May 2009 containing 307 inexpensive drugs that provide fundamental medical care to patients. Patients will be able to reimburse over 90% of EDL drug expense. The government promised to spend an extra of RMB850bn from 2009 to 2012 to push the medica
28、l reform, at least 1/5 of the spending is for procuring EDL drugs, we estimate. In 2H10, we believe volume growth of EDL drugs will be significant because Ministry of Health (衛生部) obligate all rural clinics and county hospitals to tender 100% EDL drugs before the year end. However, volume growth doe
29、s not guarantee profit growth for companies. Most of the EDL drugs are non-exclusive; capacity expansion of existing EDL drug manufacturers and possible price cut policy of NDRC can drag margins down in long run. Only exclusive products can maintain their margin in long term Exclusive drugs are an e
30、xception; the sole manufacturer will be able to maintain high margin and to enjoy volume growth. In the PRC-listed universe, companies with exclusive products on EDL include: Exhibit 2: Companies with exclusive products on EDL Listed Company Ticker Products Yunnan BaiYao Group (雲南白藥) 000538 CN Yunan
31、 Baiyao (雲南白藥) China Resources Sanjiu (華潤三九) 000999 CN Sanjiu Weitai Keli, Zhengtian Wan (三九胃泰顆粒、正天丸) Qianjin Parmacy (千金葯業) 600479 CN Fu Ke Qian Jin Jiao Nang(婦科千金膠囊) Wuhan Humanwell Healthcare (人福科技) 600079 CN Sufentanil Citrate Injection (芬太尼注射劑) Guangzhou Parmaceutical (廣州葯業) 600332 CN/ 874 HK X
32、iaoke Wan, Huatuo Zaizao Wan (消渴丸、華佗再造丸) Fosun Pharma (復星葯業 600196 CN Xianling Gubao Jiaonang (仙靈骨葆膠囊) Zhongxin Pharmaceuticals (中新藥業) 600329 CN Su Xia Jiu Xin Wan(速效救心丸) Tasly Group (天士力) 600535 CN Compound Danshen Dripping Pills (複方丹參滴丸) Jinlin Parmaceutical Co. Ltd (金陵藥業) 000919 CN Mailuoning Zhu
33、sheye (脈絡寧注射液) Merro Pharma (美羅藥業) 600297 CN Shang Ke Jie Gu Pian ( 傷科接骨片) Mayinglong Parm (馬應龍) 600993 CN Musk Hemorrhoids Oitment (馬應龍麝香痔瘡膏) Zhong Heng Group (中恒集團) 600252 CN Zhu She Yong Xue Shuan Tong (血栓通凍乾粉) Source: Company, OP Research The only company benefited from EDL in Hong Kong. Within
34、the Hong Kong listed universe, Guangzhou pharmaceutical (874.HK) is the only company with two exclusive EDL products. 1) Xiaokewan (消渴丸) accounted for 50% market shares of TCM (Traditional Chinese medicine) for diabetes in PRC and 10% market shares of all diabetes drugs in PRC. It contributed RMB500
35、mn revenue (15% of total revenue) in 2009. We believe, its relatively low price (comparing to other western medicines and better accepted by rural population) and higher reimbursement rate will make its sales double in 3 years. Oriental Patron Research 8 September 2010 Page 6 of 35 2) Huatuozaizaowa
36、n (華佗再造丸), listed as National Tier-1 Confidential Formula (國家一級 保密處方), sales of RMB150mn or 4% of the companys 2009 revenue. Being one of the crucial TCM for treating growing stroke related diseases, its volume will grow further after its entry to EDL. The company is only traded at a FY11 PE of 16X,
37、 significantly lower than the peer average of 20X. We recommend BUY at TP HK$9.86 Exhibit 3: Xiaokewan and Huatuazaizaowan Source: Company Consolidation is irreversible Reasons behind consolidations Following are reasons for industrial consolidations: 1) To improve product safety, SFDA is enforcing
38、stricter regulations, such as implementing the new European Good Manufacturing Practice (GMP) standard staring 2011; many existing plants has to be modified. Many of the smaller companies are unable to afford the extra Capex and will have to either close down or be bought out. 2) Besides, regulators
