healthcare sector review - oriental patron sector... · 2016. 6. 30. · oriental patron research 8...

Healthcare Sector ReviewHealthcare Sector ReviewHealthcare Sector ReviewHealthcare Sector Review

Wed, 08 Sep 2010

How to pick and what to pick? Equity Research

Healthcare/ China.

After significant adjustments in June and July, we believe many stocks with low valuations start to regain interests from investors. In 2H10, we expect price cut policies to affect non-exclusive drugs with multiple manufacturers. This note serves as a stock pick guide in 2H10.

Key Summaries

� Essential drug list (“EDL”, 基本藥物目錄基本藥物目錄基本藥物目錄基本藥物目錄 ) will only benefit pharmaceutical companies with exclusive products

All county hospitals and rural clinics in PRC are obligated to use the 307 drugs on EDL, implying a tremendous growth in volume of those 307 drugs. However, volume growth does not mean margin expansion.

For non-exclusive products, margins are under risk of potential price cut and capacity expansion in industry. Only companies with exclusive products can maintain margins and enjoy volume growth from EDL.

Guangzhou Pharmaceutical (874.HK, BUY, TP: HK$9.86)

� In long run, segment leaders will prevail through consolidations

Tighter pollution and safety regulations drive smaller drug companies out of business. Increasing inter-provincial drug procurements benefits large scales drug distributors. These all lead to consolidations

Segment leaders will survive and become even stronger in consolidations.

Lansen (503.HK, BUY, TP: HK$4.86), Trauson (325.HK, BUY, TP: HK$4.68), Weigao (1066.HK, NR), Lijun (2005.HK, NR) and Sino Pharm (1099.HK, NR)

� Intermediate and bulk drug companies are showing limited growth potential, they are either at fair value or overpriced

They are making commodities, with inherited high volatility. Even worse, many intermediate and bulk drug segments are showing overcapacities, driving margins down.

United Lab (3933.HK, SELL, TP: HK$9.56), China Pharm (1093.HK, NR)

� Invest in highly innovative firms with unique products; their products usually maintain higher margins

High innovation drugs are qualified for patent protections, can enjoy “higher quality, higher price” policy of the government, and most importantly are hard to copy by competitors. Therefore, their higher margins are sustainable.

Lee’s Pharm (950.HK, BUY, TP: HK$4.05) and Sino Biopharm (1177.HK, NR)

� Same quality but lower price, medical device is going to boom

Quality of PRC manufactured medical devices is improved dramatically that we believe some are almost equivalent to the imported devices. We see no difference in quality between domestic and imported medical devices in several years while gap in price is expected to remain wide.

Traunson (325.HK, BUY, TP: HK$4.68), MingYuan (233.HK, BUY, TP: HK$0.97) and Weigao (1066.HK, NR)

John Yung

Oriental Patron Securities Ltd

+852 2842 5871

[email protected]

Oriental Patron Research

8 September 2010 of 35

Table of Contents

Policies, a concern but sector is optimistic in long run .......................................................................... 3

Before the policies become substantial, panic takes over .......................................................................... 3

Warning…we anticipate price cut in 2H10 ................................................................................................. 3

Also expecting positive policies in 2H10 .................................................................................................... 3

Healthcare sector will still draw money from investors ............................................................................... 4

The PRC Healthcare Sector Investment Summaries ................................................................................ 5

Companies with exclusive products on Essential Drug List (EDL) are benefited ........................................ 5

Consolidation is irreversible ....................................................................................................................... 6

Intermediates （中間體）and bulk drugs （原料葯） are going to fade .................................................. 7

Innovative companies are going to perform ............................................................................................. 10

Medical devices, high growth potential but with less regulatory risks ....................................................... 11

The PRC Healthcare Sector, in its best era of growth ............................................................................ 14

Unmet robust demands ........................................................................................................................... 14

Medical reform, you can’t stop the train ................................................................................................... 14

Mapping the HK-listed Healthcare Sector ............................................................................................... 16

Companies

Lansen Pharmaceutical (503 HK) ............................................................................................................ 19

Lee’s Pharmaceutical (950 HK) ............................................................................................................... 20

Trauson Holdings (325 HK) ..................................................................................................................... 21

Guangzhou Pharmaceutical (874 HK) ..................................................................................................... 22

Mingyuan Medicare (233 HK) .................................................................................................................. 23

The United Laboratories (3933 HK) ......................................................................................................... 24

China Pharmaceutical (1093 HK) ............................................................................................................ 25

Lijun International (2005 HK) ................................................................................................................... 26

Ruinian International (2010 HK) .............................................................................................................. 28

Shandong Weigeo (1066 HK) .................................................................................................................. 29

Shineway Pharmaceutical (2877 HK) ...................................................................................................... 30

Sino Biopharmaceutical (1177 HK) .......................................................................................................... 31

Sinopharm (1099 HK) .............................................................................................................................. 32



Policies, a concern but sector is optimistic in long run Since late June, news about drug price regulations struck the sector. Negative market

sentiments also drove medical device and drug distribution stocks down, though they are not

even mentioned in the policy draft.

Before the policies become substantial, panic takes over

Since the National Development and Reform Commission (NDRC, 發改委) showed its

intention to further regulate margins and price setting mechanisms of the industries, the sector

experienced significant corrections (refer to “A disaster to the industry…Not yet” on 22, June,

2010).

Till today, we observed the regulators had only been restating main themes of existing

policies while no details of solid tightening policies are given.

Warning…we anticipate price cut in 2H10

However, we believe NDRC are serious about the price regulation on finished drugs and we

expect NDRC to release policies in 2H10 with following details:

1) For non-exclusive drugs with wide price range and multiple manufacturers, NDRC is

expected to take reference from the manufacturer with the most efficient cost structure, i.e.

use the existing lowest price as the new standard; higher price non-exclusive drugs will

fail to compete.

2) Exclusive and innovative products are not likely to be affected.

3) Medical device makers and drug distributors are not likely to be affected.

Therefore, you should

A) buy companies with exclusive and innovative drugs.

B) buy medical device and drug distribution sub-sector leaders.

C) avoid companies with majority non-exclusive drugs.

D) avoid intermediate and bulk drug manufacturers; their downstream customers make

non-exclusive drugs.

Also expecting positive policies in 2H10

Equally important, we expect positive policies in “the Twelfth Five-year Plan” (十二五計劃) ,

hopefully in late October

We believe “the Twelfth Five-year Plan” will mention its supports to consolidations of the

drug distribution sub-sector. The Ministry of Commerce has expressed about their future plan

to develop 2-3 “national leaders” (with over RMB100bn revenue) and about 20 “regional

leaders” (with over RMB10bn revenue) in the drug distribution sub-sector, eliminating other

smaller inefficient players.

We also believe “the Twelfth Five-year Plan” should also substantiate beneficial policies to



the Biotech sub-sector. In specific, we expect new tax benefits to qualified biotech companies

and cash awards to future biotech drug inventions. From what we heard, the government is

expected to spend RMB10bn to award each “outstanding innovation drug” RMB 5-10mn.

Healthcare sector will still draw money from investors

At this time, we are positive to the sector’s long term prospect while we can hardly argue on

the robust demands on drugs and medical care by the growing PRC patient population. Even

we try to turn around and look at the sector from a depressive view, what is going to happen if

the world economic enters recession again? The answer is no other sectors could be more

attractive than this defensive sector in a yet growing country. We see in the following exhibit

that, historically, healthcare sector has outpaced PRC GDP in growth.

Exhibit 1: PRC GDP Growth vs Healthcare sector revenue growth

0.0%

10.0%

20.0%

30.0%

2004 2005 2006 2007 2008 2009 2010E

GDP Growth Sector Revenue Growth

Source: National Statistics Bureau, Wind China



The PRC Healthcare Sector Investment Summaries

Companies with exclusive products on Essential Drug List (EDL) are

benefited

� EDL means higher reimbursements to patients, but not higher margins to companies

The PRC Essential Drug List (EDL, 基本藥物目錄) was published in May 2009 containing

307 inexpensive drugs that provide fundamental medical care to patients. Patients will be able

to reimburse over 90% of EDL drug expense. The government promised to spend an extra

of RMB850bn from 2009 to 2012 to push the medical reform, at least 1/5 of the spending is

for procuring EDL drugs, we estimate.

In 2H10, we believe volume growth of EDL drugs will be significant because Ministry of

Health (衛生部) obligate all rural clinics and county hospitals to tender 100% EDL drugs

before the year end. However, volume growth does not guarantee profit growth for companies.

Most of the EDL drugs are non-exclusive; capacity expansion of existing EDL drug

manufacturers and possible price cut policy of NDRC can drag margins down in long run.

