2018 Healthcare Sector Outlook

Transcription

1 Equity Research Healthcare 2018 Healthcare Sector Outlook Favorable structural changes to drive earnings growth in 2018 Natalie Chiu SFC CE No. AVH GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Sector view Positive The healthcare industry has seen sustained market growth, despite increased policy headwinds. Differentiation among players in each subsector is becoming increasingly significant. Prefer big pharma, TCM and CRO players over healthcare service providers. Key themes Healthcare sector lagging other cyclical sectors The sector has been seen as a laggard play vs cyclical stocks in 2017, gaining about 3 in 4Q17. The valuation gap with the MSCI China index is narrowing. We believe there is a good chance the sector will outperform in early China pharmaceutical end-market should see high single-digit growth in FY17 Amid industry transformation and a demand upgrade, the healthcare sector is likely to post steady growth for the period. More positives than negatives in the short term Positive impacts on earnings have been seen on the P&L of pharma companies that have differentiated products, and the Shanghai- and Shenzhen-Hong Kong stock connects now allow investors to buy related healthcare stocks and subsectors that had previously been out of reach. Valuation analysis The MSCI China healthcare index is trading at a forward P/E of 20.1x, above its five-year average of 18.1x. Although sector valuations look rich, we note that the valuation gap over the MSCI China index is narrowing and is now almost at the historical low of 30-45% seen at end Investment strategy Pharmas (including chemical drugs and biologics) We see upside for companies with high NDRL exposure, although there is uncertainty surrounding the impact of volume gains and pricing trade-offs in the near term. Traditional Chinese medicines (TCM) Stocks are trading at a discount to their pharma peers; government policy should spur a demand upgrade. Contract research organizations (CRO) Companies in the segment have a competitive advantage in terms of economies of scale and scope, and will benefit from government policy to accelerate drug approvals. Top picks CSPC Pharma (1093 HK, Accumulate) Continued solid growth in 3Q17; new generics launches to underpin growth. Wuxi Biologics (2268 HK, Buy) Beneficiary of pharma technology upgrades; backlog mix shifted towards post-ind services. CTCM (570 HK, Buy) Margin expansion through new acquisitions; 3Q17 sales momentum on track. CR Pharma (3320 HK, Buy) New distribution agreement could be accretive for its P/E valuation. Risks Upside risks: Faster-than-expected drug/r&d approvals; more favorable government policies Downside risks: Larger-than-expected price cuts; unfavorable government policies.

2 Pharmaceutical industry saw sustained market growth in 2017 China pharmaceutical end-market to see high single-digit growth in FY17 The industry has been growing at mid- to high-teens between , almost double China s GDP growth. This was at a time when the sector was backed by favorable demographics and government support, and the state insurance fund had lower funding pressure. As the economy has slowed in recent years, given the constraints on reimbursement, sector growth has also slowed, although still higher than the overall GDP growth. Amid industry transformation and a demand upgrade, the healthcare sector is likely to grow steadily in 2016 through Medical insurance payment growth was slower than expense growth in FY16 Total funding in 2016 by the three medical insurance programs was Rmb1448bn and payment was Rmb1231bn, implying a surplus of 15%. This compares to a surplus of 19% in As expense growth was slightly slower than funding growth in the past 2 years due to budget controls, we believe pressure to control insurance funding is lower than before. Moreover, the inclusion of more critical illness drugs into the new NRDL will also better allocate resources and avoid redundancies in the system. Healthcare sector lagging other cyclical sectors The MSCI China healthcare index is trading at a forward P/E of 20.1x, above its 5-year average of 18.1x. Although sector valuations look rich, we note that the valuation gap over MSCI China index is narrowing and is now almost at the historical low of 30-45% seen at end We thus believe there is a good chance it can outperform in 2018 if leaders continue to deliver solid results amid a moderating industry growth outlook. Figure 1: Pharmaceutical growth to sustain at 8% in FY17 Figure 2: Medical insurance fund income growth has been faster than expense growth since ,800 1,600 1,400 1,200 1, % % 15% 15% % % 5% Sales (Rmb bn) YoY % 35% 3 25% 15% 1 5% Income Growth % Expense Growth % Sources: CFDA Southern Medicine Economic Institute, GF Securities (Hong Kong) Sources: MOHRSS, GF Securities (Hong Kong) 2

3 11/2012 1/2013 3/2013 5/2013 7/2013 9/ /2013 1/2014 3/2014 5/2014 7/2014 9/ /2014 1/2015 3/2015 5/2015 7/2015 9/ /2015 1/2016 3/2016 5/2016 7/2016 9/ /2016 1/2017 3/2017 5/2017 7/2017 9/ /2012 2/2013 5/2013 8/ /2013 2/2014 5/2014 8/ /2014 2/2015 5/2015 8/ /2015 2/2016 5/2016 8/ /2016 2/2017 5/2017 8/ Sector Outlook Figure 3: MSCI China Healthcare index forward P/E Figure 4: MSCI China Healthcare index forward P/E premium over MSCI China index x MSCI China healthcare index (x) MSCI China index (x) Premium (LHS) Sources: Bloomberg, GF Securities (Hong Kong) Sources: Bloomberg, GF Securities (Hong Kong) More positives than negatives in the near term Although the industry has experienced more policy headwinds in 2017, marked by reimbursement control, market growth has so far sustained at a level similar to Positive impacts on earnings were seen on the P&L of pharma companies that have differentiated products and are preferred by doctors. We expect only positives for the companies with drugs that are newly included in the revised NDRL. Moreover, the government has implemented the two-invoice system to weed out the smaller distributors that are less competitive. This drives industry consolidation and benefits larger players with extensive networks at the provincial level. Lastly, the Shanghai- and Shenzhen-Hong Kong stock connects allow investors to invest in stocks and subsectors that markets lacks, and narrows the valuation gap between the A and H-share healthcare sector. Figure 5: Timeline of events on a forward P/E chart x New EDL issued (2012 New EDL version) implemented GSK was fined Shanghai- US$500m in Hong Kong bribery case Connect Concerns on tender delays CFDA notice on selfexamination of clinical trials CFDA notice on BE testing State Council notice on two-invoice system Shenzhen- Hong Kong Connect New NDRL issued (2017 version) State Council opinion on improving drug review and promoting R&D New NDRL implemented /2013 4/2013 7/ /2013 1/2014 4/2014 7/ /2014 1/2015 4/2015 7/ /2015 1/2016 4/2016 7/ /2016 1/2017 4/2017 7/ /2017 Sources: Bloomberg, GF Securities (Hong Kong) 3

