Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Equity Research Healthcare China TCM (570 HK) Buy (maintained) Target price: HK$5.40 Natalie Chiu SFC CE No. AVH029 nataliechiu@gfgroup.com.hk +852 3760 2030 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong 1H17 earnings beat, 2017 growth guidance reaffirmed; TP raised to HK$5.40 1H17 earnings beat consensus China TCM (CTCM) reported 1H17 revenue/net profit of Rmb3,899/599mn, increases of 21.9%/22% YoY respectively. Bottom line beat consensus and our estimates, coming in at 52% and 54% of Bloomberg and our 2017 forecast respectively. During the analyst briefing, management attributed the strong performance in 1H17 to: 1) solid growth in its concentrated TCM granules business following further network expansion in class-2 and primary healthcare institutions; 2) strong growth in emerging OTC products, offsetting the sales decline in prescription finished drugs, and; 3) effective cost control. In addition, new areas such as its TCM decoction and TCM healthcare complex businesses are providing new sources of growth, and could become prominent growth drivers. The company maintained its full-year sales growth guidance for concentrated TCM granules of, and low-single-digit guidance for finished drugs, although GPM will trend lower on a rising contribution from new businesses and higher raw material costs. Policy on TCM granules standardization to be launched by the year-end or early next year The official announcement of regulations on the administration of concentrated TCM granules, for which a draft for comments was released on Aug 16, will arrive soon, according to the company. Concentrated TCM granules were recently included as a specialty form of decoction piece in the updated Pharmaceutical Law, providing a more legitimate grounding for industry growth. As the industry is not affected by the zero mark-up policy, several provinces are giving preferential treatment to local companies in terms of market limitation and insurance coverage. The company believes the regulation will help improve the operating environment by preventing such protectionism and lead to fair competition. Bright outlook for the ready-to-use decoction business The TCM decoction pieces business represented about 5% of 1H17 revenue and posted 493% YoY growth. It offers an alternative to TCM granules, which requires further manufacturing steps. The company now has decoction centers in Shanghai and Guizhou following its two Tongjitang acquisitions in 4Q16, which will allow customers to extract TCM syrup from decoction pieces. Appropriate systems are in place to receive real-time orders from hospitals, meaning patients do not need to wait during the decoction process. Further, the segment also serves as a bulk business for finished drugs and concentrated TCM granules. The company has plans to acquire smaller extraction companies to accelerate the development of its decoction business. Stock performance 10 8 6 AR level to fall in 2H17 Operating cashflow turned negative in 1H17 as a result of: 1) account receivables rising 19% YoY despite lower turnover days of 121 vs 141 in 1H16, and; 2) higher inventory (+9 YoY) due to advanced purchases of high-demand herbs. As the credit period for its TCM granules business averaged about 180 days for direct sales to hospitals, AR should come down by end-2017. 