� Only exclusive products can maintain their margin in long term

Exclusive drugs are an exception; the sole manufacturer will be able to maintain high margin

and to enjoy volume growth. In the PRC-listed universe, companies with exclusive products

on EDL include:

Exhibit 2: Companies with exclusive products on EDL

Listed Company Ticker Products Yunnan BaiYao Group (雲南白藥) 000538 CN Yunan Baiyao (雲南白藥) China Resources Sanjiu (華潤三九) 000999 CN Sanjiu Weitai Keli, Zhengtian Wan (三九胃泰顆粒、正天丸) Qianjin Parmacy (千金葯業) 600479 CN Fu Ke Qian Jin Jiao Nang(婦科千金膠囊) Wuhan Humanwell Healthcare (人福科技) 600079 CN Sufentanil Citrate Injection (芬太尼注射劑) Guangzhou Parmaceutical (廣州葯業) 600332 CN/ 874 HK Xiaoke Wan, Huatuo Zaizao Wan (消渴丸、華佗再造丸) Fosun Pharma (復星葯業 600196 CN Xianling Gubao Jiaonang (仙靈骨葆膠囊) Zhongxin Pharmaceuticals (中新藥業) 600329 CN Su Xia Jiu Xin Wan(速效救心丸) Tasly Group (天士力) 600535 CN Compound Danshen Dripping Pills (複方丹參滴丸) Jinlin Parmaceutical Co. Ltd (金陵藥業) 000919 CN Mailuoning Zhusheye (脈絡寧注射液) Merro Pharma (美羅藥業) 600297 CN Shang Ke Jie Gu Pian ( 傷科接骨片) Mayinglong Parm (馬應龍) 600993 CN Musk Hemorrhoids Oitment (馬應龍麝香痔瘡膏) Zhong Heng Group (中恒集團) 600252 CN Zhu She Yong Xue Shuan Tong (血栓通凍乾粉) Source: Company, OP Research

� The only company benefited from EDL in Hong Kong.

Within the Hong Kong listed universe, Guangzhou pharmaceutical (874.HK) is the only

company with two exclusive EDL products.

1) Xiaokewan (消渴丸) accounted for ~50% market shares of TCM (Traditional Chinese

medicine) for diabetes in PRC and ~10% market shares of all diabetes drugs in PRC. It

contributed ~RMB500mn revenue (~15% of total revenue) in 2009. We believe, its relatively

low price (comparing to other western medicines and better accepted by rural population) and

higher reimbursement rate will make its sales double in 3 years.



2) Huatuozaizaowan (華佗再造丸), listed as National Tier-1 Confidential Formula (國家一級保密處方), sales of RMB150mn or 4% of the company’s 2009 revenue. Being one of the

crucial TCM for treating growing stroke related diseases, its volume will grow further after its

entry to EDL.

The company is only traded at a FY11 PE of 16X, significantly lower than the peer average of

20X. We recommend BUY at TP HK$9.86

Exhibit 3: Xiaokewan and Huatuazaizaowan

Source: Company

Consolidation is irreversible

� Reasons behind consolidations

Following are reasons for industrial consolidations:

1) To improve product safety, SFDA is enforcing stricter regulations, such as implementing

the new European Good Manufacturing Practice (GMP) standard staring 2011; many

existing plants has to be modified. Many of the smaller companies are unable to afford

the extra Capex and will have to either close down or be bought out.

2) Besides, regulators are enforcing more stringent requirements on pollution preventions

and require add-on constructions such as sewage treatments. Again, money problem for

smaller firms.

3) Latest medical reform policies ask drug manufacturers to limit the number of distributors

from door (of manufacturer) to door (of hospitals).

4) Inter provincial drug procurements have been happening more frequently, benefiting

bigger distributors with interprovincial networks.

5) This month, the Ministry of Commerce has expressed about their future plan in the “the

Twelfth Five-year plan” to develop 2-3 “national leaders” (with over RMB100bn revenue)

and about 20 “regional leaders” (with over RMB10bn revenue) in the drug distribution

sub-sector, eliminating other smaller inefficient players.

While 1) and 2) push consolidations in drug and medical device segments, 3), 4) and 5) push

for consolidations in drug distribution segment. After some years, smaller companies will

not survive while subsector leaders will have acquired their market shares and become

stronger.



� Meeting the leaders

In the long run, we believe consolidations will benefit the following companies with leading

positions in their segments:

Exhibit 4: Companies and their market share in the segments

Company Ticker Leading position in… Market

Shares/Ranking

Top 3 Market

Shares Combined

Sinopharm 1099 HK Logistic Distribution ~12% / 1st ~20%

Lijun 2005 HK Plastic Intravenous Infusion Products

(塑膠瓶大輸液)

~15% / 3rd ~57%

Lansen 503 HK DMARDS （風濕病慢作用藥) ~17% / 1st ~35%

Sino Biopharm 1177 HK Hepatitis Therapeutics ~12%/ 3rd ~80%

Weigao 1066 HK Stents (心臟支架) 25%/ 1st ~75%

Trauson 325 HK Trauma Orthopedic Devices ~8%/ 2nd 27%

Source: Company, OP Research,

Intermediates （（（（中間體中間體中間體中間體））））and bulk drugs （（（（原料葯原料葯原料葯原料葯）））） are going to fade

� It is a commodity business; it is hard to estimate the profit

Intermediate drugs are mostly chemicals to be further processed into drugs; bulk drugs are

raw drug powders before further containing or packaging.

Intermediate drugs and bulk drugs from different suppliers are similar in quality; they are

basically commodities. Company margins are hard to estimate and depend heavily on

frustrating market price/company ASP. The following shows the relationship of company

margins and historical price movements of intermediate drugs (6-APA, 7-ACA, etc.) and bulk

drugs (Amoxillin, Cefotaxime, Vitamin C, etc.)

Exhibit 5: Margins of the United Lab (3933.HK) intermediates depend on

market price

0

200

400

600

800

1,000

1,200

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

6-APA(RMB/Kg) 7-ACA-(RMB/Kg)

Intermediate drugs achieved 3% operating margin in 1H09

Intermediate drugs achieved 12% operatingmargin in 1H08

(RM

B/K

g)

Source: Company, OP Research, Wind China



Exhibit 6: Margins of the United Lab (3933.HK) bulk drugs depend on

market price

0

200

400

600

800

1,000

1,200

1,400

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

Amoxilin(RMB/Kg) Cefotaxime(RMB/Kg)

Bulk drugs achieved 6%operating margin in 1H09

Bulk drugs achieved 16%operating margin in 1H09

(RM

B/K

g)


Exhibit 7: Margins of the China Pharm (1093.HK) fall so does the market

price

0

20

40

60

80

100

120

140

160

Vitamin C (RMB/Kg)

Vitamin C achieved 54%operating margin in 1H09

Vitamin C achieved 43% operating marginin 1H09

(RM

B/K

g)


� Cursed by overcapacity, margins shrinking

Overcapacity has been observed in intermediate and bulk drug segments for long time; we

still constantly see new entrants to the segments. The follow shows how bad the

overcapacities are in different products.

Exhibit 8: Examples of overcapacities in intermediate and bulk drugs

Product World demand/

Annual

PRC capacity/

Annual

The United Lab (3933.HK)

Capacity/Annual

China Pharm (1093.HK)

Capacity/Annual

7-ACA 4,000ton 7,000 ton 700 ton 1,200 ton

Penicillin 60,000 ton 100, 000 ton 10,000ton 15,000ton

Vitamin C 100, 000 ton 180,000ton NA 32,000ton


Overcapacity can only drive segment margins down. In long run, we see players in the

segments become marginally profitable.



� 2H10 price cut can hit them hard

Both the United Lab (3933.HK) and China Pharm (1093.HK) have finished products, but all

are non-exclusive drugs exposed to potential NDRC price cut in 2H10.

For non-exclusive drugs with wide price range and multiple manufacturers, NDRC is

expected to take reference from the manufacturer with the most efficient cost structure, i.e.

use the existing lowest price as the new standard; higher price non-exclusive drugs will fail to

compete.

While we believe NDRC is likely to first cut price of non-exclusive EDL(基本藥物目錄)

drugs, China Pharm has about 1/3 of their finished products listed on EDL list and the United

Lab also has about 1/3 of their 34 finished products listed on EDL.

� Selling new finished products might not solve the problem

Companies understand the problem with shrinking margins and they want to rely on

introducing new finished products to boost future growth. However, we think this might not

solve the problem because:

� usually their new products are second tier technology drugs facing fierce competitions

� they need to invest a lot of time and money to develop totally different channels

For instance, the United Lab (3933.HK) launched in early FY10 their “second generation

insulin” (二代胰島素) product into the market, which is already saturated by foreign and

domestic players. In the long run, we believe the technology advanced “third generation

insulin” will take over “second generation insulin”.

Exhibit 9: Insulin market shares in PRC

Novo Nordisk z(諾和諾德)

75%

Lilly (禮來)

11%

Sanofi-Aventis (賽諾菲-安萬特)

2%

Gan & Lee (甘李)

2%

Dong Bao (東寶）10%

Source: Company, OP Research

More importantly, the United Lab has been selling only antibiotics (抗生素). For insulin, they

will need to build totally different channels in hospitals. This could means 2-3 years of efforts

for their sales force and extra SG&A expenses (finished product segment margin dropped

from 24.7% in 1H09 to 21.7% as SG&A up 33% to HK$633mn). We believe, their insulin

product might not be able to break even in 2011 while its 2012 contribution is questionable.



� Pricy stocks?