4 Several negative catalysts to be aware of One of the biggest risks in the sector is that price cuts from tenders have been more severe than expected, as local provinces adopted their own tendering policies to put more pricing pressure on drug companies. The magnitude of the price cuts has been about 20-3 in recent new tenders compared with 10-15% during previous cycles, and it could be higher for generics and less so for exclusive drugs. Figure 6: Revised NDRL implementation timeline Sept 30, 2016: MOHRSS released NDRL draft for comments Feb 23, 2017: MOHRSS launched the new NDRL July 31, 2017: Provincial DRL launches Aug 31, 2017: Implementation of new NDRL Expert reviews on the revised NDRL 36 high-priced drugs under independent negotiation Implementation Sources: GF Securities Development & Research Center, GF Securities (Hong Kong) Figure 7: Revised NDRL implementation progress Province Hubei Yunnan Hebei Anhui May Jun Jul Aug Sep Oct Nov Dec Jan Jilin Jan 1: implement Jiangsu Liaoning Henan Jan 1: implement Xinjiang Shandong Inner Mongolia Dec: Release Fujian May 1: implemented Zhejiang Hunan Jiangxi Tianjin Hainan Heilongjiang Dec: Release Dec 1: implement Qinghai Jul: Released Ningxia Sep: Released Sichuan* Jul: Released Guizhou* Beijing Shanxi* Aug: Released Dec 1: Release * Draft for comments Yellow: implement NDRL s timeline; Orange: implement provincial DRL s timeline; Green: cannot complete within the given timeline Sources: GF Securities Development & Research Center, GF Securities (Hong Kong) Pharmas, TCM and CRO companies could outperform Although the overall sector saw moderate market growth with more policy headwinds, we see large pharma, TCM and CRO companies as direct beneficiaries of the ongoing healthcare reforms, through which the government intends to support more R&D by paying patients medical bills and accelerating drug approvals. We see less positives for healthcare services providers (hospitals) and distributors. 4

5 Pharmas (including chemical drugs and biologics) Depending on a company s product portfolio, drugs that are listed in the NDRL often see a boost in sales volume despite higher risks from government price controls. The revised NDRL has expanded from 2196 drugs in 2009, an increase of 15%. Companies with high NDRL exposure have potential upside, although there is uncertainty surrounding the impact of volume gains and pricing trade-offs before the system is fully established. We expect large pharma companies to continue to outperform the overall healthcare sector before price cuts arrive in late 1H18 or 2H18. Traditional Chinese Medicines (TCM) China TCM companies are currently trading at a discount to their pharma peers. We believe this is not justified given the sector s improving fundamentals and government policy to spur a demand upgrade in TCM. In particular, some branded over-the-counter (OTC) products could benefit as consumers become more health conscious and prefer products with safety and quality. Moreover, concentrated TCM granules are categorized as TCM decoction pieces and have less price control risks and are better positioned for industry reforms. Figure 8: Market growth (pharmaceutical manufacturing) Figure 9: Market growth (chemical drugs) % % 12% 1 8% 6% 4% 2% % % 19.76% 14.94% 10.17% 10.54% % 15% 1 5% YTD reveunue growth (Rmb bn) YoY growth Chemical drugs (Rmb bn) YoY % Sources: NBS, GF Securities (Hong Kong) Sources: MIIT, GF Securities (Hong Kong) Figure 10: Market growth (biopharmaceuticals) Figure 11: Market growth (TCM decoction pieces) % 35% % 25% 17.5% 15.5% 15% 11.3% 9.5% 1 5% Biopharmaceuticals (Rmb bn) YoY % % % % 13.7% 15.1% 15.8% H16 1H17 Decoction pieces (Rmb bn) YoY % Sources: MIIT, GF Securities (Hong Kong) Sources: MIIT, GF Securities (Hong Kong) 5

