• Strong demand for core products
• New products to drive future growth
• Initiate with FV of HK$14.57

Innovative Drugs to Drive Growth

CSPC Pharmaceutical Group (CSPC) is an established pharmaceutical group deriving the bulk of its earnings from Innovative Drugs or 41% of group revenue in 1H2017. Innovative Drugs together with Generic Drugs accounted for 73% of revenue and 88% of group profits, driving the group’s growth and expansion.

Finished Drugs also enjoyed the highest gross margin of all of CSPC’s products at 68.9%, while Vitamin C saw gross margin of 33.2%, Caffeine and Others was at 29.2% and Antibiotics was at 13.1%. We are projecting revenue growth of 25-26% for Innovative Drugs, with a more stable 10-12% growth for Generic Drugs.

CSPC currently carries a portfolio of about 150 generic drugs covering a wide range of therapeutic areas including antiinflammatory, osteoporosis, antibiotics, etc. The remaining segment is its Bulk Drugs business which accounted for 27% of group revenue and a much smaller 12% of group profit.

Future Catalyst: New Products

Management is committing to continue to invest in Research & Development (R&D), even outside of China. Annual R&D expenditure is estimated to be about HK$600-700m. With this focus, it is also developing a suite of new products, and some will be introduced next year. However, as there is a gestation period for new products, it will take about 2-3 years for new products to gain acceptance. We expect the new products to provide future price catalysts, adding to contribution from its existing Innovative Drugs.

Initiate With HOLD

In line with the stellar 35% CAGR rise in its net earnings (from FY13-FY16), its valuations have also moved up to an average PER of 28x (low of 21x and high of 42x). With the strong gain in its share price, up a staggering 64% YTD, valuation is currently at 31x. As one of the bigger listed pharmaceutical companies in China and with strong contribution from its Innovative Drugs and possible future earnings from new products, we believe the stock should trade at a premium to its HK listed peers.

We peg the stock at 32X FY18 earnings and 1.5x PEG, giving a fair value estimate of HK$14.57. At current price, after this year’s strong gains, we initiate coverage on CSPC with a HOLD rating.

Source: OCBC Research - 2 Nov 2017