The United Lab (3933.HK) is trading at FY10 PE of 19X(FY11 PE of 16), we think this is

demanding for a company whose revenue still rely heavily on intermediate and bulk drugs

(~65% revenue in 2009) and risks heavy price cut to their finished products. We recommend

SELL at TP $9.56.

On the other hand, China Pharm (1093.HK) is less active on moving towards finished

products, 70% of 2009 revenue is from intermediate and bulk drugs. While it is trading at

FY11 PE of 11X, we believe the valuation is not attractive at this time.

Innovative companies are going to perform

� Generic drugs, no more fat margins

Making generic drugs can establish cash flow quickly, but the cash flow also drains quickly

when everybody rushes to make the same drug. Tendency of the government is clear: they

want companies to focus more on R&D and discovering new drugs.

Currently, only new drugs are protected by an exclusive patent period. In future, NDRC (發改委) is expected to only allows patented new drugs and the “first followers” (首仿者) to set

their price with reference to costs and global prices, resulting in higher margins. For the

“second followers” and the “third followers”, they can only set their generic drug price 10%

and 20% below that of the “first follower”, resulting in lower margins. The regulation

substantially discourages companies from making generic drug

Exhibit 10: Expected pricing policies of NDRC

Drug Category NDRC price guideline

Innovative patented new drugs Priced with reference to costs and global prices, highly flexible

“First follower” generic drug Priced with reference to costs and global prices, usually significantly

lower than price of new drugs

“Second follower” generic drug Priced10% lower than that of “First follower” generic drug

“Third follower” generic drug Priced 20% lower than that of “Second follower” generic drug

“Forth follower” generic drug Price capped by price of “Third follower” generic drug

Source: NDRC, OP Research

Moreover, we expect the “the Twelfth Five-year Plan” to mention substantial incentives to

drug innovations. From what we heard, the government is expected to spend RMB10bn to

award each “outstanding innovation drug” RMB 5-10mn.

In the future, we see generic drug makers to suffer from low margins and fierce competitions

while innovative firms dominate.

� Innovations pay off, buy companies with new drugs

In our view, companies focusing on new drug discoveries will be long term winners in the

PRC pharmaceutical industry, because they enjoy:

� favourable policies, such as “higher quality, higher price” (優質優價) and other tax

incentives.

� better patent protections, while they have 10-15 years selling the exclusive products.

� higher margins, when you compare to those of generic drugs.

� rich pipelines, to fuel long term growth of the company.



We believe there are only two companies in Hong Kong listed universe that is qualified as

innovative firms, and they are: Sino Biopharm (1177.HK) and Lee’s Pharm (950.HK).

Sino Biopharm (1177.HK) focuses on cardio-cerebral, hepatisis, oncology and analgesic

medicines. Out of their >12 major products, 7 products contribute more than RMB100mn in

2009. We believe products with high growth potentials and pioneering innovations will come

out from the company. After significant downward adjustments in previous weeks, its current

valuation at FY11 PE of 22X is attractive, we believe.

Lee’s Pharm (950.HK), focusing on heart disease, cancer and gynaecology drugs is expected

to grow its profit by >50% in 2010 and ~30% afterwards. Three of its products are looking

forward to sell over the critical revenue level of HKD100mn in the future two years. Also

downward adjusted recently, the current valuation at FY11 PE of 14X is cheap, in our view.

We recommend BUY at TP $4.05.

Medical devices, high growth potential but with less regulatory risks

� Closing up the gap with foreign players

In recent years, the domestic medical device industry advanced dramatically. Many

companies have successfully moved from fundamental devices (e.g. needles and syringes,

with lower margin) to sophisticated devices (e.g. heard implant devices, higher margin). Some

domestic companies established significant sales overseas, proving that foreign doctors

confirmed quality of domestic products. Indeed, many domestic products have been selling

OEM products to their international competitors for years. This shows that domestic products

have reached same technology and quality level as their foreign counterparts, although they

are selling at a significantly lower price.

Even better, all of the recent policies didn't imply any tightening regulations to the device

subsector; it is the best era for the medical device subsector.

� Backed by strong demands, domestic brands taking over

Medical reform also benefits the medical device subsector. From the RMB850bn fiscal

spending for the medical reform, at least 1/5 is estimated to be for building rural medical

facilities which includes vast amount of medical device procurements, we estimate. Moreover,

we believe these government procurements will mainly buy from domestic device makers

rather than their foreign counterparts. Thus, market of domestic medical devices such as stents

and orthopedic products are expected to grow significantly in the coming years

PCI (percutaneous coronary intervention, 冠脈手術) are procedures to implant stents to

patient bodies. While the PRC market of stents (支架) is about RMB25bn in 2009，we believe

that only ~4% of the patient demand is met. Therefore, we believe the market will grow at a

CAGR of >30% in the coming years. Exhibit 10 shows the comparison on population and

annual PCI procedure counts of three countries. We can see the huge growth potential of PCI

procedures once it catches up with the developed countries.



Exhibit 11: National population and PCI procedures

0

200

400

600

800

1,000

1,200

1,400

0

200

400

600

800

1,000

1,200

1,400

US Japan PRC

Population (mn) PCI (000')

Po

pu

lati

on

(M

n)

PC

I p

roced

ure

s ('0

00)


� Domestic domination is proven in history

In Exhibit 11 we see currently 75% of market share is acquired by domestic players; back in

2006 over 90% market share was occupied by international players.

Exhibit 12: Market share change in PRC stent market

Beijing Lepu25%

Weigao#

25%

2009

3 Internatioanl players*25%

Shanghai Microport25%

2006

Domestic players~10%

International players~90%

Source: Company, OP Research. * Three international players are Johnson & Johnson (JNJ), Medtronic (MDT), and Boston Scientific (BSX); #Stents of Weigao are sold under subsidiary Jiwei.

Orthopedic products with a PRC market size of about RMB 6.0bn in 2009 and domestic

market share is below 20%; we believe domestic companies are going to dominate the

orthopedic market following the stent example. Looking forward, the market is expected to

grow at a CAGR~30%.

� Medical device companies in spotlight

Weigao (1066.HK) is the all around medical device supplier with products ranging from

medical consumables, orthopedic devices and heart surgery stents to blood purification

products. While the company ‘s consumable, stents and orthopedic products are expected to

grow over 30% each year, its blood purification products should achieve >100% growth in the

coming 2- 3 years, we estimate.



On the other hand, Trauson, focuses only on orthopedic devices. While its trauma products

(11% market shares) and spine products (3% market shares) rank the 3rd

and the 6th

in PRC.

The company profit is expected to grow at a CAGR of 30% in the coming three years.

While Weigao (1066.HK) and Trauson (325.HK) are both quality device companies in the

HK-listed universe. We believe Trauson (trading at FY11 PE of 18X) is more attractive in

valuation than Weigao (trading at FY11 PE of 35X), and therefore should be preferred. We

recommend buying Trauson at TP HK$4.68.



The PRC Healthcare Sector, in its best era of growth

Unmet robust demands

We can hardly argue about the PRC’s fast growing GDP and the rising healthcare awareness

of its population. To catch up with developed countries on healthcare expenditure, sector

revenues are going to grow constantly.

On the other hand, we believe the majority of patient populations are not being treated

because of the current low coverage rate of medical care system. Medical reform is expected

to be the solution.

Exhibit 13: Healthcare Expenditure as % GDP

0

2

4

6

8

10

12

14

16

(%)

Source: Company, OP Research, Ministry of Health

Exhibit 14: Treatment rate of some major diseases in PRC

Disease Infected Population Treatment rate

Diabetes ~100mn ~15%

Coronary Heart disease ~20mn ~5%

Cancer ~11mn ~10%

Source: Company, OP Research, National Statistics Bureau

Medical reform, you can’t stop the train

The ultimate goal of medical reform is to establish a basic, universal healthcare framework to

provide Chinese citizens with safe, efficient, convenient and affordable healthcare.

� Step 1: from 2009-2011, to increase the accessibility while reducing the cost of healthcare

and to build up network of basic healthcare facilities, expand the coverage of the public

medical insurance system to cover >90% of the population and to reform the drug supply

and public hospital system.

� Step2: 2011 to 2020, to establish a universal healthcare system. The entire population

should be covered by public medical insurance; drug and medical services should be

accessible and affordable to citizens in all public healthcare facilities.

� Starting from 2010, subsidy for each participant in Urban Resident Program increases

from RMB40 to RMB 120, subsidy for each participant in New Urban Insurance Scheme



Program increases from RMB80 to RMB 120.

� To build 29,000 rural clinics in 2009, an additional 5,000 rural clinics, 2,000 county

hospitals and 2,400 urban community clinics in under-developed areas.

In our view, medical reform is irreversible, the robust demand it brought makes the PRC

healthcare sector defensive yet fast growing in the coming years.



Mapping the HK-listed Healthcare Sector Since the IPO of Sinopharm (1099.HK) in 2009, the healthcare sector in Hong kong

constantly gains more investor attentions. In exhibit 15 we selected HK-listed companies in

the sector and tried to map them according to different sub-sectors (such as chemical drugs

and medical devices, the vertical scale) and their positions in the industrial value chain (from

intermediate drugs all the way to channels, the horizontal scale).