6 US Germany Australia UK South Korea Japan Taiwan Singapore Hong Kong Malaysia Thailand Philippines China India 2018 Sector Outlook Contract research organizations (CRO) We see plenty of low hanging fruit in the CRO sector, even though most Chinese CROs are not listed. CROs in China (vs US/Europe) have the competitive advantage of economies of scale and scope. Since 2015, the government has launched a series of guidelines and policies (such as bioequivalence testing and a green channel for foreign innovative drugs that are manufactured locally in China), aimed at R&D and a quality upgrade. This would benefit CROs with strong clinical and analytical support. We believe the CRO sector will outperform the overall healthcare sector. Figure 12: China CRO market Figure 13: Clinical trial density in selected countries (2016) CRO market (Rmb bn) CRO market for pre-clinical services (Rmb bn) Sources: Frost & Sullivan, GF Securities (Hong Kong) Distributors As reforms continue, distributors should also benefit, but with a mixed outlook. Industry consolidation remains the key theme, with the government committed to rolling out the two-invoice policy nationwide in 2018 to further squeeze profit out of the drug distribution process. The industry will also continue to see more M&A to boost revenue growth for leading distributors. While industry consolidation will favor larger players with wide distribution networks, their margins will come under pressure due to more indirect sales to hospitals. Figure 14: Policies streamlining the distribution process Policy Type Two invoice system Business tax to Value-added tax Description Issuances of only two invoices between hospital and drug manufacturers and between drug manufacturers to distributors Central procurement of drugs by all public hospitals and establish a trace mechanism to identify drug s ex-factory price, thereby increasing the transparency of the drug distribution chain Drug distributors Business Tax of 5% is now converted to VAT of 11%, increasing the tax burden of drug distributors, thereby preventing mechanisms such as: the dominance of low invoicing cost drug distributors and transfer of invoicing Prescription drugs outflow Allowing the outflow of prescription drugs from hospitals to retailers Sources: Wind, GF Securities (Hong Kong) 6

7 Figure 15: Policies encouraging drug R&D Policy Type Prioritized review and approval system Product registration Medical insurance support Increased clinical trial monitoring Description Projects with major innovation can obtain prioritized approval via the green channel Marketing Authorization Holder Pilot Program Medical insurance independent negotiation system; Development in commercial insurance, etc. Clinical data self-examination and verification etc. Sources: Wind, GF Securities (Hong Kong) Figure 16: China healthcare reform progress Period Key Policies Healthcare Reforms 2007 to to to to Comments on county level hospitals pilot reform 2. Comments on strengthening and improving the essential drugs system 3. Comments on developing critical illness insurance for urban and rural residents 1. Proposal on deepening healthcare reform during twelve 5-year plan 2. Accelerating public hospital reforms 3. Promoting private participation in healthcare 4. Pilot program of critical illness insurance 5. Accelerating reform progress of county level hospitals 1. Facilitating pharmaceuticalprice reform 2. Strengthening and improving tieredhealth care system 3. Deepening healthcare reform at grassroots medical institutions 4. Opinions on carrying out the two invoice system for drug procurement 5. Conducting self-examination by drug clinical trial institutions 1. Evaluation of the quality and efficacy of generic drugs 2. Pilot program plan for the system of the drug marketing authorization authorisation holders 3. Deepening reform on the system for review and examination and approval of drugs and medical devices Accessibility: Universal health insurance, promoting the unification of 3 government insurances Establish a basic medical system and a system for all general practitioners Promote the use of NDRL Payable: Pricing, bidding and medical insurance jointly control medical costs Speed up public hospital and county-level hospital s deep reform Abolishing the system of providing compensation to doctors via high drug costs Quality and efficiency: Strengthen the industry standard, eliminate distribution channel profits Payer reform, develop business insurance Encourage the society to develop hospitals, in particular, medical centers within the primary market Improve quality standards to promote industry consolidation Drug quality and innovation: Establish priority review system based on clinical value of drugs Accelerate import drugs approval Resolve registration backlog of chemical drugs Sources: GF Securities (Hong Kong) Limited room for upward earnings revisions and/or surprises in the near term The healthcare sector s forward P/E is currently at a high level as 1) corporate earnings YTD are growing 5-1 faster than market expectation, and 2) consensus is expecting one-year forward earnings growth of about YoY in While a YoY growth target may not seem too aggressive for quality leaders, any negative news such as earlier than expected price cuts may increase risks to maintain such a high valuation. The last time consensus had forward earnings expectations of YoY and a similar P/E profile was in early 2014 after strong earnings surprises. We believe further re-rating will be mainly driven by forward P/E expansion based on the currently improving market sentiment. Healthcare sector to become more structurally defensive The China healthcare sector has been underweight by investors as more fund allocations were placed in cyclical names. Considering that China is going through an economic rebalancing phase, with a shift from investment to consumption, we expect an expanding premium vs MSCI China index, supported by improving earnings in 4Q17 and 1H18 earnings. We recommend investors stay selective and consider stocks that either have less exposure to uncertainties or would benefit most from reforms. 7

