Industry news

Ministry Department of China issued “12th five-year development plan for pharmaceutical industry” on January 19, 2012, in order to speed up the restructuring and upgrading of the pharmaceutical industry and foster the development of bio-pharmaceutical industry. The major developments include 1) causing industry to be grown stably and rapidly. The average annual total production and average annual growth rate of industry will grow by 20% and 16% respectively. 2) increasing concentration of industry. In 2015, the number of company with sales over RMB 50 billion will be five or above while over 100 companies will have over 10 billion sales turnover. Also, the sales of first 100 companies will account for 50% or above of industry`s. The policy in the future is expected to be tilted to large pharmaceutical companies. The integration of industry will be achieved through the survival of the fittest and the elimination of the weakest. 3) enhancing international competitiveness. The goal is to make an average annual growth of pharmaceutical exports reached more than 20% and improve the structure of export, causing the ratio of exporting finished products to be 10% or above. Moreover, more than 200 generic pharmaceutical finished products will be registered in Europe and other developed countries and to encourage more than 50 companies to establish R & D center and production base in oversea.

Recombinant human insulin products

The Group`s recombinant human insulin products were formally launched in the market in the 2011 1H. Recently, the number of current diabetics in China is over 100 million and the market for recombinant human insulin worths RMB 5 billion. This product will become a major driving force for the Group and it will bring profit for the group until 2013 and is expected to grow by 10% to 15% annually.

Reiterate “HOLD” rating

We use DCF valuation to evaluate the Group and HK$ 5.20 of 12-month target price is given, which is equivalent to 8.5x of 2012 leading PE ratio and 0.654x of PEG. Compared to HK$ 4.89 of current price, the potential upside is 6% and reiterate “HOLD” rating.

Forecast of annual result in 2011

The sales turnover of Group in 2011 1H was HK$ 3.3 billion, up 9.6% yoy, however the profit attributable to shareholders decreased by 36.4% and was HK$ 307 million. The reasons causing the increase in sales with the decline of profit are 1) inflation causing the rise in price of raw materials. 2) Central government strengthens the regulation of pharmaceutical industry. 3) The policies for controlling the price of medicines. Although the control of inflation in China is successful initially that the inflation rate in December was down to 4.1%, the annual inflation rate in 2011 is still higher than 4% of central government target. Since medicine is necessities, it is expected that the central government will continue to control the price of medicine until 2013. We forecast that the annual sales of Group in 2011 will grow by 10% to HK$ 7.15 billion while the profit attributable to shareholders will be decreased by 27% to HK$ 700 million.

The distribution of Group`s businesses

The income of Group is mainly come from three businesses including 1) Intermediate product, 2) Bulk medicine and 3) Finished products.

Intermediate product

Intermediate product is the core business of the Group. Among three businesses, intermediate product is the most profitable. The sales is mainly contributed from selling products of 7-ACA and 6-APA. 7-ACA product is the raw material of manufacturing high-end antibiotics products. The relevant regulatory authorities of China`s pharmaceutical industry promulgated a number of measures to reduce the prices of medicines, resulting in the reduction in the price of 7-ACA products. The sales in 2011 1H were mainly driven by 6-APA products and this situation is expected to remain in 2011 2H. We forecast the annual sales of intermediate product in 2011 will be HK$ 3.3 billion, up 10% yoy.

Bulk medicine

The demand of bulk medicine is affected by the introduction of price reduction policy on medicines and restriction on the uses of antibiotics medicines in medical institutions at all levels, resulting in the reduction of the price of bulk medicine. In the aspect of manufacturing bulk medicine, the Group is a leading enterprise in the industry and became the second pharmaceutical enterprise in the world that commanded the production of amoxicillin bulk medicine by enzyme process and successfully launched its new product to the market, which assisted the Group to further reduce production costs and improve production effectiveness, enabling the Group more flexible and competitive on product pricing. However, we think that the price reduction policy is at initial stage and more price reduction measures will be launched, The bulk medicine business will be suppressed continuously. The annual sales turnover in 2011 is forecasted to be HK$ 3.4 billion, up 10% yoy.

Finished products

Finished products include antibiotics finished products, non-antibiotic finished products and hollow capsules. The Government announced in April that it will impose limitation on the types of antibacterial agents for use by medical institutions as various levels. Medical institutions at various levels postponed the purchase of finished antibacterial agents, thereby further decelerating the sales of finished products. Medicine affected includes Amoxicillin capsule and Ampicillin capsule. As antibiotics finished products are necessities of hospital, once the details of measures are clear, hospitals will keep on purchasing finished products, raising the sales and prices of products. The annual sales in 2011 is expected to grow by 11% to HK$ 2.1 billion.

New products: Recombinant human insulin products

The Group`s recombinant human insulin products were formally launched in the market in the 2011 1H. Compared to insulin imported from oversea, the Group has competitive advantage on pricing. Due to aging population and the change of eating habitat, the number of diabetics in China is recently over 100 million and the market for recombinant human insulin worths RMB 5 billion. This product will become a major driving force for the Group. We expect the Group has to put a lot of capitals and human resources to develop insulin business in 2011 and 2012. The business will be profitable until 2013 and is expected to grow by 10% to 15% annually.

Valuation

We use DCF for valuation. According to Bloomberg data, the Group`s beta and equity risk premium are 0.89 and 11.4% respectively. Assume the risk-free rate (US 10-year Treasury yield) is 1.5%. The Group`s WACC is calculated as 9.6%. We forecast the free cash flow in the next 10 years and the free cash flow will grow at 3% of terminal growth rate after 2020.

According to DCF valuation, the 12-month TP of Group is HK$ 5.20. We forecast the earning per share in 2011, 2012 and 2013 are HK$ 0.543, HK$ 0.611 and HK$ 0.764 respectively. The target price implies 2012 leading P/E of 8.5x and 0.675 PEG. Compared to HK$ 4.89 of current price, the potential upside for one year is 6%. Reiterate “HOLD” rating.

Peer valuation table

Financial statements

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