While you see most of the companies are only manufactures of finished products, companies

like the United Lab (3933.HK) and China Pharm (1093.HK) span also the upstream

intermediates and bulk drugs, companies like Guangzhou Pharmaceutical (874.HK) also has

business in distribution and retails.

In exhibit 16, we try to summarize the characteristics of each of these sub-sectors in the

HK-listed universe.

Lastly, exhibit 17 shows the ongoing growth trend of the whole PRC healthcare industry,

broken down in segments.



Exhibit 15: Mapping major HK-listed companies in the sector

Bulk Medicines

Intermediates Finished Products

To other companies

Distributors

Other Distributors

Channels

Retailers

325 HK

233 HK

1099 HK

� Distribution: 93%

� Retail: 3%

� Amino Acid Supplements: 80%

� Health Drink:19%

� Other Drugs:1%2010 HK

� TCM: 51% � Distribution and Retail: 49%874 HK

� Intermediate: 46%

� Bulk Medicines: 26%

� Finished Products 28%1093 HK

� Injections: 57%

� Granules:17%

� Soft Capsules: 24%

� Others:2%2877 HK

� Other Drugs: 20%� Intravenous Infusion: 37%

� Antibiotics:43%2005 HK

� Rheumatology drugs:69%

� Medical plant extract:19%

� Generic drugs: 12%503 HK

� Oncology: 6%

� others: 27%

� Hepatitis : 48%

� Cardio-Cerebral:19%1177 HK

� Cardio: 45%

� Surgical: 30%

� Infection: 8%

� Others: 27%950 HK

� Consumables: 81%

� Orthopetic: 7%

� Blood Purification: 4%

� Others: 8%8199 HK

� Trauma: 66%

� Spine: 21%

� OEM: 9%

� Other: 4%325 HK

� Protein Chip: 82%

� Healthcare screening: 10%

� Medical Center: 8%233 HK

Su

pp

lem

en

ts

� Intermediates: 17%

� Bulk Medicines:48%3933 HK

� Finished Products:35%

TC

MC

hem

ical

Bio

Devic

es

Source: Company, OP research. *TCM = Traditional Chinese Medicine, Bio = Biotech drugs, Chemical = Chemical Drugs, Devices = Medical Devices, Supplements = Health Supplements,



Exhibit 16: Characteristics of sub-sectors

• Properties:

� Most of drug makers in PRC fall into this Subsector � Easier to copy many generic drugs � Lower in margin

� Antibiotics and aspirin fall into this category • Average Gross Margin*: 47%

• Total sales in 2009: RMB521bn

* Selected samples In HK-Listed universe

Chemical Drugs

• Properties:

� High tech and represents the latest trend � More demanding procedures, so harder to copy � Usually higher in margin

� Products are usually proteins • Average Gross Margin*: 70%

• Total sales in 2009: RMB

• Properties:

� With the longest history in PRC � Usually cheaper in price and popular in rural areas � Same product in different brand varies in quality and price

� Hard to scientifically quantify the effectiveness • Average Gross Margin*: 50%


• Properties:

� Technology and quality advancing fast � Domestic companies focus on mid to low end market � Domestic companies acquiring higher market shares

� High Margin • Average Gross Margin*: 62%


• Properties:

� High Margin � Low regulatory risk � Behavior similar to commercial stocks

� High SM&A cost • Average Gross Margin*: 69%


Biotech

TCM

Devices

Health Supplements


Exhibit 17: Turnover of selected sub-sectors

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

2003 2004 2005 2006 2007 2008 2009 2010*

(RM

B m

n)

SupplementCAGR: 10%

DeviceCAGR:32%

BiotechCAGR:24%

TCMCAGR:20%

ChemicalCAGR:18%

CAGR of Total Turnover: 20%




Lansen Pharmaceutical (朗生醫藥)

Target Price: HK$4.86 (+40%) Price: HK$3.48 HKEx Code: 503

Leader in the niche of DMARDS Lansen is the leader in PRC DMARDS market, holding ~25% market share.

DMARDS （風濕病慢作用藥）, one kind of rheumatic drug (風濕病藥), accounts for 1/5 of the overall rheumatic drug market which was about RMB60bn in 2009.

While the overall PRC rheumatic drug market is growing at a CAGR over 18%, PRC DMARDS sector grows at 29.2% CAGR.

Leveraging on the established network While we estimate the PRC rheumatic disease population to be over 50mn, the

disease ranks 4th

in the PRC chronic diseases and is undertreated. Most of the older

patients simply accept the chronic disease without seeking out professional medical

care. This is going to change along with the increasing medical care coverage and rising life quality being pursued.

Currently, all of Lansen’s rheumatic drugs are in the National Medical Insurance

Reimbursement List; patients can seek 80% to 100% reimbursements using the

company’s products. Lansen serves over 1000 hospitals which include all the

hospitals with rheumatology departments and the hospitals with high potential to

open one. In particular, the company has maintained relationships with most of the rheumatology specialists in PRC hospitals.

We think this established network is the core completive edge of the company

comparing to its competitor. We believe the company can leverage on the network

and capture the future high growth of rheumatic drugs in PRC.

The risk: most of the key products are not self-developed 5 out of the 6 core rheumatic drugs being sold are licensed in; that is, Lansen is only

being the sole distributor in PRC and the roles of sole distributor are subjected to contract renewals.

However, most of the distribution relationships have been lasted for long time and

original product makers developed reliance on the distribution interwork of Lansen. Therefore, we believe chance is slim for Lansen to lose their distributorships.

Undervalued

The stock is currently trading at FY11 PE of 15X, significantly lower than the peer

average of 20X. Given the company’s leading position in selling rheumatic drugs in

PRC, we don’t think the company deserve any discount. We used FY11 PE of 20X

and the Bloomberg consensus FY11 profit of HK96mn; we recommend BUY at TP

HK$4.86.

BUY

Key Data

Close price (HK$) 3.48

12 Months High (HK$) 5.25

12 Month Low (HK$) 3.08

3M Avg Dail Vol. (mn) 2.68

Issue Share (mn) 415.00

Market Cap (HK$mn) 1,444.20

Free Float % 37.58

Net cash/share (HK$)

Net debt/equity (%) 52.72

Fiscal Year 12/2009

Major shareholder (s) Cathay Int'l (50.6%)

Source: Company data, Bloomberg, OP Research Closing price are as of 7/9/2010 All figures are subject to rounding

Price Chart

0.0

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3.0

4.0

5.0

6.0

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Company Background

The principal activities of the Group are engaged in

the development, production and sale of specialty

prescription western pharmaceuticals for the

treatment of autoimmune rheumatic diseases in the

PRC.

The “5-pillar” Analysis

5

3

44

5

Profitability

Technology/ Innovation

Growth Potential

Policy Benefit

Valuation Attractiveness

Exhibit A: Investment Summary

Year to Dec (USD mn) FY07A FY08A FY09A 1H09 1H10

Revenue (mn) 24.2 37.1 47.9 20.8 28.4

Growth (%) - 53.7 29.1 n/a 36.3

Net Income (mn) 0.4 5.1 7.4 3.4 5

Growth (%) - 1,074.3 45.5 n/a 49.2

Gross margin (%) 68.1 70.1 67.7 68.1 65.4

Profit margin (%) 1.8 13.7 15.4 16.2 17.6

ROE (%) na 23.2 28.0 na na

ROA (%) na 9.5 11.9 na na

EPS na na na na na

P/E (x) na na na na na

P/B (x) na na na na na

Dividend yield (%) na na na na na

EV/EBITDA (X) na na na na na

Source: Bloomberg, OP Research



Lee's Pharmaceutical (李氏大藥廠)


Multiple pipelines fueling the growth

While product pipeline decides future profitability of a pharmaceutical company,

Lee’s Pharm ensures new product continuity by sourcing from 1) in-house R&D, 2)

partnerships in international drug discovery projects and 3) being sole-distributors of

foreign pharmaceuticals.

The model is not so easily copies by others as 2) and 3) requires thorough

understanding to the international pharmaceutical industry (CEO of the company

worked in the US pharmaceutical companies for over 20 years) and good

relationships with foreign companies (the company gets connections from its

American and European strategic investors).

Focusing on 4 rising urban disease sectors in PRC

1) Heart diseases, currently 250mn patients in China, 2) Cancers, there were about

11 mn cancer patients being diagnosed in PRC, 3) Gynopathy diseases (婦科病),

there were 150mn gynopathy disease patients being diagnosed in 2008,

4)Dermatology diseases（皮膚病）, there were about 60mn dermatology disease

patients being diagnosed in 2008 Main products and their contributions

High growth supported by existing and new products

For existing products, Livaracine®

(heart disease drug) had just gained the “better

quality, higher price (“優質優價”) approval and has increased the retail price by

40% since January 2010, Carnitene®

(heart disease drug) and Slounase®

(surgery

drug) entered the national medical insurance reimbursement list since Jun 2010.

The company has plans to promote its 2010 launched products, especially Zanidip®,

the drug to treat hypertension. In 2009, hypertension patient population is larger than

200mn, or about 20% of national population. However, only approximately 25% of

these patients are treated.

