China Pharmaceutical Sector - DBS Bank (from 20.9% in 2009 to 27.1% in 2010) Source: , CEIC Data, DBS Vickers In September 2016, the government released a consultation paper for the

ASIAN INSIGHTS VICKERS SECURITIES

ed-SL/ sa- DL

16 Feb 2017 DBS Group Research . Equity

Inflection point emerging

Good time to revisit drugs suppliers as sector’s sales growth could rebound in late-2017 and the valuation now is attractive

Based on a set of criteria to pick long-run winners, we recommend buying CSPC (1093 HK) and China Traditional Chinese Medicine (CTCM, 570 HK)

Good time to revisit drugs suppliers. The sector’s sales growth has been decelerating from 19% (2013) to 9% (first nine months of 2016) due to the government’s cut in average selling prices (ASP). It could rebound by late-2017 as two forces emerge to support the growth: 1) The number of drugs reimbursable from public medical insurance programmes is likely to increase by over 14% this year; and 2) the percentage of floating population (2015: 247 million) under effective public medical insurance protection should increase from 20-32% in 2016 to over 50% in 2018. Meanwhile, the one-year forward PE multiple of most drugs suppliers are at a three-year low and one standard deviation below the historical average.

We have a set of criteria to pick long-run winners: CSPC

and CTCM. Our criteria evaluate the growth potential of a player’s current drugs portfolio by looking at the drugs’ exclusiveness, market size and medical institutes’ incentives to promote them; and the player’s ability to launch new drugs in the next three years. CSPC meets those criteria. We expect its EPS compound annual growth rate (CAGR) to be 22% in 2016 to 2019, driven by sales network expansion. The CAGR could accelerate thanks to the launches of new drugs. CTCM’s major product – concentrated Chinese medicine granules (CCMG), which made up 64% of revenue in the 1H2016, meets one of the very crucial criteria set by us: It is one of the very few drugs still allowed to be marked up over procurement cost when hospitals sell it. This provides a strong incentive for hospitals to push CCMG sales. Driven by CCMG, we expect 18% EPS CAGR in 2016 to 2020. At 14x FY17F PE, CTCM’s valuation is attractive now.

HSI: 23,995 ANALYST Mark KONG, CFA +852 2820 4619 [email protected]

Recommendation & valuation

Company Pric eT arget

Pric e RecM k tCap

F Y 17FPE

HK $ HK $ HK $bn x

CSPC Pharma(1093 HK)

8.98 11.20 BUY 54 21.1

CTCM (570 HK) 3.86 5.60 BUY 17 14.0Sinopharm(1099 HK)

36.80 36.40 HOLD 102 17.2

Source: Thomson Reuters, DBS Vickers

Our proprietary research on the growth trends in China’s pharmaceutical industry and development of criteria to analyze the growth potential of pharmaceutical products are based on in-depth interviews with 1) the management of 19 pharmaceutical companies listed in Hong Kong and mainland China; 2) 10 managers in charge of finance and drug procurement for public hospitals; and 3) 6 bankers who have business relationships with pharmaceutical companies in China.

Asian Insights SparX

China Pharmaceutical Sector Refer to important disclosures at the end of this report

Asian Insights SparX China Pharmaceutical Sector


Page 2

The DBS Asian Insights SparX report is a deep dive look into thematic angles impacting the longer term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one off treatise on the topic, and invite feedback from our readers, and in particular welcome follow on questions worthy of closer examination.

Table of Contents

Why should we look at China’s pharmaceutical sector now? 3 Criteria to select long-run winners 11 Stock Profiles 15

CSPC Pharmaceutical (1093 HK) - Sustainable long-term growth on strong new drugs pipeline 16 China Traditional Chinese Medicine (570 HK) - Rising with CCMG increasing popularity 39 China Resources Pharmaceutical (3320 HK) - Trading opportunity on government-led market consolidation 46 Luye Pharma (2186 HK) - Trading opportunity on two catalysts 48 Sinopharm Group (1099 HK) - Further penetration into 2nd & 3rd cities 50 3Sbio Incorporated (1530 HK) - Outlook in 2017 largely hinges on new drugs from overseas 56 China Medical System (867 HK) - Positives mostly priced in 58 Shanghai Fosun Pharmaceutical (2196 HK) - Well diversified healthcare player 60 Shanghai Pharmaceuticals (2607 HK) - Most positives are priced in 62 Sihuan Pharmaceutical (460 HK) - Rebuilding confidence takes time 64 Sino Biopharmaceutical (1177 HK) - Stretched valuation 66 The United Laboratories (3933 HK) - Stretched valuation 68

Note: Prices used as of 15 Feb 2017



Page 3

Why should we look at China’s pharmaceutical sector now?

There are two reasons why we should look at China’s pharmaceutical sector now:

1. The sector has been de-rated due to decelerated industry sales growth in the last five years (see the following chart). The deceleration should end this year as growth could rebound mildly in late-2017.

2. Current valuations have already priced in most negatives. This should end the de-rating. The one-year forward price-to-earnings of most stocks in this sector are now trading at three-year lows and one standard deviation below the historical average.