8 Figure 16: Top 10 outperformers (% chg YTD as of Nov 10) Figure 17: Top 10 Underperformers (% chg YTD as of Nov 10) (10) (20) (30) (40) (50) (60) Sources: Bloomberg, GF Securities (Hong Kong) Figure 28: Valuation summary (as of Nov 16) Mkt Cap P/E (x) Revenue growth (%) Net profit growth (%) ROE (%) EPS CAGR PEG (x) Ticker (HK$ m) Price YTD FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E FY17-19E FY18E H-Pharmaceuticals Fosun Pharma 2196 HK 118, % 1.4 CSPC Pharm 1093 HK 101, % 1.1 Sino Biopharm 1177 HK 83, % 1.7 China Medical System 867 HK 38, % 0.9 3SBio 1530 HK 39, (2) na % 1.1 Sihuan Pharm 460 HK 25, (17) Livzon Pharm 1513 HK 42, (33) % 1.4 Luye Pharma 2186 HK 18, na % 1.3 SSY Pharm 2005 HK 11, % 0.7 United Lab 3933 HK 10, (8) NA NA % -0.1 Dawnrays 2348 HK 3, (4) (15) (12) NA NA NA % 0.6 HEC Pharm 1558 HK 11, % 0.6 Lee's Pharm 950 HK 4, % 1.2 Simple average % 1.0 H-TCM Guangzhou BYS 874 HK 58, % 2.2 China TCM 570 HK 19, TRT Tech 1666 HK 14, (22) (4) % 1.5 TRT CM 8138 HK 9, % 1.2 Shineway 2877 HK 5, (16) (3) (15) 2 3 (10) (33) Simple average H-Medtech Microport 853 HK 13, (217) NA % 0.4 SSY Group 2005 HK 11, % 0.7 Modern Dental 3600 HK 2, (24) % 0.3 Simple average (43) % 0.6 H-Distribution Sinopharm 1099 HK 87, (1) % 2.7 China Resources Pharm 3320 HK 63, (1) % 2.2 Shanghai Pharm 2607 HK 71, % 0.9 Simple average % 2.0 H-Hospital services China Resources Phoenix 1515 HK 12, (2) NA (130) NA NA Kangning Hospital 2120 HK 2, % 1.6 Guangdong Kanghua 3689 HK 3, (4) Simple average (32) % 1.8 H-CROs Wuxi Biologics 2269 HK 50, % 0.9 Genscript Biotech 1548 HK 16, % 29.4 Simple average % 15.1 Sources: Bloomberg, GF Securities (Hong Kong) 8

9 CSPC Pharmaceutical (1093 HK) Accumulate (maintained) Target price: HK$16.10 Continued solid growth in 3Q17 Figure 19: Stock performance (as of Nov 16) Figure 20: Key data HK Equity Hang Seng Index Nov 16 close (HK$) Shares in issue (m) 6243 Major shareholder Massive Giant Group (17.9%) Market cap (HK$ bn) day avg. vol. (m) W high/low (HK$) 7.43/ Sources: Bloomberg Figure 21: Stock valuation Turnover (HK$ m) Net profit (HK$ m) EPS (HK$) EPS YoY (%) P/E BPS (HK$) P/B ROE (%) ,394 1, % % ,369 2, % % 2017E 15,038 2, % % 2018E 17,779 3, % % 2019E 20,294 4, % % Better-than-expected 3Q17 operation CSPC Pharma posted HK$4.0bn in net profit and HK$730m in net profit during 3Q17, representing growth of 29% and 37% respectively. The accelerating growth vs 1H17 s 17% and 27% was a result of rapid growth in finished drugs and the turnaround of its API businesses. Near-term pipeline products - albumin-bound paclitaxel and clopidogrel to receive approval by end-2017 Abraxane reached US$973m in worldwide sales in 2016, vs about Rmb270m in China. As a 2nd-line treatment for several types of cancers in China, Celgene is currently the only player, accounting for about 15% of the Rmb1bn paclitaxel market. According to CDE, CSPC Ouyi Pharma, Jiangsui Hengrui ( CH) and seven other companies have filed for applications. The former two were granted priority review in March and June 2017 respectively. Management targets Rmb200m in sales for paclitaxel and sales of Rmb500m-1bn for metformin in 2018, based on the current market size of Rmb1bn and Rmb3.1bn respectively, which would imply and 25% market shares after launch. Figure 22: Overall revenue mix (3Q17) Figure 23: Finished drugs revenue mix (3Q17) 3 43% 41% 32% 27% 1 6% 11% Innovative drugs Bulk drugs Generic drugs NBP Oulaining Xuanning Oncology Generic drugs Valuation As a leading drug manufacturer with above peers bottom-line growth, we think CSPC Pharma should trade at a premium to its peers. Our one-year target price of HK$16.10 is based on a target P/E of 24x our 2019 EPS forecast. 9