To further promote its new products, the company plans to expand its sales force

from 150 to 300 people by the end of 2010. We estimate Zanidip® to start

contributing about RMB10mn revenue in 2010 and will grow at CAGR over 100%

in the future three years.

We believe the company will grow at over 35% CAGR for the future three years

while FY10 profit is expected to grow over 50% yoy. We reiterate BUY with a

target price at HK$4.05.

BUY

Key Data







Free Float % 31.48

Net cash/share (HK$) (0.10)

Net debt/equity (%) Net Cash

Fiscal Year 12/2009

Major shareholder (s) Lee's Family (40.0%)


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%950 HK MSCI CHINA

Company Background


manufacture and sale of self- developed

pharmaceutical products, trading of license-in

pharmaceutical products.


5

5

54

5

Profitability


Growth Potential

Policy Benefit


Exhibit B: Investment Summary

Year ended Dec (HK$mn) FY09A FY10E FY11E FY12E 1H09 1H10

Revenue (mn) 173.8 259.1 356.7 491.1 76.6 105.3

Growth (%) 38.6 50 38 38 n/a 37.5

Net Income (mn) 46.4 68.1 88.3 117.7 20.1 26.3

Growth (%) 65.2 48 30 33 n/a 30.8

Gross margin (%) 72 72 72 72 72 72

Profit margin (%) 27 26 25 24 26. 25

ROE (%) 40 34 33 32 na na

ROA (%) 29 27 26 26 na na

EPS 0.10 0.15 0.20 0.26 na na

P/E (x) 28 20 12 10 na na

P/B (x) 9 5 4 3 na na




Trauson Holdings (創生控股)


Doing well in its niche The company, though with incomparable scale and product variety to Weigao, performs in the niche of PRC orthopedic device (including trauma, spine and joint products) subsector. Market share of Trauma: 8.4%, the largest domestic maker. Market share of Spine: 3%, 2nd largest domestic market. The following shows ranking and market share of players in

Tapping into the joint orthopedic market While you might realize that the company sells no joint products now, they are entering the market by first distributing joint products of a Taiwanese orthopedic manufacturer.

In the future, the company will release joint products in their R&D pipeline and leverage on their existing distribution channels. The potential is high as we believe PRC joint orthopedic market is going to grow at ~35% CAGR in the coming years, among the highest of the other two segments (Trauma: expected CAGR~25%, Spine:CAGR~30%)

Substitutes to foreign brands Same story as Weigaos’s, the company makes OEM products for many foreign orthopedic device companies, including Medtronic (MDT.US). With almost the same quality and the existing price discount, company is going to further acquire existing market share of foreign players

Undervalued While Trauson is in the same medical device sub-sector as Weigao (1066.HK) and enjoys a similar high growth rate, its smaller market cap and its shorter listed history should make it deserve a discount on valuation, we believe. We did our back-of-envelope calculation using FY11 PE of 24X (30% discount to Weigao’s FY11 PE of 35X) and using the Bloomberg consensus FY11 profit of HK151mn; our TP is at HK$4.68, BUY.

BUY

Key Data




3M Avg Dail Vol. (mn) NA



Free Float % 38.28

Net cash/share (HK$) -


Fiscal Year 12/2009

Major shareholder (s) Xu Yan Hua (67.2%)


Price Chart

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3.1 3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

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Company Background


design, manufacturing and sale of a broad range of

trauma and spine orthopaedic implants under the

brands Trauson and Orthmed and related surgical

instruments in China.


4

4

45

4

Profitability


Growth Potential

Policy Benefit


Exhibit D: Investment Summary

Year to Dec (RMB mn) FY07A FY08A FY09A 1H09 1H10Revenue (mn) 131.6 173.7 211.5 88.6 120.3 Growth (%) 32.0 21.8 n/a 35.8Net Income (mn) 55.7 64.8 82.2 32.7 37.4 Growth (%) na 16.4 26.8 n/a 14.3

Gross margin (%) 59.0 66.1 70.6 69.6 72.5Profit margin (%) 42.3 37.3 38.9 36.9 31.1ROE (%) na 54.7 42.5 na naROA (%) na 29.8 27.6 na naEPS 0.2 0.1 0.2 na naP/E (x) 22.44 29.92 23.93 na naP/B (x) na na na na naDividend yield (%) na na na na naEV/EBITDA (X) na na na na na


Exhibit C: Market share and ranking in PRC othorpedic market

Trauma Market Rank Company Name Market Share (PRC)

1 Synthes, Inc. US & Switz. 13.8%2 Trauson PRC 8.4%3 Kanghui Medical PRC 5.1%4 Shangdong Weigao PRC 3.6%5 Beijing Libeier PRC 2.7%6 Tianjin Walkman Biomateriald PRC 2.3%Spine Market

1 Medtronics, Inc. US 13.3%2 Johnson & Johnson (Depuy) International 11.1%3 Shangdong Weigao PRC 8.1%4 Synthes, Inc International 7.4%5 Styker Corporation International 5.7%6 Trauson PRC 3.0%




Guangzhou Pharmaceutical (廣州藥業)


New force to historical repudiated brands

The leading TCM company in China composed of 12 subsidiaries, 400 products

ranging from prescription drugs to herbal teas with 40 out of that included in the

“National protedted Chinese medicine list” (中藥保護品種) Intangible but valuable

assets include famous brands like “Wang Lao Ji” (王老吉) and “Pan Gao Shou” (潘高壽), Jingxiutang (敬修堂), Chenliji (陳李濟) while the earliest was established in

1600s.

Starting in 2004, the company brought in investors and formed JV on brand

“Wanglaoji” to bring in new strategies to the state own management; revenue of

“Wanglaoji” since then grew over 200% in three years. In the future, we believe the

company will apply the same business model to its other brands with high potentials.

Only HK-listed company with exclusive products on EDL

While the company has more than 10 products listed on EDL (Essential Drug List，基本藥物目錄), two are exclusive. While all EDL products will grow in volume

from tenders of all rural medical facilities in 2H10, two exclusive products listed

below can also maintain a stable margin in long run.

1) Xiaokewan (消渴丸) accounted for ~50% market shares of Traditional

Chinese Medicine (TCM) for diabetes in PRC and ~10% market shares of all

diabetes drugs in PRC. It contributed ~RMB500mn revenue (~15% of total

revenue) in 2009. We believe, its relatively low price (comparing to other western

medicines and better accepted by rural population) and higher reimbursement rate

will make its sales double in 3 years.

2) Huatuozaizha (華佗再造丸), listed as National Tier-1 Confidential Formula (國家一級保密處方), sales of RMB150 mn or 4% of the company’s 2009 revenue.

Being one of the crucial TCM for treating stroke related diseases, its volume will

grow further after its entry to EDL.

Low valuation

The stock is currently trading at FY11 PE of 16X, significantly lower than the peer

average of 20X. The company owns many valuable brands and popular products; we

expect future improvements to operation to be successful and the company deserves

higher than its current valuation. Using FY11 PE of 20X and using the Bloomberg

consensus FY11 profit of HK385mn ; we recommend BUY at TP HK$9.86.

BUY

Key Data







Free Float % 100.00



Fiscal Year 12/2009

Major shareholder (s) Guangzhou Pharm. (48.2%)


Price Chart

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%874 HK MSCI CHINA

Company Background

The Group is principally engaged in the

manufacture and sales of Chinese Patent Medicine

(CPM); wholesale, retail, import and export of

western and Chinese pharmaceutical products and

medical apparatus; and research and development

of natural medicine and biological medicine.


3

3

44

5

Profitability


Growth Potential

Policy Benefit


Exhibit E: Investment Summary

Year to Dec (RMB mn) FY07A FY08A FY09A 1H09 1H10

Revenue (mn) 11,873.5 3,450.6 3,802.4 1,903.0 2,282.8

Growth (%) 15.9 -70.9 10.2 -8.0 20.0

Net Income (mn) 320.3 181.8 214.9 118.8 169.4

Growth (%) 46.9 -43.2 18.2 -20.5 42.6

Gross margin (%) 15.1 29.1 26.6 24.5 27

Profit margin (%) 2.7 5.3 5.7 6.3 7.4

ROE (%) 10.6 5.7 6.4 na na

ROA (%) 5.3 3.4 4.9 na na

EPS 0.4 0.2 0.3 na na

P/E (x) 20.38 35.94 30.38 na na

P/B (x) 2.06 2.01 1.89 na na

Dividend yield (%) 1.54 0.50 0.62 na na

EV/EBITDA (X) 21.3 38.2 45.0 na na




Mingyuan Medicare (銘源醫療)


Pioneer in preventative screening of diseases

The company provides solutions to early detection and prevention of disease in PRC.

Its products include: 1) C-12 cancer screening chip, which check patients for 10

cancers on one chip and 2)HPV cervical cancer screening kit is to check female

patients for the 13 high-risk HPV viruses and 3)H1N1 testing kit and 4) Tuberculosis testing kit.

Slower growth in 2010, catalyst ahead

We think the 1H10 results revealed that growth in both products C-12 (96% of

expected FY10 revenue) and HPV testing kits are below the previous guidance of

the company and we believe the slow growth will continue in 2H10.