China pharmaceutical industry sales growth deceleration (year-on-year)

21.1%

18.8%

14.1%

9.5% 9.1%

0%

5%

10%

15%

20%

25%

2012 2013 2014 2015 9M16 Source: CEIC Data, DBS Vickers

*The drugs sales above consist of four segments: Chemical medicine, biological product, Chinese prepared medicine, Chinese herb medicine

China pharmaceutical industry sales (Chinese yuan, billion)

1,054

1,253

1,429 1,565

1,200

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2012 2013 2014 2015 9M16

RMB bn

Source: CEIC Data, DBS Vickers

*The drugs sales above consist of four segments: Chemical medicine, biological product, Chinese prepared medicine, Chinese herb medicine

Two forces emerging to support industry sales growth. The price cut imposed by the government has been dragging down the industry in the last five years. Recently, there have been two new forces emerging to support industry sales growth. Thus, we believe the sales growth deceleration will end this year and growth is likely to rebound mildly in late-2017. The forces are:

1. Force 1: The number of drugs reimbursable from public medical insurance programmes could increase by over 14% this year. There are two reasons why this will happen:

A. The number of drugs reimbursable from public medical insurance programmes in rural areas could surge by over 30% in 2017. That drives the demand for drugs in rural areas. Based on National Bureau of Statistics data, the rural population made up 44% of the total in 2015.

According to the “State council’s opinion on consolidation of basic medical insurance systems for residents in urban and rural areas” (國務院關於

整合城鄉居民基本醫療保險制度的意見) issued in January 2016, the number of drugs reimbursable in rural public medical insurance programmes will be the same as in urban areas by 2017. As the number of drugs reimbursable in urban areas is much bigger than in rural areas, the number in rural areas will drastically increase.

In reference to the number in six provinces (Hebei, Shandong, Guangdong, Ningxia, Tianjin, Inner Mongolia), it could increase by 31-250%. Thus, we conservatively estimate the number of drugs reimbursable from public medical insurance programs in rural areas could surge by at least 30%;

B. The list of drugs reimbursable from public medical insurance programmes in both rural and urban areas are decided based on the National Reimbursement Drug List (“the List”). The number of drugs in the List is likely to increase by 14% this year.

The first version of the List was released in 2000. The government revised it in 2004 and 2009. More medicines were included in each revision. Every time the List expanded, the industry’s sales growth accelerated remarkably in the following year (see the following table).



Page 4

Pharmaceutical industry sales after expansion of National Reimbursement Drug List

Nu mb er o f d ru gsin c reased in t h e

Nat ion alReimbu rsemen t Drug

L ist

Pharmac eu t ic alind ust ry sales g row t h

ac c elerat ion in t hef o llow in g y ear

2 00 4 323

8.5ppt

(from 18.3% in 2004 to26.8% in 2005)

2 00 9 340

6.2ppt

(from 20.9% in 2009 to27.1% in 2010)

Source: www.cnstock.com, CEIC Data, DBS Vickers

In September 2016, the government released a consultation paper for the revision of the List. It targets to release the new version in 2017 and should include more medicines. The current version includes 2,151 medicines. China Pharmaceutical Enterprise Management Association estimates the List will adopt 300 more medicines – a 14% increase. We believe this will stimulate the industry’s sales growth, as happened in 2004 and 2009.

We believe the public medical insurance programmes have sufficient financial resources to finance the increase in reimbursable drugs. Based on the numbers from the National Bureau of Statistics and the National Health and Family Planning Commission, we estimate the aggregate cumulative reserves of public medical insurance programmes in both urban and rural areas equalled 1.13 times of the programmes’ expenditures in 2015 (1,387 billion yuan/1,225 billion yuan = 1.13 times). That means the reserve is sufficient for the expense in the next 12 months even if there is no revenue. In 2011 to 2015, the revenue of those programmes had always been higher than the expenditure. On average, it was higher by 20% annually. Thus, we can say these programmes are running in good shape on the whole.

2 Force 2: Floating population (247 million) made up 18% of total population in 2015. More and more of them will be able to claim medical expenses from public insurance programmes. This will boost the demand for drugs.

The floating population have public medical insurance accounts in their own registered domiciles. However, when they move to other places to live, it is very difficult for them to reimburse their medical expenses from the public medical insurance accounts in their own registered domiciles, due to lack of information & technology infrastructure and communication among regional

governments. Some of them can participate in the public medical insurance programmes where they live, but, based on a study by Peking University’s School of Economics, we estimate that this applies to only 20-32% of the total floating population. That implies that around 70% of the floating population are without effective public medical insurance protection.

To improve the medical coverage of the floating population, Premier of the State Council Li Keqiang, in March 2016, required all regional governments to connect their public medical insurance programme systems within two years, in order to facilitate their medical expense claims.

By the end of 2016, 30 provinces had successfully connected the public medical insurance programmes among cities within the province, according to the Ministry of Human Resources and Social Security. This has already drastically slowed down the drop of pharmaceutical sales growth from an average annual drop of 3.9 percentage points in 2012 to 2015 to only 0.4 percentage points in the first nine months of 2016. The central government targets to achieve inter-province connection within 2017. With the government’s effort, we estimate the percentage of floating population under effective public medical insurance protection could gradually increase from around 30% in 2016 to over 50% in 2018.

With the above-mentioned two forces in play, we project the industry’s sales growth to stabilise at 9.1% in 2017 and rebound to 9.2-10% in 2018.

The impact of price cuts on drugs will be smaller than before. Price cuts imposed by the government will still be a concern for the pharmaceutical sector. But the impact should be smaller than it was in 2015 and 2016 for two reasons:

1. We believe provincial governments are now more careful before imposing price cuts, because if the cut were too harsh, many drug manufacturers would give up the sales to the province. That impacts the overall drugs supply to the province. This has happened in the last two years.