4 - -4 Source: Bloomberg 570 HK Equity Hang Seng Index Maintain Buy and raise TP from HK$5.00 to HK$5.40 We have revised up our 2017-18 earnings forecasts by 4.8%/1.2% to reflect slightly higher revenue growth assumptions for concentrated TCM granules and lower opex ratios. Hence, we raise our target price from HK$5.00 to HK$5.40, based on a 16% EPS CAGR during 2017-19, and 1.0x PEG. Risks 1) Lower-than-expected tender prices for its exclusive EDL drugs; 2) Weaker-thanexpected volume growth after withdrawing from tenders; 3) More intense competition after the opening-up of the TMC granules industry. Key data Aug 21 close (HK$) 4.35 Shares in issue (m) 4432.00 Major shareholder Sinopharm HK (36%) Market cap (HK$ bn) 19.28 3M avg. vol. (m) 6.43 52W high/low (HK$) 4.45/2.95 Source: Bloomberg Stock valuation Turnover Net profit EPS EPS YoY P/E BPS P/B ROE (Rmb) (%) (Rmb) (%) 2015 3,709 626 0.17 4% 21.9 3.0 1.2 9% 2016 6,533 967 0.22 28% 17.1 2.6 1.4 9% 2017E 7,910 1,169 0.26 21% 14.1 2.8 1.3 1 2018E 9,061 1,311 0.30 12% 12.6 3.0 1.2 11% 2019E 10,233 1,485 0.34 13% 11.1 3.2 1.1 11% estimates
Figure 1: 1H17 results highlights YoY Chg 2016 1H16 1H17 2016 1H17 Remarks TCM granules 4,359 2,055 2,543 345% 24% Above guidance of ~ Finished drugs 2,174 1,111 1,144-3% In line TCM decoction pieces - 31 185-493% Consolidated financial statements of Shanghai & Guizhou Tongjitang TCM healthcare complex - 2 26-1119% Contribution from Guizhou Tongjitang Pharmacy Chain Total revenue 6,533 3,199 3,899 76% 22% Gross profit 2,201 1,834 2,170 72% 18% Selling expenses (1,968) (877) (1,022) 65% 17% General and administrative expens (330) (187) (165) 21% -12% No major impairment of receivables R&D expenses (187) (112) (122) 66% 8% EBIT 1,377 699 886 81% 27% Finance expenses (73) (34) (85) 5% 149% Due to corporate bonds issued in Nov 2016 and June 2017 Net profit before tax 1,304 665 799 89% Income tax expenses (217) (120) (136) 82% 13% Tax rate 17% 18% 17% -0.6ppt -0.1ppt Net profit after tax 967 491 663 69% 35% Minority interests (120) (54) (64) 548% 18% Reported net profit 967 491 599 55% 22% Represented 52% of FY17 consensus forecasts EPS: Diluted (Rmb) 0.217 0.110 0.135 28% 23% Profitability ratios (%) 2016 1H16 1H17 2016 1H17 Remarks Gross margin 58. 57.3% 55.6% -1.3 ppt -1.7ppt Due to raw material cost increases and a bigger contribution from new low-margin businesses Operating margin 21.1% 21.8% 22.7% +0.3pp +0.9pp Net margin 14.8% 15.3% 15.4% -2.1pp +0.1pp Figure 2: Revenue analysis by region (concentrated TCM granules business) 2015 2016 1H17 YoY chg Region's contribution in 1H17 Eastern China 1241 1,553 992 28.9% 39% Southern China 608 795 484 30.1% 19% Northern China 470 560 285 3.9% 11% Central China 414 546 255 29.6% 1 Northwest China 239 304 173 11.1% 7% Northeast China 376 286 168 12.4% 7% Southwest China 158 221 152 46.2% 6% Other 74 94 34 4.9% 1% Figure 3: Revenue analysis by terminal channels (Concentrated TCM granules business) Class III hospitals Class II hospitals 2015 2016 TCM hospitals 963 1133 Non-TCM healthcare institutions 288 402 TCM hospitals 586 758 Non-TCM healthcare institutions 369 501 1H17 YoY Chg Channel contribution (1H17) TCM hospitals 82 88 Primary healthcare institutions 378 Non-TCM healthcare institutions 290 405 67% 15% Sales through agents 1002 1092 515 2% 845 805 17% 34% 33% 32% Figure 4: Revenue analysis by distribution layers (finished drugs business) 2015 Proportion 2016 Proportion 1H17 Proportion Tier-one distributors 1,759 57% 1,821 65% 2,227 71.1 Tier-two and general distributors 1,313 43% 994 35% 905 28.9 Total 3,072 10 2,815 10 3,132 10 2
Figure 5: CTCM s finished drugs revenue (2014-18) Figure 6: CTCM s CCMG business revenue (2015-18) 3,000 2,500 2,000 1,500 1,000 500-10 90. 8 6 4 3. 3. 3. -20.4% - -4 2014 2015 2016 2017E 2018E Finished products YoY growth (finished products) 7,000 6,000 5,000 4,000 3,000 2,000 1,000-25% 22. 21.8% 18. 15% 1 5% 2015 2016 2017E 2018E Concentrated TCM granules YoY growth (concentrated TCM granules) estimates Figure 7: 12-month forward P/E band 10 9 8 7 6 5 4 3 2 1 Share Price 13x 18x 23x 28x 33x Sources: Bloomberg 3