We think, while the company should remain a slow growth of ~5% in short term,

any unanticipated catalysts (such as the possible C-12 entrance to National Medical

Insurance Reimbursement List) can bring significant re-rating to the stock.

Attractive price after adjustments

However, we believe the stock is trading close to fair value and with limited

downside risk after the previous adjustments. We believe the company has a

spectrum of well equipped products. Riding on the tide of medical reform and the

improve health awareness of PRC population; the company should grow with the

whole medical sector.

The stock is trading at a FY11 PE of 18X and we reiterate BUY at TP HK$0.97.

BUY

Key Data





Issue Share (mn) 3,732.02


Free Float % 52.68



Fiscal Year 12/2009

Major shareholder (s) Yao Yuan & Family (27.0%)


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%233 HK MSCI CHINA

Company Background


manufacture and trading of protein chips and

equipments, provision of cervical cancer care and

operation of Shanghai Woman and Child Healthcare

Hospital of Hong-Kou District, Shanghai, the PRC,

and Medical Centres Management.


5

4

25

4

Profitability


Growth Potential

Policy Benefit


Exhibit F: Investment Summary

Year end Dec (HKD ) FY09A FY10E FY11E FY12E 1H09 1H10

Revenue (mn) 394.3 447.5 509.7 584.6 208 233.9

Growth (%) 20.9 13.5 13.9 14.7 35.0 12.5

Net Income (mn) 76.8 155.6 171.3 189.6 88.7 91.3

Growth (%) -48.8 102.6 10.1 10.7 8 3

Gross margin (%) 81.0 79.4 78.6 77.6 81.5 79.5

Profit margin (%) 19.5 34.8 33.6 32.4 42.7 39.0

ROE (%) 6 12.0 11 11 na na

ROA (%) 5 8 8 8 na na

P/E (x) 37 23 20 18 na na

P/B (x) 1.1 1.8 1.6 1.5 na na




The United Laboratories (聯邦制藥)

Target Price: HK$9.56 (-39%) Price: HK$15.70 HKEx Code: 3933

Finished drugs, hit hard if 2H10 price cut

All of the company’s finished drugs are non-exclusive and is exposed to potential NDRC price cut in 2H10. While we believe NDRC is likely to first cut price of non-exclusive EDL (基本藥物目錄) drugs, the United Lab also has about 1/3 of their 34 finished products listed on EDL.

Relying on intermediate and bulk drugs, bothered by unstable

margins and overcapacity

The company relies on contributions from intermediates and bulk drugs. In FY09, 65% of revenue is from them. Like China Pharm (1093.HK), the company is affected by the unstable margin (led by market price volatility) and overcapacities.

Outstanding vertical integration helps ease the harm of price volatility, but overcapacity concern remains

On the bright side, the company has well managed vertical integration system. The company has its finished products Amoxicillin and Ampicillin (both are the downstream made out of intermediate and bulk drugs) awarded “better quality, better price”(優質優價) and can be sold at 40% retail premium than its competitive products. The company has higher flexibilities shifting revenues to downstream.

However, the defensive mechanism does not change the growing overcapacities of intermediate and bulk drugs in PRC. Eventually, profit margin of the segments is in the trend going down.

Overpriced, as a commodity company

While the company plans to sell more finished products in the future, the first thing will be launching its “second generation” insulin product in 2H10. However, we are not too optimistic about the success of this new product because 1) it is the product with dated technology (most of the market players are moving towards the “third generation” insulin and 2) it will take the United Lab years to develop totally different channels in hospitals.

Comparing to China Pharm (1093.HK), we think the company has better vertical integration and higher operational flexibilities but falls into the same business sub-sector: intermediate and bulk drugs. We think the company should at most trade at 20% premium over China Pharm’s FY10 PE of 8.7X, or 10.4X Using the FY10 PE of 10.4X and the Bloomberg consensus FY10 profit of HK960mn; we recommend SELL at TP HK$9.56.

SELL

Key Data







Free Float % 26.42

Net cash/share (HK$) 1.87


Fiscal Year 12/2009

Major shareholder (s) Choy Kam Lok & family

(65.4%)


Price Chart

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%3933 HK MSCI CHINA

Company Background

The Group is engaged in the manufacture and sale

of antibiotics finished products, the bulk medicine

and intermediate products. Moreover, the Group

also produces and sells small amounts of cough

syrup, anti-allergy medicine and capsule casings.


3

2

32

2

Profitability


Growth Potential

Policy Benefit


Exhibit G: Investment Summary

Year to Dec (HKD mn) FY07A FY08A FY09A 1H09 1H10

Revenue (mn) 2,594.9 3,755.9 4,643.2 2,076.2 3,079.1

Growth (%) 24.7 44.7 23.6 5.3 48.3

Net Income (mn) 510.5 430.2 541.4 134.4 483.9

Growth (%) 193.6 -15.7 25.9 -55.2 260.0

Gross margin (%) 46.5 38.1 39.1 35.7 40.6

Profit margin (%) 19.7 11.5 11.7 6.5 15.7

ROE (%) 27.1 16.3 18.0 na na

ROA (%) 12.1 7.9 7.9 na na

EPS 0.5 0.4 0.5 na na

P/E (x) 32.71 43.85 34.81 na na

P/B (x) 7.68 6.69 5.90 na na


EV/EBITDA (X) 8.3 4.9 6.4 na na




China Pharmaceutical (中國製藥)

Price: HK$4.08 HKEx Code: 1093

Heavy contribution from intermediate and bulk drugs, unstable

margins

The company has 72% of 09 revenue contributed from intermediates and bulk drugs,

segments with high price volatility. Price volatility of these products can change

company operating margin from high double digits in first half to low single digit in

second half in same year.

Capacity leader in the industry which is cursed by

overcapacity.

The company is the largest 7-ACA manufacturer in PRC and the largest Vitamin

manufacturer in the world. The leading position in capacity does not bring more

bargaining power to the company; instead, it means high fixed cost and lower

margins.

The lower margins are unfortunately due to overcapacity of the company’s main

products. For instance, Vitamin C (~35% of 09 revenue of the company) has a world

demand of 100,000 ton/annual; production capacity in PRC is 180,000 ton/annual.

Similar situation happens on other products of the company.

Lack of growth catalysts in the near future

The company claims that they will sell more finished drugs in the future so that they

will rely less on intermediate and bulk drugs. However, at this stage, we do not see

any future products form the company which is attractive and can contribute

significantly to the company bottom line in short term.

We do not believe commodity business nature of the company will be changed in

short term and we think it is being traded at its fair value.

Not Rated

Key Data







Free Float % 48.96



Fiscal Year 12/2009

Major shareholder (s) Legend Holdings Ltd (51.0%)


Price Chart

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%1093 HK MSCI CHINA

Company Background

The principal activities of the Group are the

manufacturing and sale of pharmaceutical products.


3

2

22

3

Profitability


Growth Potential

Policy Benefit


Exhibit H: Investment Summary

Year to Dec (HKD mn) FY07A FY08A FY09A 1H09 1H10

Revenue (mn) 4,986.1 6,830.0 7,031.6 3,502.9 3,941

Growth (%) 40.9 37.0 3.0 6.3 12.5

Net Income (mn) 477.4 940.6 970.7 532.7 426.2

Growth (%) 2,947.7 97.0 3.2 20 -20.0

Gross margin (%) 30.8 33.4 32.2 33.5 31.2

Profit margin (%) 9.6 13.8 13.8 15.2 10.8

ROE (%) 15.9 24.0 20.1 na na

ROA (%) 8.1 13.1 11.5 na na

EPS 0.3 0.6 0.6 na na

P/E (x) 13.14 6.67 6.45 na na

P/B (x) 1.87 1.39 1.21 na na






Lijun International (利君國際)


IVI is where the high growth lies in

Intravaneous Infusion (“IVI”, 靜脈輸液 ,打點滴 ) products. IVI products

manufactured in its Shijiazhuang plant (石家莊四葯) contributed for 40% of

revenues and 60% of profit in 2009.

In 2010, the Shijiazhung plant is the middle to expand its IVI capacity from 500mn

bottles/bags to 600mn bottles/bags. The company expects to expand capacity in IVI

products by 100mn bottles/bags every year until the capacity reaches 1bn

bottles/bags. We believe the IVI arm of Lijun to grow in a CAGR of >25% in future

three years.

Consolidation of IVI market is irreversible

IVI products can be classified into plastic and glass IVI products, while the market

trend is eliminating dated class products and moving towards plastic products.

Lijun has 70% of its capacity in plastic IVI products ranked #3 in the PRC IVI

market (6% market share in overall IVI market and 15% in plastic IVI products). In

the ongoing irriversible consolidations in PRC IVI market, Lijun is expected to be

benefited as one of the market leaders.