For example, according to China Daily, in Zhejiang province in 2015, a big price cut saw foreign players withdraw 60.5% of drugs sold to the public medical institutes through tender. To ensure a stable supply of drugs, some provinces became more flexible on price cuts. This was seen, for example, in Anhui province in 2015, when the Anhui provincial government imposed a substantial price cut on uremic clearance granules (UCG), Consun’s (1681 HK) key product. (Consun did not disclose how much the cut was). Consun gave up the sales of UCG to the public medical institutes there



Page 5

in the 2015 second half, and was not the only drug maker to do so. That impacted the drug supply to Anhui. Eventually, the Anhui provincial government did not insist on implementing the new lower price. Consun is now selling UCG there at the original price;

2. 23 out of 31 provinces completed their tenders for drugs in November 2015 to November 2016. The tenders decided the prices of drugs sold to public medical institutes there. As most provinces have already decided the prices and other provinces will make reference to the decided prices in setting of their own

drug prices, we believe drugs’ prices could be relatively stable in 2017 – more so than in 2015 and 2016.

The valuation of pharmaceutical stocks is attractive now. We looked at 23 pharmaceutical stocks which capture over 70% of total healthcare sector market capitalisation in the Hong Kong stock market. Of these 23, 14 have already seen their one-year forward price–to-earnings drop to three-year lows (or trough since listing,) and are trading at around one standard deviation below historical average (see the following charts). At this level, we believe most negatives are priced in.

One-year forward price-to-earnings (stocks with daily trading turnover over US$2 million)

Sinopharm (1099 HK) CSPC (1093 HK)

10

12

14

16

18

20

22

24

26

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 17.2x

+1SD: 19.3x

-1SD: 15.1x

14

19

24

29

34

39

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 22.6x

+1SD: 26.3x

-1SD: 3.2x

Sino biopharm (1177 HK) Luye (2186 HK)

1012141618202224262830

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 18.8x

+1SD: 21.4x

-1SD: 16.1x

0

5

10

15

20

25

30

35

40

45

Jul-1

4

Jul-1

5

Jul-1

6

Jul-1

7

x

Avg: 24.9x

+1SD: 33.4x

-1SD: 16.3x




Page 6


Sihuan (460 HK) CMS (867 HK)

0

5

10

15

20

25

30

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 17x

+1SD: 22.8x

-1SD: 11.2x

10

15

20

25

30

35

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 19.5x

+1SD: 23.4x

-1SD: 15.7x

3Sbio (1530 HK) United Lab (3933 HK)

10

15

20

25

30

35

40

Jun-

15

Dec

-15

Jun-

16

Dec

-16

Jun-

17

Dec

-17

x

Avg: 24.6x

+1SD: 29.7x

-1SD: 19.6x

0

10

20

30

40

50

60

70

80

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 32.2x

+1SD: 73.7x

-1SD: -7x

CTCM (570 HK) Baiyunshan (874 HK)

0

5

10

15

20

25

30

35

40

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 20.1x

+1SD: 29.1x

-1SD: 10.8x

1012141618202224262830

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 19.2x

+1SD: 22.1x

-1SD: 16.3x




Page 7


Shanghai Pharm (2607 HK) Fosun Pharm (2196 HK)

5

10

15

20

25

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 13.5x

+1SD: 15.5x

-1SD: 11.4x

1012141618202224262830

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 18.8x

+1SD: 22.8x

-1SD: 14.8x




Page 8

One-year forward price-to-earnings (stocks with daily trading turnover between US$200,000 and US$2 million)

China Resources Pharmaceutical (3320 HK) Tong Ren Tang Technologies (1666 HK)

13.5

14.0

14.5

15.0

15.5

16.0

16.5

17.0

Oct

-16

Nov

-16

Dec

-16

Jan-

17

x

Avg: 15.5x

+1SD: 15.9x

-1SD: 15x

15

20

25

30

35

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 22.6x

+1SD: 25.4x

-1SD: 19.8x

SSY Group Limited (2005 HK) China Shineway (2877 HK)

0

5

10

15

20

25

30

35

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 17.9x

+1SD: 15.8x

-1SD: 13.3x

9

10

11

12

13

14

15

16

17

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 12.8x

+1SD: 14x

-1SD: 11.6x

Bloomage Biotechnology (963 HK) Yichang HEC Changjiang (1558 HK)

10

15

20

25

30

35

40

45

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 22.3x

+1SD: 28.5x

-1SD: 16.1x

10

11

12

13

14

15

16

17

Dec

-15

May

-16

Oct

-16

Mar

-17

Aug

-17

Dec

-17

x

Avg: 14.1x

+1SD: 15.4x

-1SD: 12.8x




Page 9

One-year forward price-to-earnings (stocks with daily trading turnover between US$200,000 and US$2 million)

Shanghai Fudan-Zhangjiang (1349 HK) Consun Pharmaceutical (1681 HK)

20

30

40

50

60

70

80

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 39x

+1SD: 47.7x

-1SD: 30.4x

5

10

15

20

25

30

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 15.9x

+1SD: 20.4x

-1SD: 11.4x

Dawnrays Pharmaceutical (2348 HK) Shanghai Haohai Biological (6826 HK)

6

8

10

12

14

16

18

20

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 13.4x

+1SD: 16.1x

-1SD: 10.6x

10

15

20

25

30

Apr

-15

Sep-

15

Feb-

16

Jun-

16

Nov

-16

Mar

-17

Aug

-17

Dec

-17

x

Avg: 18.6x

+1SD: 22.3x

-1SD: 15x

Lee's Pharmaceutical (950 HK)

0

5

10

15

20

25

30

35

40

45

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

x

Avg: 23x

+1SD: 29.4x

-1SD: 16.6x




Page 10

Based on market consensus estimates (see the following table), on market capitalisation weighted average, they are trading at 17 times the 2017 forecast price-to-earnings, ranging between 8.9 times and 24 times. At this level, we think it is worth revisiting pharmaceutical stocks, as 10 of

them are trading at below 1 times price/earnings to growth (PEG, 2017 forecast price-to-earnings/2018 forecast EPS growth). The PEG could be lower as EPS growth could accelerate thanks to launches of new products.