39、 are enforcing more stringent requirements on pollution preventions and require add-on constructions such as sewage treatments. Again, money problem for smaller firms. 3) Latest medical reform policies ask drug manufacturers to limit the number of distributors from door (of manufacturer) to door (of
40、 hospitals). 4) Inter provincial drug procurements have been happening more frequently, benefiting bigger distributors with interprovincial networks. 5) This month, the Ministry of Commerce has expressed about their future plan in the “the Twelfth Five-year plan” to develop 2-3 “national leaders” (w
41、ith over RMB100bn revenue) and about 20 “regional leaders” (with over RMB10bn revenue) in the drug distribution sub-sector, eliminating other smaller inefficient players. While 1) and 2) push consolidations in drug and medical device segments, 3), 4) and 5) push for consolidations in drug distributi
42、on segment. After some years, smaller companies will not survive while subsector leaders will have acquired their market shares and become stronger. Oriental Patron Research 8 September 2010 Page 7 of 35 Meeting the leaders In the long run, we believe consolidations will benefit the following compan
43、ies with leading positions in their segments: Exhibit 4: Companies and their market share in the segments Company Ticker Leading position in Market Shares/Ranking Top 3 Market Shares Combined Sinopharm 1099 HK Logistic Distribution 12% / 1st 20% Lijun 2005 HK Plastic Intravenous Infusion Products (塑
44、膠瓶大輸液) 15% / 3rd 57% Lansen 503 HK DMARDS （) 17% / 1st 35% Sino Biopharm 1177 HK Hepatitis Therapeutics 12%/ 3rd 80% Weigao 1066 HK Stents (心臟支架) 25%/ 1st 75% Trauson 325 HK Trauma Orthopedic Devices 8%/ 2nd 27% Source: Company, OP Research, Intermediates （中間體）（中間體）and bulk drugs （原料葯）（原料葯） are goin
45、g to fade It is a commodity business; it is hard to estimate the profit Intermediate drugs are mostly chemicals to be further processed into drugs; bulk drugs are raw drug powders before further containing or packaging. Intermediate drugs and bulk drugs from different suppliers are similar in qualit
46、y; they are basically commodities. Company margins are hard to estimate and depend heavily on frustrating market price/company ASP. The following shows the relationship of company margins and historical price movements of intermediate drugs (6-APA, 7-ACA, etc.) and bulk drugs (Amoxillin, Cefotaxime,
47、 Vitamin C, etc.) Exhibit 5: Margins of the United Lab (3933.HK) intermediates depend on market price 0 200 400 600 800 1,000 1,200 Jan-07Jul-07Jan-08Jul-08Jan-09Jul-09Jan-10 6-APA(RMB/Kg)7-ACA-(RMB/Kg) Intermediate drugs achieved 3% operating margin in 1H09 Intermediate drugs achieved 12% operating
48、 margin in 1H08 (RMB/Kg) Source: Company, OP Research, Wind China Oriental Patron Research 8 September 2010 Page 8 of 35 Exhibit 6: Margins of the United Lab (3933.HK) bulk drugs depend on market price 0 200 400 600 800 1,000 1,200 1,400 Jan-07Jul-07Jan-08Jul-08Jan-09Jul-09Jan-10 Amoxilin(RMB/Kg)Cef
49、otaxime(RMB/Kg) Bulk drugs achieved 6% operating margin in 1H09 Bulk drugs achieved 16% operating margin in 1H09 (RMB/Kg) Source: Company, OP Research, Wind China Exhibit 7: Margins of the China Pharm (1093.HK) fall so does the market price 0 20 40 60 80 100 120 140 160 Vitamin C (RMB/Kg) Vitamin C achieved54% operating marginin 1H09 Vitamin C achieved 43% operatingmargin in 1H09 (RMB/Kg) Source: Company, OP Research, Wind China Cursed by overcapacity, margins shrinking Overcapacity has been observed in