• Reforms have been a drag
• Potential hit on earnings
• Environment likely to stay challenging

Lack of Clarity on Future Earnings Impact

Since our last report on 23 Nov 2018, the operating environment for pharmaceutical companies in China has become more challenging with the introduction of new policy changes. This has further aggravated an already very tough operating environment.

Reflective of this, the MSCI China Health Care index (MXCN0HC) fell from 174.69 on 13 Dec 2018 to as low as 151.74 on 27 Dec 2018, a decline of 13.1% over 10 trading sessions. As a result of this, the index has shed a total of 27.1% from the start of the year. With these changes, which were announced in recent months, the earnings outlook has diminished as there is a lack of clarity on which products will be on the affected list and the potential impact on longer term sales and profits from these products.

In view of this lack of clarity, the initial market reaction was to assume the worst, and healthcare/pharmaceutical stocks came under further selling pressure in Dec 2018. While some companies have reassured investors that the impact is unlikely to be significant for now and others have bought back their own shares at current significantly lower levels, this has not stemmed the selling as potential earnings impact is still not ascertainable at this juncture.

Margins Could Come Under Pressure

As a recap, Sino Biopharmaceutical Ltd posted 9- mth net earnings of RMB2,201.3m, up 22%, while revenue rose 37% to RMB15,730.2m. Sales of new products accounted for about 18.1% of its revenue. Gross margin improved slightly from 79.1% in 9M17 to 80.4% in 9M18. However, with the likely change to its operating environment, margins could come under pressure in the coming years.

Management has earlier shared that its focus on R&D (about 11% of revenue) and innovation will help it to maintain or gain market share. They intend to continue to focus on developing specialized medicines where its strengths lie so as to build up its brand in specialist therapeutic areas.

FV of HK$5.45

The uncertainty over the current market reforms is likely to continue and will exert pressure on share price performance, effectively capping near term price upside. Valuations have come off sharply in recent weeks. For example, the MXCN0HC estimated PER has dropped from 31x in Jun 2018 to 19x currently.

Taking into account the challenges ahead, we have pared our valuation peg to 18x earnings, dropping our fair value estimate to HK$5.45.

Source: OCBC Research - 2 Jan 2019