10 Figure 24: Financial statements Income Statement Balance Sheet Year-end Dec 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Revenue 11,394 12,369 15,038 17,779 20,294 Non-current assets Cost of sales (6,173) (6,060) (6,083) (7,024) (7,888) PPE 5,143 5,415 5,663 5,952 6,140 Gross profit 5,221 6,309 8,955 10,755 12,406 Prepaid lease payments Goodwill Other income Intangible assets Marketing expenses (2,267) (2,788) (4,093) (4,871) (5,520) Available-for-sale investments Administration expenses (535) (554) (668) (782) (873) Interest in JV and associate Other expenses (339) (424) (847) (918) (893) Deferred tax assets Operating profit 2,166 2,649 3,498 4,361 5,323 5,892 6,333 6,445 6,694 6,843 Finance cost (56) (42) (32) (36) (41) Other non-recurring items Current assets Profit before tax 2,112 2,635 3,468 4,327 5,284 Inventories 1,819 1,933 1,940 2,241 2,516 Income tax expense (432) (522) (711) (887) (1,083) Trade and other receivables 1,878 1,835 1,744 1,656 1,574 Net profit 1,680 2,113 2,757 3,440 4,201 Bills receivables 1,389 1,215 1,477 1,747 1,994 Minority interests Trade receivables due from related companies Net profit attributable to shareholders 1,665 2,101 2,746 3,423 4,180 Amount due from a joint venture EPS (HK$) Trade payables due to related companies Prepaid lease payments Growth rates (%) Tax recoverable Revenue % 21.6% 18.2% 14.1% Held for trading investments Adjusted net profit 31.3% 26.2% 30.7% 24.7% 22.1% Restricted bank deposits Adjusted EPS 31.5% 25.1% 27.7% 21.8% 22.1% Bank balance and cash 2,299 3,235 5,411 7,400 9,988 7,649 8,428 10,638 13,103 16,125 Margin & ratios (%) Gross margin 45.8% % 60.5% 61.1% Total assets 13,541 14,760 17,083 19,797 22,968 OP margin % 23.3% 24.5% 26.2% Net margin 14.6% % 19.3% 20.6% Current liabilities Effective tax rate 20.5% 19.8% 20.5% 20.5% 20.5% Trade and other payables 2,489 2,938 2,949 3,405 3,824 Payout ratio % Other payables and accrued expenses Amount due to related parties Cash Flow Statement Tax liabilitites Year-end Dec 31 (HK$ m) FY15 FY16E FY17E FY18E FY19E Bank borrowings ,484 4,085 4,017 4,407 4,794 Profit before tax 2,112 2,635 3,468 4,327 5,284 Depreciation and Amortization Non-current liabilities Net finance income Deferred tax liabilities Others (26) (81) (77) (90) (103) Borrowings 1, Change of working capital (46) (70) (60) Government grants Tax paid (293) (477) (616) (799) (985) 1, Operating cash flow 2,251 3,000 3,733 4,068 4,938 Equity Capex (816) (1,134) (1,000) (1,000) (1,000) Shareholders' equity 8,814 10,191 12,541 14,721 17,390 Change of AFS investments Acquisitions (27) Total liabilities & equity 13,541 14,760 17,083 19,797 22,968 Others Investing cash flow (714) (1,070) (979) (980) (981) Financial Ratios Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Change of borrowings (1,324) New borrowings raised 1, Current ratio Dividend paid (591) (650) (715) (1,098) (1,369) Quick ratio Others (277) (2) (1) 0 0 Financing cash flow (605) (328) (578) (1,098) (1,369) Asset turnover Total assets/total equity Net change of cash flow 932 1,602 2,176 1,989 2,588 Net cash/(debt) (HK$ m) 843 2,099 4,411 6,400 8,988 Forex changes (103) Cash and cash equivalents an beginning 1,468 2,299 3,235 5,411 7,400 ROE (%) 24% 27% 27% 29% Cash and cash equivalents an end 2,299 3,901 5,411 7,400 9,988 ROA (%) 13% 16% 19% 21% 10

11 Jun-17 Jun-17 Jun-17 Jul-17 Jul-17 Jul-17 Jul-17 Aug-17 Aug-17 Aug-17 Aug-17 Aug-17 Sep-17 Sep-17 Sep-17 Sep-17 Oct-17 Oct-17 Oct-17 Oct-17 Oct Sector Outlook WuXi Biologics (2269 HK) Buy (maintained) Target price: HK$50.1 Primary beneficiary of pharma technology upgrade Figure 25: Stock performance (as of Nov 1) Figure 26: Key data HK Equity Hang Seng Index Nov 8 close (HK$) Shares in issue (m) 1163 Major shareholder Founding Individuals (80.59% Market cap (HK$ bn) M avg. vol. (m) 1, W high/low (HK$) 25/49.25 Sources: Bloomberg Figure 27: Stock valuation Turnover (Rmb m) Adj net profit (Rmb m) Adj EPS (Rmb) EPS YoY (%) P/E BPS (Rmb) P/B ROE (%) % % % % 2017E 1, % % 2018E 2, % % 2019E 4,272 1, % Follow-the-molecule strategy through end-to-end services platform WuXi Biologics was China s largest biologics outsourcing services provider in 2016 with a market share of 48%. It has been working on customer projects from an early stage of the biologics development process and develops an in-depth understanding of the relevant biologics drug candidates. With a solid track record in growing its customer base, WuXi Biologics should see improving quality and efficiency for its services for such projects once it progresses to later stages. Strong backlog to support future earnings growth WuXi Biologics posted a backlog of US$452m as of 1H17 with new business of US$172m (+163% HoH) and US$69m (+18% MoM). Of the US$383.2m backlog in May 2017, the company will convert US$172.4m, US$136.5m and US$74.6m into service fees in 2017, 2018 and afterwards, representing a backlog conversion rate of about 45%. We expect revenue growth momentum to remain strong in 2H17, as its backlog mix shifts to late phase projects and anticipated milestone fees of US$816m from Arcus Biosciences. Figure 28: Revenue breakdown by pre-ind services and post-ind services (2016) Figure 29: Revenue breakdown by development phases (2016) 31% % 65.6 Pre-IND services Post-IND services Drug Discovery Preclinical Development Early Phase (Phase I & II) Late Phase (Phase III) Commercial Manufacturing Sources: company data, GF Securities (Hong Kong) Valuation Our PEG-derived target price is HK$50.10 which is based on 80.5% EPS CAGR and 1.0x PEG. The DCF valuation gave us HK$47.80/share for the intrinsic value of the company, with a WACC of 8% and terminal growth rate of 2%. 11