Peers’ 2017 fiscal year price-to-earnings forecast

PE 17F EPS Grow th 17F EPS Grow th 18F PEG

x % % PE 17F / EPS Gth 18F

Sinopharm 1099 HK 17.2 10.4 15.1 1.14CSPC 1093 HK 21.1 21.7 22.4 0.94

Sino-biopharm 1177 HK 20.8 9.9 13.3 1.56Luye 2186 HK 13.7 22.0 13.3 1.03

Sihuan 460 HK 12.0 7.1 9.9 1.21

CMS 867 HK 17.5 21.7 16.8 1.043Sbio 1530 HK 18.2 29.1 18.0 1.01

United Lab 3933 HK 18.4 146.7 7.6 2.44CTCM 570 HK 14.0 20.6 17.3 0.81

Baiyunshan 874 HK 17.3 4.4 4.3 4.01

Shanghai Fosun Pharm 2196 HK 16.7 16.4 13.7 1.22Shanghai Pharm 2607 HK 13.0 11.9 12.8 1.02

Tong Ren Tang 1666 HK 22.2 13.9 9.3 2.37Ssy Group 2005 HK 15.0 9.7 23.5 0.64

China Shineway 2877 HK 12.4 5.9 3.8 3.21

Bloomage Biotechnology 963 HK 14.8 20.7 22.5 0.66Yichang Hec Changjiang 1558 HK 13.0 28.6 20.9 0.62

Shanghai Fudan 1349 HK 23.8 36.0 34.2 0.69

Consun Pharmaceutical 1681 HK 10.2 17.0 16.3 0.62Dawnrays Pharmaceutical 2348 HK 8.9 20.0 16.7 0.53

Shanghai Haohai 6826 HK 14.3 22.1 17.6 0.81Lee'S Pharmaceutical 950 HK 15.7 9.1 13.5 1.17

CR Pharmaceutical 3320 HK 15.5 14.1 17.9 0.87

M k t Cap Wt . A v erage 16.9 16.5 14.9 1.13




Page 11

Criteria to select long-run winners

As mentioned above, now is the time to revisit pharmaceutical stocks. We have designed a set of criteria to select long-run winners. The criteria look at two aspects of a pharmaceutical company: 1) the growth potential of the current products portfolio; and 2) the ability to launch new products in future;

Growth potential of the current products portfolio. We believe if the drugs of a company hit certain criteria set below (see the following table), the drug should be able to grow steadily in future. We look at three aspects of a drug:

a) Its exclusiveness to stand out in competition

b) Its market size

c) Incentive for medical institutes to prescribe it

Criteria to evaluate the potential of a drug

Exclusiveness

1. Protected? Is the drug categorised

as class 1 or class 2 by the China

Food & Drug Administration (CFDA)?

Class 1: A drug with an innovative active ingredient or chemical structure;

Class 2: A drug with an innovative way to deliver known active ingredient. A drug categorised in either class is an exclusive product. Its exclusiveness protects it from

competition to enjoy more stable growth. For example, 3SBio’s (1530 HK) TPIAO, a recombinant

human thrombopoietin injection, is a class 1 medicine for treatment of platelet deficiency. Its

exclusiveness allowed its sales to grow at a 42% CAGR in 2012 to 2015, from 210 million yuan

to 605 million yuan.

2. Substitutable? Is the drug free

from the potential threat of other

drug(s) under clinical trial with the

same or similar indication?

Other drugs with similar indication under clinical trial could threaten the current product in

future. There are some websites providing such information, such as http://db.yaozh.com/

Market size

3. Reimbursable? Is the drug

included in the reimbursable drugs

list of public medical insurance

programmes?

Such inclusion implies patients' expenditure on the drug is subsided by public medical insurance

programmes. As such, patients are more willing to take the drug, which warrants demand.

Medicines included in the list are divided into class A and class B. The government subsidises

100% of class A expenditure while class B will only be partially subsidised.

4. Disease nature – fatal? Is the

drug tackling a fatal disease with a

large number of patients (e.g.

stroke)?

A drug tackling fatal disease implies it is almost necessary for the patient to take the medicine.

That already warrants demand. If the number of patients is large, the demand is further

warranted. For example, CSPC’s (1093 HK) NBP (Chinese name: 恩必普, chemical name: Butylphthalide) is a

class 1 drug for treatment of acute ischemic stroke, which is a fatal disease with a large number

of patients. Strokes cause around 1.5 million deaths annually. There are over 7 million patients in

China. The Chinese Center For Disease Control and Prevention projects there are 2 million new

stroke patients each year. Thanks to the above features, the sales of NBP had been surging at a

42% CAGR in 2012 to 2015, from around 548 million yuan to 1,550 million yuan.

5. Disease nature – chronic? Is

the drug tackling a chronic disease

with a large number of patients (e.g.

kidney failure)?

Patients suffering from chronic diseases need to take drug for a long period of time. This

warrants continuous demand. Consun’s (1681 HK)’s uremic clearance granules – an exclusive drug used to delay the onset of

kidney failure which is a chronic disease – is an example. We estimate there are over 50 million

patients suffering from different stages of kidney failure. Thanks to the huge demand, the sales

of uremic clearance granules had been growing at a 22% CAGR in 2012 to 2015, from 348

million yuan to around 630 million yuan.

6. Supply shortage? Is a significant

portion of the drug supply in China

satisfied by imports?

If so, this implies supply shortage of the product in China. For example, human albumin products, which are plasma-based pharmaceutical products, widely

used in emergency rooms and intensive care units for surgery. They are used to remedy

hypovolemia and hypovolemic shock, abnormally high intracranial pressure, edema and ascites.