Figure 8: Financial statements Income Statement Balance Sheet Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Revenue 3,709 6,533 7,910 9,061 10,233 Non-current assets Cost of sales (1,509) (2,745) (3,522) (4,041) (4,584) PP&E 1,669 2,019 2,300 2,531 2,713 Gross profit 2,201 3,788 4,388 5,020 5,649 Investment properties 3 2 0 0 0 Deposits and prepayments 136 162 170 179 187 Other income 141 74 52 81 89 Prepaid lease payments 308 334 301 271 244 Selling and distribution expenses (1,196) (1,968) (2,105) (2,446) (2,763) Goodwill 3,341 3,456 3,456 3,456 3,456 Administration expenses (273) (330) (348) (408) (460) Intangible assets 6,680 6,764 6,817 6,866 6,911 Operating profit 761 1,377 1,741 1,966 2,197 Interest in JV and associate 88 89 98 107 118 Net finance income (cost) (70) (73) (173) (210) (209) Deferred tax assets 111 140 140 140 140 Other non-recurring items (2) 0 (4) 0 0 Other financial assets 0 0 171 296 418 Profit before tax 689 1,304 1,565 1,755 1,988 12,336 12,966 13,453 13,847 14,188 Income tax expense (119) (217) (266) (298) (338) Net profit 644 1,087 1,299 1,457 1,650 Current assets Minority interests (18) (120) (130) (146) (165) Inventories 1,236 1,894 2,062 2,477 2,672 Net profit attributable to shareholders 626 967 1,169 1,311 1,485 Trade and other receivables 3,398 2,716 4,652 3,789 5,743 EPS (Rmb) 0.17 0.22 0.26 0.30 0.34 Other current assets 106 34 0 0 0 Pledged bank deposits 36 2 0 0 0 Growth rates (%) Fixed deposits 0 1,050 1,050 1,050 1,050 Revenue 40. 76.1% 21.1% 14.6% 12.9% Bank balance and cash 2,102 2,373 4,305 4,490 5,053 Adjusted net profit 51.4% 54.6% 20.9% 12.2% 13.2% 6,878 8,070 12,068 11,806 14,518 Adjusted EPS 4.1% 28. 21.4% 12.2% 13.2% Total assets 19,214 21,037 25,521 25,652 28,706 Margin & ratios (%) Gross margin 59.3% 58. 55.5% 55.4% 55.2% Current liabilities OP margin 20.5% 21.1% 22. 21.7% 21.5% Trade and other payables 2,660 2,304 4,064 3,132 5,032 Net margin 16.9% 14.8% 14.8% 14.5% 14.5% Current portion of deferred govt grants 76 0 0 0 0 Effective tax rate 17.3% 16.7% 17. 17. 17. Tax liabilitites 149 202 202 202 202 Payout ratio 0. 40.2% 30. 30. 30. Bank borrowings 1,600 1,001 800 800 800 4,485 3,507 5,066 4,134 6,034 Cash Flow Statement Non-current liabilities Year-end Dec 31 FY15 FY16 FY17E FY18E FY19E Deferred tax liabilities 1,669 1,723 1,723 1,723 1,722.92 Borrowings 850 423 400 400 350 Profit before tax 763 1,304 1,565 1,755 1,988 Unsecured notes 0 2,486 4,486 4,486 4,486 Depreciation and amortization 157 334 369 419 468 Government grants 70 143 143 143 143 Net finance cost (income) (25) 59 164 200 199 2,589 4,774 6,751 6,751 6,701 Others (39) 19 - - - Change of working capital (189) (47) (340) (485) (250) Equity Tax paid (149) (204) (250) (281) (318) Shareholders' equity 11,133 11,588 12,407 13,324 14,364 Operating cash flow 519 1,465 1,508 1,609 2,086.9 Minority interests 1,007 1,168 1,297 1,443 1,608 12,140 12,756 13,704 14,768 15,972 Capex (7,677) (1,531) (850) (850) (850) Change of AFS investments 301 - - - - Total liabilities & equity 19,214 21,037 25,521 25,652 28,706 Interest received 89 15 9 10 11 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 1.5 2.3 2.4 2.9 2.4 Proceeds from issue of shares 7,200 0 0 0 0 Quick ratio 1.2 1.5 1.8 2.0 1.8 Dividend distribution 0 (59) (140) (170) (170) Others (72) (634) (351) (393) (445) Asset turnover 0.2 0.3 0.3 0.4 0.4 Financing cash flow 8,330 1,128 1,285 (564) (665) Total assets/total equity 1.7 1.8 2.1 1.9 3,903 Net cash/(debt) (312) (484) (331) (146) 467 Net change of cash flow 1,691 92 1,932 185 563 Gearing ratio (%) 22% 34% 46% 43% 39% Forex changes (28) 0 0 0 0 Cash and cash equivalents at beginning 439 2,102 2,373 4,305 4,490 ROE (%) 9% 9% 1 11% 11% Cash and cash equivalents at end 2,102 2,194 4,305 4,490 5,053 ROA (%) 5% 5% 6% 5% 6% estimates 4
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