12 Figure 30: Financial statements Income Statement Balance Sheet Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Revenue ,563 2,305 4,272 Non-current assets Cost of sales (376) (600) (944) (1,408) (2,589) Plant and equipment 754 1,153 2,000 2,769 3,342 Gross profit ,683 Deferred tax assets Other income ,155 2,003 2,769 3,342 Other gains and losses 6 (2) (42) 0 0 Administration expenses (44) (95) (86) (92) 0 Current assets Selling and marketing expenses (13) (15) (31) (35) (150) Inventories Research and development expenses (40) (53) (84) (92) (150) Service work in progress Other expenses - (32) (16) 0 0 Trade and other receivables ,342 Operating profit ,324 Income tax recoverable Finance cost (3) (24) (47) (18) (34) Restricted bank deposits Profit before tax ,290 Bank balance and cash ,108 1,486 1,969 Income tax expense (21) (35) (76) (135) (264) ,020 2,653 3,870 Net profit ,026 Adjusted net profit ,116 Total assets 1,357 1,985 5,023 5,422 7,212 EPS (Rmb) Core EPS (Rmb) Current liabilities Trade and other payables ,373 Growth rates (%) Loans from related parties Revenue 67.9% 77.6% % 85.3% Income tax payable Adjusted net profit 38.7% 237.6% 71.2% 63.8% 81.7% Bank borrowings Adjusted EPS 38.7% 237.6% 41.9% 63.8% 81.7% Obligations under a finance lease , ,583 Margin & ratios (%) Gross margin 32.4% 39.3% 39.6% 38.9% 39.4% Non-current liabilities OP margin 9.9% 22.8% 26.7% 29.4% 31. Deferred revenue Net margin 11.7% 22.2% % 26.1% Bank borrowings Effective tax rate 31.9% 19.8% 20.5% 20.5% 20.5% Deferred tax liabilities Payout ratio Others Cash Flow Statement Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Equity Shareholders' equity ,032 4,555 5,581 Profit before tax ,290 Depreciation and Amortization Total liabilities & equity 1,357 1,985 5,023 5,422 7,212 Interest expense Others Financial Ratios Change of working capital (40) (206) 170 (299) 110 Year-end Dec 31 FY15 FY16 FY17E FY18E FY20E Tax paid (4) (47) (76) (135) (264) Operating cash flow ,698 Current ratio Quick ratio Capex (334) (429) (1,000) (1,000) (1,000) Option fee received Asset turnover Others (2) (19) Total assets/total equity Investing cash flow (336) (421) (969) (968) (966) Net cash/(debt) (Rmb m) 158 (736) 1,908 1,686 2,169 Change of borrowings (4) 905 (705) 0 0 ROE (%) 12% 97% 109% 13% 23% Proceeds from issue of ordinary shares 0 0 3, ROA (%) 1 16% 19% 12% 21% Dividend paid (18) Others 400 (562) (697) (227) (249) Financing cash flow ,171 (227) (249) Net change of cash flow ,939 (622) 483 Forex changes 4 17 (18) 0 0 Cash and cash equivalents an beginning ,108 1,486 Cash and cash equivalents at end of year ,108 1,486 1,969 12

13 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep Sector Outlook China TCM (570 HK) Buy (maintained) Target price: HK$5.40 Margin expansion through new acquisitions Figure 31: Stock performance (as of Nov 14) Figure 32: Key data HK Equity Hang Seng Index Nov 14 close (HK$) 4.47 Shares in issue (m) Major shareholder Sinopharm HK (36%) Market cap (HK$ bn) M avg. vol. (m) W high/low (HK$) 4.45/2.95 Sources: Bloomberg Figure 33: Stock valuation Turnover (Rmb m) Net profit (Rmb m) EPS (Rmb) EPS YoY (%) P/E BPS (Rmb) P/B ROE (%) , % % , % % 2017E 7,910 1, % E 9,971 1, % % 2019E 12,008 1, % % 3Q17 operations on track Sales momentum of Tianjiang and Yifang continued ( and over respectively) in 3Q17 after solid growth in 1H17 (+24% YoY). Sales in Guangdong reached Rmb600m and maintained market position with a significant increase in the number of medicine dispensing machines. Management is still expecting the segment to grow at least in Chance to improve net margins from integration China TCM will have nationwide geographic coverage of TCM decoction pieces in key regions in China following the Huamiao, Jianyou and HLJ Sinopharm acquisitions. This will give it healthy exposure to the entire value chain of the CCMG business. China TCM already has an extensive channel network in eastern and southern China while Huamiao and Jianyou have a larger market exposure in Beijing and Sichuan. In addition, the integration will also expand production capacity for its modernized decoction and toxic decoction pieces. The production plant in Sichuan is the largest production base for toxic decoction pieces in China with an annual production capacity of 4,000 tonnes. Consolidation of the four companies is expected in early Figure 34: Revenue growth projection (concentrated TCM granules) Figure 35: Revenue growth projection (finished drugs) 7,000 6,000 5,000 4,000 3,000 2,000 1,000-25% % % 1 5% E 2018E Concentrated TCM granules (Rmb m) YoY growth (concentrated TCM granules) 3,000 2,500 2,000 1,500 1, % E 2018E Finished products (Rmb m) YoY growth (finished products) Valuation Our target price of HK$5.40 is based on a 16% EPS CAGR during , and 1.0x PEG. 13