According to the National Institutes for Food and Drug Control, in 2012 to 2015, 48-59% of the

industry’s sales were generated from imports, implying supply shortage in China. In this period,

industry sales had been growing at a 23% CAGR.

Source: DBS Vickers



Page 12

Criteria to evaluate the potential of a drug (continued)

Market size 7. Market well established? Is the

drug well established in the over-

the-counter market (well established

means a five-year history and

revenue over 100 million yuan)?

Drugs stores or over-the-counter (OTC) is the second largest sales channel for drugs in China.

According to IMS, it contributed 17% of pharmaceutical industry sales in 2016. Unlike the other

two channels (hospitals and the third party terminals), the suppliers providing drugs to the OTC

channel need not to go through the provincial tender organised by the government. That implies

they need not suffer from ASP cuts imposed by tenders. The price cutting risk is smaller.

If it is well received by market, the drug supplier can even raise the price. For example, the

cardiovascular drugs portfolio of Dawnrays (2348 HK), including amlodipine besylate tablets,

levamlodipine besylate tablets, losartan potassium and hydroclorothiazide tablets and telmisartan

tablets, generate revenue of over 300 million yuan for Dawnrays. Although they are all generic

drugs, they are well received by the OTC market. In January 2016, Dawnrays raised their ex-

factory prices by double-digits.

Incentive to prescribe

8. Core drug? Is the drug regarded

as first line drug for treatment of a

disease by an authoritative industry

association?

If it is regarded as first line, it should be the first drug to be prescribed by physicians once they

encounter the disease. This warrants demand.

For example, oseltamivir phosphate. The Chinese Medical Association regards it as the first line

drug for treatment of influenza, while the National Health and Family Planning Commission

recommends it as the top preferred drug for the treatment of H1N1 and H7N9 influenza. Its

total sales in 2012 to 2014 had been growing at 106% CAGR from 82 million yuan to 349

million yuan.

9. Markup allowed? When

hospitals are selling the drug, are

they allowed to mark up over the

procurement cost in long run?

Hospitals are the largest sales channel for drugs, contributing 69% of drug sales in 2016

according to IMS (the others were: 17% drug stores; 14% third party sales terminal, which are

smaller size medical institutes such as village clinics and community clinics). In the past, they

were all allowed to mark up by 15% over procurement costs when selling drugs. That provides

incentive for them to sell drugs. But the government is gradually removing the mark-up, and

wants to remove it entirely in the long-run. That basically removes their incentive to sell drugs.

However, the mark-up of certain kinds of drugs in hospitals is still allowed, for example

concentrated Chinese medicine granule (CCMG). As hospitals can continue to make money due

to the mark-up, they have strong incentive to promote the product. Thanks to allowance of the

mark-up, the sales of CCMG had been growing at a 28% CAGR in 2012 to 2015, from 4.6

billion yuan to 9.8 billion yuan. We believe it can maintain annual growth of around 20% in the

next five years.

Source: DBS Vickers



Page 13

Ability to launch new products is the key to a higher valuation. A company with a strong and visible earnings growth prospect in the long-run can often ask for a higher valuation in the market. In the pharmaceutical universe, the continuous launch of new products on the back of a large products pipeline is the key to achieving strong earnings growth.

To judge if the products pipeline or the research and development (R&D) capability of a drug company is strong, we look at the following aspects:

1. Is the drug to be launched an exclusive product in the market? Exclusiveness is a sign of strong R&D capability. It protects the drug from price cutting risks due to competition from similar products.

One way to answer this question is to see if the drug is classified as class 1 or class 2 according to new classification of drugs issued by CFDA in March 2016. Class 1: A drug with an innovative active ingredient or chemical structure. Class 2: A drug with an innovative way to deliver active ingredient.

2. On the back of the pipeline, can the company get approval from CFDA to launch at least one new product a year in the next three years to fuel earnings growth?

One way to answer this question is to see which stage of clinical trials the drugs have reached. If the drugs have already passed through, or will soon pass through, the final phase of the clinical trail (phase 3), it is likely to launch in the market in the near-term.

We have compared the pipeline of three major drugs manufacturers listed in the Hong Kong stock market: CSPC (1093 HK), 3SBio (1530 HK) and Luye (2186 HK) (see the following table). They are among the top ten drug producers listed in Hong Kong in terms of market cap. In our view, CSPC’s pipeline is stronger than the others because it has the most number of class 1 drugs going through clinical trial; and it has most number of class 1 drugs going through clinical trial phase 2 or 3. That implies it could have the most class 1 drugs complete all phases of clinical trial and launched in the market in the next five years. Actually, CSPC targets to get approval from CFDA to launch at least one class 1 drug each year in 2018 to 2022.

Comparison of class 1 drugs pipeline

CSPC(109 3 HK )

3 S B io(15 30 HK )

L u y e(21 86 HK )

Number of class 1drug going throughclinical trial

9 5 2

Stage of clinical trialPhase 1 5 4 1

Phase 2 3 1

Phase 3 1 1Last update Nov -16 Oct-16 Dec-16

Source: Companies, DBS Vickers

Taking into account the above criteria and valuation, we recommend the following two stocks:

CSPC (1093 HK).(BUY, target price: HK$11.2)

CSPC has been listed in the Hong Kong stock market for over 22 years. It generated 72% of its revenue in the first nine months of 2016 from finished drugs, and 28% from bulk drugs or intermediates. We estimate its flagship drug NBP (a class 1 drug for treatment of acute ischemic stroke) contributed around 40% of its earnings in that period.

