• Share price up 40% YTD
• Government support for generic drugs
• Positive prospects

Up 40% YTD Vs. Little Gains in the Overall Market

YTD, the prices of Chinese drug makers have outperformed the market by a vast margin. So far, the MSCI China Health care index is up 21% vs. a 2% gain for the MSCI China Index and -1% for the MSCI Hong Kong Index. This has been driven by strong earnings growth of companies (e.g. CSPC Pharmaceutical saw its FY17 earnings grow as much as 32%), favourable government policies, and less fundamental factors such as investors seeking companies with little exposure to the US with escalating trade tensions. CSPC’s share price itself is currently up about 40% YTD.

Government Promoting Generic Drug Industry

Just last week, China’s State Council said that it will encourage the research and development of generic drugs and improve the quality of such medicine. Tax cuts will be offered to qualified generic drug companies and further support may be given in the future. In FY17, revenue from common generic drugs accounted for about 30% of CSPC’s total revenue, and the group is likely to be a beneficiary of the government policy.

Along with the direct earnings impact due to the tax cuts, sentiment from this development is positive as it further highlights the government’s intention to promote the local drug making industry, which has positive implications over the longer term.

Remaining Optimistic

We remain optimistic about CSPC’s prospects for FY18 and beyond, and expect acquisitions to further bulk up its capabilities in the biopharmaceutical area, laying the foundation for further growth in this segment. The outlook for the group’s oncology drugs is also bright. With positive regulatory developments, we are increasing our P/E from 36x FY18/19 earnings to 40x blended earnings.

The current PEG ratio is at 1.5x and is below peers’ average of 2.3x. Our fair value estimate rises from HK$22.90 to HK$25.40. Risks to our valuation include

1. unexpected sales slowdown,
2. delay in commercialization of drugs in R&D pipeline,
3. price cuts of certain drugs, and
4. execution risks.

Source: OCBC Research - 11 Apr 2018