Comparing to other 2 leaders, Kelun (002422.SZ) and Shuanghe (600062.SH), we

believe Lijun has better economy of scale and quality control by concentrating all

IVI productions in one site. Therefore, we believe Lijun’s gap between its bigger

Not Rated

Key Data







Free Float % 27.51



Fiscal Year 12/2009

Major shareholder (s) Prime United Ind (27.3%)


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%2005 HK MSCI CHINA

Company Background

The Group is principally engaged in the research,

development, manufacture and sale of a wide range

of pharmaceutical products, including antibiotics,

intravenous infusion solution, non-antibiotics

finished medicines, bulk pharmaceuticals and OTC

and healthcare products.


3

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34

4

Profitability


Growth Potential

Policy Benefit


Exhibit J: Investment Summary


Revenue (mn) 1,110.9 1,420.1 1,533.2 866.3 988.8

Growth (%) 29.1 27.8 8.0 2.4 14.1

Net Income (mn) 116.5 91.1 190.4 112.2 140.3

Growth (%) 37.8 -21.8 109.0 -3.6 25.1

Gross margin (%) 50.8 45.7 49.4 48.8 51.6

Profit margin (%) 10.5 6.4 12.4 12.95 14.19

ROE (%) 14.1 8.0 14.4 na na

ROA (%) 8.0 4.5 8.6 na na

EPS 0.1 0.0 0.1 na na

P/E (x) 40.28 60.72 29.01 na na

P/B (x) 4.89 4.56 4.02 na na




Exhibit I: China IVI product break-down (current and projected)

Plastictic IVI Product35%

Glass IVI Product 65%

Current

Plastictic IVI Product70%

Glass IVI Product 30%

2014

Source: Company, OP research



competetor is going to narrowed if not reversed.

Gradually growing old business: Antibiotics and chemical drugs.

Major products include Lijunsha (利君沙 , an antibiotic) which provides stable cash flow and

Paiqi (派奇, an antibiotic). We believe the sector should remain high single digit or low teen

growth before another significant new product is released. In FY09, both antibiotics and

chemical drugs contributed 56% of revenues.



Ruinian International (瑞年國際)


High growth consumer stock?

The company mainly sells amino acid supplements (71%of revenue) and health

drinks (22% of revenue). While supplements are not drugs, they also need to be

approved by SFDA, but with less stringent procedures and is less time consuming.

Interim result is Not apple to apple, growth in 2011

questionable

While 1H10 revenue and profit grew yoy 132% and 325% respectively, they only

grew hoh 4% and 6%, due to the 2H skewed revenue and profit distribution in FY09

(1H09 revenue = RMB 263mn, 1H09 profit = RMB41mn; 2H09 revenue = RMB

587mn, 2H09 profit = RMB168mn).

If 2H10 and FY11 repeat a single digit hoh growth similar to that of 1H10, company

will be unable to achieve the Bloomberg consensus CAGR of 38% (FY10-FY12),

we believe.

In the shadow of divestments

Investors are scattered while multiple funds holding about 34% of outstanding

shares with the lowest entry costs ranging from HK$1.36/share to HK$2.70/share.

While the stock is currently trading at HK$5.97/share, we think the selling pressure

is high.

Not Rated

Key Data







Free Float % 47.80

Net cash/share (HK$)


Fiscal Year 12/2009

Major shareholder (s) Wang Fucai (38.2%)


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Company Background


the manufacturing and sales of amino acid-based

nutritional supplement, general health products,

health drinks and pharmaceutical products.


4

3

3

04

Profitability


Growth Potential

Policy Benefit


* analysis on policy effect of this company is not

appropriate

Exhibit L: Investment Summary


Revenue (mn) 405.5 632.4 850.6 263.9 612.8

Growth (%) 106.1 55.9 34.5 n/a 132.2

Net Income (mn) 135.2 120.0 209.7 41.8 177.6

Growth (%) 451.5 -11.3 74.8 n/a 325.1

Gross margin (%) 78.6 67.4 69.2 60.05 73.43

Profit margin (%) 33.3 19.0 24.7 15.83 28.98

ROE (%) 55.7 25.9 29.8 na na

ROA (%) 16.9 14.1 19.6 na na

EPS 0.3 0.2 0.3 na na

P/E (x) 22.64 37.50 21.43 na na

P/B (x) na na na na na

Dividend yield (%) na na na na na

EV/EBITDA (X) na na na na na


Exhibit K: Selected investors and their status

Name of selected investors Holding share count/

% of outstanding

Investment cost

of shares

Status

Tetrad(Government of

Singapore Investments)

68.5mn shares/6.55% HK$2.4 All shares sold at price

HK$5.71 on 24/8/2010

Templeton 50.3mn/4.80% HK$2.32 Selling pressure exists

Raffles 54.7mn/5.23% HK$1.36 Selling pressure exists

Turrence (CK life Science) 93.2mn/8.91% HK$1.36 Selling pressure exists

CCBI 14.4mn/1.44% HK$2.70 Selling pressure exists

HSBC Holdings 45.0mn/4.30% N/A NA

Harvest Fund 48.5mn/4.63% N/A NA

JP Morgan Chase &Co 45.8mn/4.37% N/A NA

Source: company prospectus, Bloomberg



Shandong Weigao (山東威高)


True domestic leader in medical device

The company produces and sells 1) Consumables (overall: 15% market share;

infusion sets (40%market share), syringes(20% market share) and blood bags(50%

market shares), 2) Blood purification filters (6% market share), 3) Orthopedic

products (4% market share)and 4)Stents(25% market share).

While none of domestic medical device companies can compare to Weigao on

product variety, we believe the company should further reinforce its leadership roles.

The big trend of domestic brands taking over

Indeed, many domestic producers have been selling OEM products to their

international competitors for years showing that many domestic products have

reached similar technology and quality level in some products comparing to their

foreign counterparts, although they are selling at a significantly lower price. In the

long run, we believe domestic devices are going to further acquire market shares of

foreign brands.

This trend is shown in the stent segment: currently, 75% of market share is acquired

by domestic players; back in 2006 over 90% market share was occupied by

international players.

A sustainable high growth

The company will benefit from volume growth in absolute term driven by the

demand of medical reform. While most of the company’s revenues are from high

end hospitals, medical reform triggers demands in rural areas. We estimate, within

the RMB850bn extra fiscal spending for medical reform, about 1/5 will be used to

acquire medical devices and for building rural area medical facilities.

We think the company should continue to be the leader in the sub-sector.

Considering its sustainable high growth potential in the future, we established our

long view to the company.

Not Rated

Key Data







Free Float % 81.15



Fiscal Year 12/2009

Major shareholder (s) Weigao Holding (49.5%)


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%1066 HK MSCI CHINA

Company Background

The Group is principally engaged in the research

and development, production and sale of single-sue

medical devices.


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Profitability


Growth Potential

Policy Benefit


Exhibit M: Investment Summary


Revenue (mn) 1,095.1 1,514.4 1,878.5 874.1 1,137.6

Growth (%) 39.2 38.3 24.0 n/a 30.1

Net Income (mn) 308.1 482.4 633.9 257.6 335.5

Growth (%) 80.3 56.5 31.4 n/a 30.2

Gross margin (%) 45.7 50.1 53.3 49.2 52.7

Profit margin (%) 28.1 31.9 33.7 29.5 29.5

ROE (%) 30.4 25.4 23.4 na na

ROA (%) 17.4 17.6 17.4 na na

EPS 0.2 0.2 0.3 na na

P/E (x) 138.06 89.17 72.54 na na

P/B (x) 32.09 18.60 15.67 na na


EV/EBITDA (X) 50.4 20.2 39.4 na na




Shineway Pharmaceutical (中國神威藥業)


Mass market focused, impressive margin

The company offers a range of prescription and OTC modern Chinese medicines.

The spectrum of products focus on the treatment of common illness of mid to old

aged patients and children, such as cardiovascular disease, respiratory system

sickness, cold and fever and digestive system diseases.

The company’s 30 products are included in the latest Essential Drug List（基本藥物） while most of its products are included in the National Medical Insurance

Reimbursement List (國家醫保). While most of its products are selling at a discount

to competitors and focus on mass market, the company has maintained an

impressive >70% gross margin for over three years.

High margin might not be sustainable.

The fact that most of its products are non-exclusive made us suspect if the company

can sustain such a high margin while other competitors drag it into price war. For

most of its products in EDL, future overcapacities are possible if other competitors

decide to expand production lines like Shinway did.

On the other hand, If the government really decides to regulate companies by gross

margins and operating margins, the company (with a gross margin over 70%) is

more affected comparing to other not as profitable peers.

Not Rated

Key Data







Free Float % 42.40



Fiscal Year 12/2009

Major shareholder (s) Forway Inv.Ltd. (57.6%)


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%2877 HK MSCI CHINA

Company Background

The Group is principally engaged in research and

development, production and sales of modern

Chinese medicines mainly in injections, soft

capsules and granules formats.