We recommend this stock because:

1) The current finished drugs portfolio is strong based on our criteria set above. They met criterion 1 (a class 1 or 2 drug classified by CFDA), criterion 3 (covered by national and provincial medical insurance programmes), criterion 4 (the drugs are for treatment of fatal diseases) and criterion 8 (the drug is regarded as a first line drug for treatment of the disease). On the back of this portfolio, we project the EPS CAGR of CSPC in 2017 to 2019 to be 22%;

2) It has a strong new products pipeline, which enables it to launch one new class 1 drug each year in 2018 to 2022 to fuel earnings growth in the long-run. Thanks to the launch of new products, the EPS CAGR in 2017 to 2019 could be higher than our expectation of 22%;

3) Undemanding valuation. The stock is trading at 21 times the 2017 forecast price-to-earnings. In view of expected annual EPS growth of 20-25% in 2016 to 2020, backed by new drugs launches and sales network expansion for current products, the current valuation is undemanding;

4) There is a potential share price catalyst this year. As discussed above, the government targets to issue a new list of reimbursable drugs for national public medical insurance programmes this year. Three of CSPC’s drugs -- NBP injection, Jinyouli and Oulaining – are likely to be included in the new list. We estimate they had an aggregate contribution of around 25% to the group’s earnings in the first nine months of 2016. The sales of those drugs could increase at a faster pace if they are included. This is the catalyst.



Page 14

China Traditional Chinese Medicine (570 HK) (BUY, target price: HK$5.60).

CTCM is running two businesses: CCMG and finished Chinese medicines. We estimate they contributed 69% and 31% of 2016 revenue respectively. The largest shareholder of the company is China National Pharmaceutical Group Corporation, which is one of 102 state-owned enterprises directly under the State-owned Assets Supervision & Administration Commission. It has a 36% stake in the company.

We recommend this stock because:

1) EPS CAGR is forecast at 18% in 2017 to 2020, driven by CCMG. CTCM is the largest CCMG maker in China with around 50% market share. This is one of the very few pharmaceutical products that the government allows hospitals to mark up over procurement cost when selling it. This meets criterion 9 set above – providing strong incentive for hospitals to promote this product. CCMG is derived from herbal Chinese medicine but is more convenient – herbal Chinese medicines requires a two- to three-hour decoction process while CCMG can dissolve in water instantly for patients to drink. It is to replace herbal medicine gradually. The penetration of CCMG is still very low in China: We estimate the CCMG market size equalled just 4-5% of the herbal Chinese medicine

market size in 2016, versus over 10% in Hong Kong and over 50% in Taiwan and Japan. That implies plenty of room to grow. More importantly, there are only five licensed players to enjoy the growth.

2) Attractive valuation. CTCM is now trading at 14 times the 2017 forecast price-to-earnings. Relative to its expected EPS CAGR of 18% in 2017 to 2020, this is attractive.

3) There is one potential share price catalyst: The possible acquisition of herbal medicine supplier(s) to accelerate earnings growth. CTCM has always been looking for mergers and acquisitions (M&A) targets that are profitable. We estimate it is possible to acquire herbal medicines supplier(s) for two advantages. First, herbal medicines are the feedstock of CCMG. Owning a herbal medicines supplier can warrant the supply and quality of CCMG feedstock in the long-run. Second, CCMG cannot replace all herbal medicines. Hospitals need both herbal medicines and CCMG. The ability to supply both products provides a more complete products range to hospitals. That helps to yield more new customers in the long-run. We expect CTCM to be in net cash position by the end of 2016. It should have sufficient financial resources for M&A.



Page 15

STOCK PROFILES

ed- TH, JS, CK / sa- DL

BUY (Initiate coverage)

Last Traded Price ( 15 Feb 2017):HK$8.98 (HSI : 23,995) Price Target 12-mth: HK$11.20 (25% upside) Potential Catalyst: Launch of new drugs, more new products to be included in National Reimbursement Drug List Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation FY Dec (HK$ m) 2015A 2016F 2017F 2018FTurnover 11,394 12,905 14,418 16,001 EBITDA 2,765 3,286 3,854 4,561 Pre-tax Profit 2,112 2,620 3,188 3,904 Net Profit 1,665 2,066 2,514 3,077 Net Pft (Pre Ex) (core profit)

1,665 2,066 2,514 3,078

EPS (HK$) 0.28 0.35 0.43 0.52 Core EPS (HK$) 0.28 0.35 0.43 0.52 EPS Gth (%) 31.3 24.0 21.7 22.4 Core EPS Gth (%) 31.3 24.0 21.7 22.5 Diluted EPS (HK$) 0.28 0.35 0.43 0.52 DPS (HK$) 0.11 0.14 0.17 0.20 BV Per Share (HK$) 1.48 1.73 2.02 2.37 PE (X) 31.9 25.7 21.1 17.2 Core PE (X) 31.9 25.7 21.1 17.2 P/Cash Flow (X) 23.6 28.2 17.2 15.8 P/Free CF (X) 36.7 41.5 21.4 19.2 EV/EBITDA (X) 18.9 15.7 13.0 10.6 Net Div Yield (%) 1.2 1.5 1.8 2.3 P/Book Value (X) 6.1 5.2 4.5 3.8 Net Debt/Equity (X) CASH CASH CASH CASH ROAE (%) 19.8 21.8 22.7 23.7 Earnings Rev (%): New New New Consensus EPS (HK$) 0.35 0.43 0.52 Other Broker Recs: B: 21 S: 0 H: 0