14 Figure 36: Financial statements Income Statement Balance Sheet Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Revenue 3,709 6,533 7,910 9,971 12,008 Non-current assets Cost of sales (1,509) (2,745) (3,522) (4,447) (5,380) PP&E 1,669 2,019 2,300 2,531 2,713 Gross profit 2,201 3,788 4,388 5,524 6,628 Investment properties Deposits and prepayments Other income Prepaid lease payments Selling and distribution expenses (1,196) (1,968) (2,105) (2,692) (3,242) Goodwill 3,341 3,456 3,456 3,456 3,456 Administration expenses (273) (330) (348) (449) (540) Intangible assets 6,680 6,764 6,817 6,866 6,911 Operating profit 761 1,377 1,741 2,155 2,563 Interest in JV and associate Net finance income (cost) (70) (73) (173) (210) (209) Deferred tax assets Other non-recurring items (2) 0 (4) 0 0 Other financial assets Profit before tax 689 1,304 1,565 1,945 2,353 12,336 12,966 13,453 13,742 13,853 Income tax expense (119) (217) (266) (331) (400) Net profit 644 1,087 1,299 1,614 1,953 Current assets Minority interests (18) (120) (130) (161) (195) Inventories 1,236 1,894 2,062 2,934 3,109 Net profit attributable to shareholders ,169 1,350 1,531 Trade and other receivables 3,398 2,716 4,652 4,637 6,549 EPS (Rmb) Other current assets Pledged bank deposits Growth rates (%) Fixed deposits 0 1,050 1,050 1,050 1,050 Revenue % 21.1% 26.1% 20.4% Bank balance and cash 2,102 2,373 4,305 4,056 4,944 Adjusted net profit 51.4% 54.6% 20.9% 15.5% 13.4% 6,878 8,070 12,068 12,676 15,652 Adjusted EPS 4.1% % 15.5% 13.4% Total assets 19,214 21,037 25,521 26,419 29,505 Margin & ratios (%) Gross margin 59.3% % 55.4% 55.2% Current liabilities OP margin 20.5% 21.1% % 21.3% Trade and other payables 2,660 2,304 4,064 3,855 5,725 Net margin 16.9% 14.8% 14.8% 13.5% 12.7% Current portion of deferred govt grants Effective tax rate 17.3% 16.7% Tax liabilitites Payout ratio % Bank borrowings 1,600 1, ,485 3,507 5,066 4,857 6,727 Cash Flow Statement Non-current liabilities Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Deferred tax liabilities 1,669 1,723 1,723 1,723 1, Borrowings Profit before tax 763 1,304 1,565 1,945 2,353 Unsecured notes 0 2,486 4,486 4,486 4,486 Depreciation and amortization Government grants Net finance cost (income) (25) ,589 4,774 6,751 6,751 6,701 Others (39) Change of working capital (189) (47) (340) (1,066) (218) Equity Tax paid (149) (204) (250) (311) (376) Shareholders' equity 11,133 11,588 12,407 13,352 14,423 Operating cash flow 519 1,465 1,508 1,187 2,425.8 Minority interests 1,007 1,168 1,297 1,459 1,654 12,140 12,756 13,704 14,811 16,078 Capex (7,677) (1,531) (850) (850) (850) Change of AFS investments Total liabilities & equity 19,214 21,037 25,521 26,419 29,505 Interest received Others 129 (984) (20) (20) (20) Financial Ratios Investing cash flow (7,158) (2,500) (861) (860) (859) Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Change of borrowings 1,202 1,821 1,776 0 (50) Current ratio Proceeds from issue of shares 7, Quick ratio Dividend distribution 0 (59) (140) (170) (170) Others (72) (634) (351) (405) (459) Asset turnover Financing cash flow 8,330 1,128 1,285 (575) (679) Total assets/total equity ,794 Net cash/(debt) (Rmb m) (312) (484) (331) (580) 358 Net change of cash flow 1, ,932 (249) 888 Gearing ratio (%) 22% 34% 46% 43% 39% Forex changes (28) Cash and cash equivalents at beginning 439 2,102 2,373 4,305 4,056 ROE (%) 9% 9% 1 11% 11% Cash and cash equivalents at end 2,102 2,194 4,305 4,056 4,944 ROA (%) 5% 5% 6% 5% 6% 14

15 China Resources Pharma (3320 HK) Buy (maintained) Target price: HK$11.10 New distribution agreement could be accretive for its P/E valuation Figure 37: Stock performance (as of Nov 14) Figure 38: Key data 3 25% 15% 1 5% -5% -1 Nov 13 close (HK$) 9.45 Shares in issue (m) Major shareholder CR Corp (53.04%) Market cap (HK$ bn) M avg. vol. (m) W high/low (HK$) 8.28/ HK Hang Seng Index Sources: Bloomberg Figure 39: Stock valuation Turnover (HK$ m) Net profit (HK$ m) EPS (HK$) EPS YoY (%) P/E BPS (HK$) ,568 2, NA % ,705 2, % % 2017E 173,075 3, % % 2018E 193,122 4, % E 214,362 4, % P/B ROE (%) New distribution agreement with Beigene On Nov 10, CR Pharma signed a distribution agreement with Beigene to distribute three blockbuster products in China (Abraxane, Revlimid and Vidaza). Abraxane and Revlimid have a market size of about Rmb270m and Rmb19m respectively, whereas Vidaza will launch soon in China. While the company did not disclose much information about the payment terms and conditions, we believe it could be accretive to its earnings given these products have high margins and high growth. Pharmaceutical distribution saw stable momentum in 8M17 The company s distribution business posted stable revenue growth in July and Aug They see ongoing distribution GPM pressure from the rollout of the two-invoice system but believe the effect will be offset by higher direct-to-hospital sales. Figure 40: Overall revenue mix (HK$ m, 1H17) Figure 41: CR Pharma's distribution channel mix Manufacturing, 11,480, 14% Retail, 2,117, 3% Distribution, 69,070, 83% H16 Hospitals and other medical institutions Other distributors Retail pharmacies and others Valuation We expect the company to maintain above-peer profitability in FY17-18 on an expansion of its distribution network, stable growth in its manufacturing business, and a more proactive M&A strategy. Our SOTP-derived TP of HK$11.10 implies 17.3x FY18 P/E on 21% growth. 15