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4

Profitability


Growth Potential

Policy Benefit


Exhibit N: Investment Summary


Revenue (mn) 1,012.9 1,275.2 1,633.2 707.8 925.4

Growth (%) 20.4 25.9 28.1 10.2 30.7

Net Income (mn) 490.6 398.2 767.3 401.3 420.7

Growth (%) 47.3 -18.8 92.7 49.5 4.8

Gross margin (%) 72.9 71.7 72.1 70.5 69.5

Profit margin (%) 48.4 31.2 47.0 56.7 45.5

ROE (%) 25.6 18.9 31.6 na na

ROA (%) 22.2 16.5 26.9 na na

EPS 0.6 0.5 0.9 na na

P/E (x) 36.61 45.00 23.23 na na

P/B (x) 8.63 8.36 6.56 na na






Sino Biopharmaceutical (中國生物製藥)


Balanced product spectrum, with growing demands

The company sells and develops drugs for hepatitis (肝炎, 48% of 09 revenue), cardio-cerebral disease (心腦病, 19% of 09 revenue), oncology (癌症, 6% of 09 revenue), respiratory system disease (呼吸系統疾病), analgesic (止痛) and diabetics (糖尿病).

The company has 148 products in the National Medical Insurance Reimbursement List (NMIRL, 國家醫保目錄). While 5 new entries (Mingzheng, Ganmei, Kaifen, Runzhong, and Fenghaineng Fructose) happened in the 2009 NMIRL, we believe volume growth from these items should be shown in the coming 2-3 years.

Multiple products are members of the “Hundred Million Club”

For many Chinese drug companies, selling a product with revenue of RMB100mn makes the product a blockbuster; Sino Biopharm has many of these block-busters.

Sustainable growth, driven by innovation

Overall, we estimate that its growth in 2010 to be about 25% yoy, thanks to the volume growth of multiple products. In the coming 2-3 years, the company will remain a high growth rate ~25%, which is above the subsector average of ~20%.

In the long run, the company focuses on R&D (09 R&D expense is over 5% of revenue). We believe that the company is one of the most innovative pharmaceutical companies in PRC and we respect its ability to deliver new products. In 2009, the company achieved 3 new product approvals, 1 import registration approval, 16 production approvals and 6 clinical research approvals. We believe the company will constantly roll out new products for growth.

Not Rated

Key Data







Free Float % 45.24



Fiscal Year 12/2009

Major shareholder (s) Tse Ping (42.6%)


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Company Background


the research, development, manufacturing and

marketing a vast array of biopharmaceuticals,

modernized Chinese medicines and chemical

medicines.


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3

Profitability


Growth Potential

Policy Benefit


Exhibit P: Investment Summary

Year to Dec (HKD mn) FY07A FY08A FY09A 1H09A 1H10A

Revenue (mn) 1,164.3 2,282.2 3,243.6 1572.4 1928.3

Growth (%) 58.5 96.0 42.1 49.4 22.6

Net Income (mn) 224.4 297.6 397.0 176.3 192.4

Growth (%) 58.9 32.7 33.4 31.4 9.1

Gross margin (%) 82.3 79.3 80.3 78.1 79.4

Profit margin (%) 19.3 13.0 12.2 11.2 10.0

ROE (%) 11.4 14.0 16.9 na na

ROA (%) 9.4 10.2 11.3 na na

EPS 0.0 0.1 0.1 na na

P/E (x) 59.13 44.56 33.41 na na

P/B (x) 6.57 5.95 5.36 na na




Exhibit O: Major products of Sino Biopharm

Product name 09 sales/ % of 09 total sales Function

Kaishi injection RMB760mn/ 25% cardio-cerebral drug

Mingzheng Capsules RMB634mn//20% hepatitis

Tianqingganmei RMB333mn/10% hepatitis

Ganlixin RMB239mn/ hepatitis

Kaifen RMB191mn analgesic

Taianqingganping RMB183mn hepatitis

Tianqingfuxin RMB111mn hepatitis

Tianqingganning RMB103mn cardio-cerebral




Sinopharm (國藥控股)


The biggest drug distributor in PRC

It is currently the biggest distributor (~12% market share) in the nation, with 25

distribution centers, covering 19 provinces and religions in PRC, covering over

4,700 major hospitals and over 24,000 other institutional customers, including

pharmaceutical distributors, retail pharmacies, and other healthcare institutions.

Benefited from consolidation

In the subsector, second biggest distributor only has a market share about 5% and

the top 5 players only accounts for ~25%; industrial concentration is low. We believe

consolidations in the sector are irreversible and the pace will only get faster. Without

the economies of scale and established network, smaller players will be eliminated

or acquired by bigger players like Sinopharm.

On the policy side, the government expressed their will to limit 1) distributor

numbers and 2) price add-on from door of drug companies to door of hospitals. Also,

we believe “the Twelfth Five-year Plan” will further mention its support to

consolidations of the drug distribution sub-sector. The Ministry of Commerce has

expressed about their future plan to develop 2-3 “national leaders” (with over

RMB100bn revenue) and about 20 “regional leaders” (with over RMB10bn revenue)

in the drug distribution sub-sector, eliminating other smaller inefficient players.

OTC retail business, not so attractive now but with high

potential

By May FY09, the company has 632 owned retail pharmacies and 186 franchise

units. While the segment faces fierce competition and only contributed 1% of the

FY09 EBIT. We believe the segmental profitability will be improved in future while

its distribution network continuously provides synergy to the retail arm.

Trading at a premium, but a “must have” for many investors

The company has been trading at a premium (FY11 PE at 35X while the peer

average is <20). We believe this premium is going to continue given 1) its proxy

nature to the PRC pharmaceutical sector and 2) investors’ popularity on quality big

caps in the PRC healthcare sector.

Not Rated

Key Data







Free Float % 90.91



Fiscal Year 12/2009

Major shareholder (s) CNPGC (69.5%)


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Company Background


the distribution of medicine and pharmaceutical

products to wholesale customers, including

hospitals and distributors; operation of medicine

chain stores; and distribution of laboratory supplies,

manufacturing and distribution of chemical reagents

and production and sale of pharmaceutical.


1

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45

2

Profitability


Growth Potential

Policy Benefit


* analysis on tech of this company is not appropriate

Exhibit Q: Investment Summary


Revenue (mn) 31,110.2 38,191.9 47,045.9 23,294.3 31,567.5

Growth (%) 31.1 22.8 23.2 20.4 35.5

Net Income (mn) 380.9 587.6 845.8 494.3 628.6

Growth (%) 275.9 54.3 43.9 44.6 27.2

Gross margin (%) 8.2 8.0 8.0 8.0 8.2

Profit margin (%) 1.2 1.5 1.8 2.1 2.0

ROE (%) 22.1 29.7 12.8 na na

ROA (%) 2.9 3.9 3.8 na na

EPS 0.2 0.4 0.5 na na

P/E (x) 136.74 87.36 66.91 na na

P/B (x) na 22.71 6.53 na na

Dividend yield (%) na na 0.03 na na

EV/EBITDA (X) na na 31.5 na na




Exhibit R: Peer Group Comparison

Bloomberg Year Mkt Cap Local Price YTD 1D 5D PER (x) Yield (%) P/B (x)

code Currency End (mil) 7/9/10 (%) (%) (%) FY09A FY10E FY11E FY09A FY10E FY11E FY09A FY10E FY11E

Medical Sector

SINO BIOPHARM 1177 HK HKD 12/2009 14,523 2.93 19.1 (1.7) 11.0 44.6 29.0 23.3 1.0 1.7 2.0 6.0 3.8 3.4

SHANDONG WEIG-H 1066 HK CNY 12/2009 32,194 21.40 65.3 2.1 10.3 79.6 48.2 35.4 0.3 0.4 0.6 16.4 10.8 8.6

LIJUN INTL PHARM 2005 HK CNY 12/2009 6,382 2.71 116.8 (0.4) 14.8 54.2 22.0 17.8 0.5 1.4 1.7 4.0 2.9 2.6

LEE'S PHARM 950 HK HKD 12/2009 1,356 3.01 79.2 0.7 16.2 44.5 18.8 13.7 0.5 1.3 1.9 14.6 6.8 4.9

SINOPHARM-H 1099 HK CNY 12/2009 71,221 31.45 14.2 0.3 6.1 77.9 48.5 36.2 - 0.5 0.7 20.0 5.4 4.8

MINGYUAN MEDICA 233 HK HKD 12/2009 3,396 0.91 (31.6) 5.8 15.2 17.7 16.5 13.6 - 1.3 1.4 2.6 1.9 1.7

TRAUSON HOLDINGS 325 HK CNY 12/2009 2,780 3.59 na 2.0 2.0 26.7 22.4 18.4 - 1.2 1.5 N/A 2.7 2.5

LANSEN PHARMACEU 503 HK USD 12/2009 1,444 3.48 na 0.6 11.5 N/A 20.4 14.6 - N/A N/A N/A N/A N/A

CHINA SHINEWAY 2877 HK CNY 12/2009 17,863 21.60 49.5 2.1 5.9 40.2 19.3 15.5 1.1 1.9 2.4 7.4 5.0 4.3

GUANGZHOU PHAR-H 874 HK CNY 12/2009 10,707 8.05 37.6 - 16.2 32.1 19.8 16.0 0.5 0.7 1.0 1.8 1.6 1.5

Average 44 1 11 46 27 20 0 1 1 9 5 4

Median 44 1 11 44 21 17 0 1 1 7 4 3

Source: Bloomberg



Exhibit S: The “5-pillar” Analysis key

Source: OP research.

Oriental Patron Research – Equities


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