ICB Industry: Health Care ICB Sector: Pharmaceuticals & Biotechnology

Principal Business: Healthcare

Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Sustainable long-term growth on strong new drugs pipeline Expect EPS CAGR of 22% in 2016-19 mainly on sales

network expansion for finished drugs EPS CAGR to accelerate on launch of new products and

inclusion of more products in National Reimbursement Drug

List (NDRL) for public medical insurance Initiate with TP of HK$11.2 and BUY call in light of the

decent EPS and strong pipeline of new products A strong pipeline of innovative drugs to support long-term growth. CSPC has 9 innovative drugs to launch in 2018-24. They are for treatment of serious diseases like cancer. Their exclusiveness protects them from price cutting risk. They can serve as a catalyst to underpin its long-term growth. In the near term, driven by current products’ entry into the reimbursement drug list of more provincial governments, penetration into lower tiered hospitals, we project EPS CAGR of 22% (FY16F-19F). Two share price catalysts in the next 24 months. Firstly, three current products are likely to be included in the NDRL this year due to their remarkable efficacy and popularity. This could boost FY19F earnings by 12%. Secondly, an innovative drug in the pipeline for treating hypertension & hyperlipidaemia is in the final stage of clinical trial – slated for launch in 2018. Assuming a 1% share in that therapeutic area could lead to additional earnings of HK$60m. Based on past trends, approval of an innovative drug or the inclusion of a drug on the NRDL can lead to strong share price performance. Valuation: Our TP of HK$11.2 is based on 26x FY17F PE premised on the following: 1) 26x PE is c.1 standard deviation above its historical 1-year forward PE average for the past three years; valuation is supported by the improving business environment – industry sales growth could rebound in 2017 on more demand from floating population and public medical insurance schemes; 2) 26x PE is c.35% above the mean of similar companies, which is justified by its >20% EPS CAGR in 2016-22 from its pipeline of new products. Key Risks to Our View:

ASP cut by the government and intensifying competition. At A Glance Issued Capital (m shrs) 6,053 Mkt. Cap (HK$m/US$m) 54,352 / 7,005

Major Shareholders Cai Dong Chen (%) 30.6 Massive Giant Group Limited (%) 17.5 UBS Group AG (%) 5.9 JPMorgan Chase & Co. (%) 5.9

Free Float (%) 40.1 3m Avg. Daily Val. (US$m) 15.0

89

139

189

239

289

2.6

3.6

4.6

5.6

6.6

7.6

8.6

9.6

Feb-13 Feb-14 Feb-15 Feb-16 Feb-17

Relative IndexHK$

CSPC Pharmaceutical (LHS) Relative HSI (RHS)

DBS Group Research . Equity 16 Feb 2017

China / Hong Kong Company Guide

CSPC Pharmaceutical Version 1 | Bloomberg: 1093 HK EQUITY | Reuters: 1093.HK

Refer to important disclosures at the end of this report

China/Hong Kong Company Guide

CSPC Pharmaceutical

Page 17

SWOT Analysis

Strengths Weaknesses

A strong new product pipeline which enables CSPC to launch one new drug each year during 2018-22 which is not easy in this industry

Leader in global caffeine industry with c.50% market share (caffeine made up c.6% of operating profit in 9M16)

Over 10% of revenue is exposed to vitamin C which is facing overcapacity

Over 30% of revenue is exposed to common generic drugs where there are many players producing the same product. ASP cuts due to competition is possible

Opportunities Threats

Three of the current drugs (contributed an estimated c.25% of earnings in 9M16) are likely to be included in the new version of National Reimbursement Drug List this year

Possible ASP cuts imposed by the government, as the government wants to reduce expenses on public medical insurance programmes

Potential ASP cut due to competition from other generic drug manufacturers

Source: DBS Vickers

China /Hong Kong Company Guide

CSPC Pharmaceutical

Page 18

Key company information

Revenue breakdown by segments in 9M16

Finished drugs72%

Antibiotics11%

Vitamin C11%

Caffeine & others

6%

Total revenue : HK$9.25bn

Source: Company, DBS Vickers

Gross margin by segment in 9M16

9M 16 G ross marg in O perat ing marg in

F inished drugs 64.7% 29.1%

Antibiotics 9.2% 2.3%V itamin C 6.9% 0.3%

Caffeine & others 31.9% 22.7%


Revenue breakdown by products in 9M16

9M 16Rev enue(HK $ m)

F in ished drugs segment 6,632NBP 1,950

Injection 905Capsules 1,045

Oulaining 801Injection 596

Capsules 205Xuanning 343Duomeisu (oncology ) 253

J inyouli (oncology ) 96Others (oncology ) 63

Common generic drugs 3,126Bulk drugs & int ermediat essegment

2,618

Antibotics (API) 1,020V itamin (API) 1,021

Caffeine & others (API) 577T ot al 9,250


Introduction of major finished drugs in 9M16

Commo n n ame Ind ic at ion Pub lic med ic alin su ranc ec ov erage

Remark

NBP - Capsules Buty phthalide Acute ischemic stroke NationalExclusiv e, patent-protected

NBP - Injection Buty phthalide Same as abov e 7 prov inces Same as abov e

Oulaining -Capsules

OxiracetamMild to moderate memory & mental impairmentresulting from v ascular dementia, senile dementiaand brain trauma

12 prov inces

Oulaining -Injection

Oxiracetam Same as abov e 21 prov incesExclusiv e oxiracetampowder formulation

Xuanning Lev amlodipine meleateHy pertension, chronic stable angina & v ariantangina

National

DuomeisuDoxorubicinhy drochloride liposomeinjection

Cancer (multiple my eloma, ly mphoma, ov ariancancer, breast cancer)

2 prov inces

J iny ouli PEG-rhG-CSF injectionUsed in chemotherapy to restore white bloodcells & reduce chances of infection