16 Figure 42: Financial statements Income Statement Balance Sheet Year-end Dec 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Revenue 146, , , , ,362 Non-current assets Cost of sales (123,369) (132,596) (146,885) (163,675) (181,676) PPE 12,578 12,500 13,645 13,944 14,156 Gross profit 23,199 24,109 26,190 29,447 32,685 Investment properties 1,020 1,390 1,390 1,390 1,390 Prepaid lease payments 2,321 2,224 2,427 2,480 2,518 Selling and distribution expenses (10,112) (10,947) (11,596) (13,132) (14,577) Goodwill 16,395 17,405 17,405 17,405 17,405 Administration expenses (3,845) (3,882) (3,677) (4,442) (4,716) Intangible assets 3,894 3,807 4,010 4,199 4,373 Other income and expenses Other receivables 1, Operating profit 10,043 9,861 11,090 12,259 13,822 Interest in JVs and associates 441 1,949 2,144 2,358 2,594 Share of results of associates Deferred tax assets Listing expenses 0 (71) ,292 40,183 41,930 42,685 43,345 Finance costs (2,050) (1,796) (2,077) (2,317) (2,572) Profit before tax 8,050 8,043 9,066 10,000 11,313 Current assets Income tax expense (1,968) (2,075) (2,266) (2,200) (2,489) Inventories 15,252 18,859 21,942 23,523 26,943 Net profit 6,082 5,968 6,799 7,800 8,824 Trade and other receivables 47,514 54,337 57,569 64,125 70,794 Minority interests (3,232) (3,147) (3,462) (3,766) (4,180) Other current assets 11,471 3,971 3,962 3,964 3,965 Net profit attributable to shareholders 2,850 2,821 3,338 4,034 4,644 Restricted bank deposits 2,241 2,675 2,832 2,551 3,462 EPS (HK$) Bank balance and cash 12,379 13,960 14,783 13,317 18,067 88,857 93, , , ,230 Growth rates (%) Revenue % 10.4% 11.6% 11. Total assets 127, , , , ,574 Net profit 7.7% % 20.9% 15.1% EPS NA -8.1% -6.8% 20.9% 15.1% Current liabilities Trade and other payables 41,953 50,961 42,255 48,140 55,053 Margin & ratios (%) Other current liabilities 5, Gross margin 15.8% 15.4% 15.1% 15.2% 15.2% Bonds payable 0 5,590 5,210 4,168 4,168 OP margin 6.9% 6.3% 6.4% 6.3% 6.4% Bank borrowings 24,335 13,737 25,000 20,000 20,000 Net margin 1.9% 1.8% 1.9% 2.1% 2.2% 72,224 70,985 73,132 72,995 79,932 Effective tax rate 24.4% 25.8% Payout ratio Non-current liabilities Deferred tax liabilities Cash Flow Statement Bonds payable 8,235 4,359 4,304 4,304 4,304 Year-end Dec 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Borrowings 4,648 2,025 2,000 2,000 2,000 Other non-current liabilities 1,334 1,376 1,358 1,358 1,358 Profit before tax 8,050 8,043 9,066 10,000 11,313 15,079 8,699 8,613 8,613 8,613 Depreciation and amortization 867 1,274 1,399 1,502 1,605 Interest income (145) (265) (214) (237) (239) Equity Others 1,186 1,401 1,692 1,980 2,193 Shareholders' equity 39,846 54,302 61,273 68,557 78,029 Change of working capital (2,213) (4,154) (15,021) (2,252) (3,175) Tax paid (1,756) (2,179) (2,381) (2,311) (2,615) Total liabilities & equity 127, , , , ,574 Operating cash flow 5,989 4,120 (5,459) 8,682 9,082 Capex (2,218) (1,982) (2,559) (1,905) (1,889) Financial Ratios Others (1,702) Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Investing cash flow (3,919) (1,953) (2,559) (1,905) (1,889) Current ratio Change of borrowings 2,733 (9,267) 10,803 (6,042) 0 Quick ratio Interest paid (1,963) (1,705) (1,973) (2,202) (2,444) Net proceeds from shares issued 0 7, Asset turnover Others (2,324) 2, Total assets/total equity Financing cash flow (1,554) (625) 8,830 (8,244) (2,444) Net debt/(cash) (HK$ m) 24,840 11,751 18,899 14,604 8,944 Net debt/equity (%) 62% 22% 31% 21% 11% Net change of cash flow 515 1, (1,466) 4,750 Forex changes (1,036) (784) Cash and cash equivalents at beginning 13,735 13,214 13,972 14,783 13,317 ROE (%) 14% 13% 9% 1 1 Cash and cash equivalents at end 13,214 13,972 14,783 13,317 18,067 ROA (%) 5% 4% 5% 5% 5% 16

17 Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 1 Neutral Expected sector relative performance ranges between -1 and 1 Cautious Sector expected to underperform benchmark by more than 1 Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited ( GF Securities (Hong Kong) ) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report. Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or recommendation for investment in, any securities. 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