3 prov inces



CSPC Pharmaceutical

Page 19

Share price catalysts in the next 24 months

In our view, anything that can accelerate earnings growth can be a share price catalyst. We foresee two catalysts in 24 months:

1. Three of the current products are likely to be included in the new version of National Reimbursement Drug List (NRDL) this year. Inclusion of those drugs can boost their sales. If it occurs, we estimate the earnings of CSPC in 19F to be raised by c.12% or c.HK$455m, from HK$3.66bn to HK$4.1bn. The three products are :

A) NBP injection. We estimate that it could contribute 63% or HK$287m of the potential earnings increase in 19F. CSPC has both NBP injections and NBP capsules. They are both for treatment of acute ischemic stroke. The capsule is already in the current NRDL (2009 version). The injection is not in current NRDL as it was launched in 2010. Due to its efficacy, seven provincial governments have adopted it in their reimbursement drug lists. Both NBP capsules and injections are carrying the same active ingredient. So, the acceptance of NBP capsule by NRDL prompts us to believe that the NRDL will accept NBP injection too in the future;

B) Jinyouli. We estimate it to contribute 29% or HK$132m of the potential earnings increase in 19F. It is for prevention of leucopenia and infection induced by chemotherapy treatment. Medicines with a similar efficacy are mostly short-acting. That implies patients might take one injection every 2-3 days throughout the treatment period. This medicine is the first approved long-acting growth factor drug with the targeted indication in China. It takes 21 days for patients to take another injection. As the number of injection in a treatment period is fewer, the pain and side effects for the patient is smaller. Hence, it is likely to be included in the new NDRL;

C) Oulaining powder injection. We estimate that it could contribute 8% or HK$36m of the potential earnings increase in 19F. It is for treatment of moderate memory and mental impairment and has been included in the reimbursable drugs list of 21 provinces. As it is already very widely used, it is likely to be included in the new NRDL.

Historically, when the drugs of a company were included in NDRL, the share price could perform strongly in the year. An example is Yunnan Baiyao (000538 CH). When its products were included the new edition of NRDL in 2000 and 2009, its share price were up by 61% and 76% respectively.

2. ‘Compound levamlodipine & atorvastatin calcium tablet”, a new class 1 drug (a drug with totally new chemical structure or totally new active ingredient) could get approval from China Food & Drug Administration to launch in 2018. If so, it provides one more earnings growth driver for CSPC in the long run.

The drug is for treatment of hypertension and hyperlipidemia. Very few drugs can deal with the two diseases simultaneously like this one. So, we believe it can gain market share from the drug market for hypertension. We estimate the market size of hypertension drugs in China to be Rmb22bn in 2016. Assuming the drug has 1% market share and the net margin is 25%, it could bring annual revenue and earnings of Rmb220m and Rmb55m respectively to CSPC.

Based on historical trends, the approval of an innovative drug (class 1 drug) could drive a company’s share price up strongly in a week. An example is NT Pharm (1011 HK). On 4 Jan 2017, NT Pharm announced that its class 1 new drug Xi Di Ke (uroacitides injection) had been approved by the China Food & Drug Administration for launch in the market. Its share price surged by up to 22% that week. .


CSPC Pharmaceutical

Page 20

Valuation

Our TP of HK$11.2 is based on 26x FY17F PE. There are two reasons why we used 26x FY17F PE as a benchmark:

1) A valuation of 26x FY17F PE is c.35% higher than the market cap weighted average PE valuation of the top five chemical drug manufacturers/suppliers listed in Hong Kong in terms of market cap. They are Sino-biopharm (1177 HK), CMS (867 HK), 3SBio (1530 HK), Luye (2186 HK), United Lab (3933 HK).

CSPC deserves the premium valuation because of its stronger ability to launch new class 1 drugs compared to its peers as discussed above. It targets to launch one new class 1 drug each year in 2018-22. On the back of this, we believe CSPC can sustain over 20% earnings growth annually in 2016-22. In our view, this earnings sustainability deserves the valuation premium.

2) A valuation of 26x FY17F PE is also close to 1 standard deviation above CSPC’s historical average 1-year forward PE valuation (the average of the last three years). It deserves this premium because the operating environment for CSPC in future will be better than the last three years. The pharmaceutical industry’s sales growth had been decelerating from 14.1% in 2014 to 9.1% in 9M16 due to price cuts imposed by government. Although price cuts will have an impact on the sector like in the past, there are two new forces emerging that will lead to a rebound in industry

growth in late 2017. Firstly, the number of drugs reimbursable from public medical insurance programs will increase by over 10%, based on our estimates. Secondly, the higher ‘floating population’ base would also be able to be reimbursed for medical expenses from public medical insurance programs. That will drive the demand of drugs and improve the overall outlook of the pharmaceutical industry. As such, we believe CSPC deserves to trade at higher PE than its average historical PE.

In our view, the risk of investing in CSPC at the current share price level is lower than in the past because:

1) CSPC is targeting 20-30% earnings growth p.a. in the future. Current consensus expects 22% earnings CAGR in 2016-18 which is at the low end of CSPC’s target. This implies the market is already conservative about the growth prospects of CSPC;

2) Trading at 22x FY17F PE of 22x, this level is still below the 3-year historical average 1-year forward PE of CSPC;

3) The improving operating environment in the pharmaceutical industry should attract funds flow into this sector. CSPC has the largest market cap in the pharmaceutical sector. As a large representative of this sector, CSPC will benefit from funds inflow.

PE band chart

PB band chart

02468

101214161820

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

Share Price (HK$)

1x

9x26x

26x

34x

456789

1011121314

Jan-

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Jul-1

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Jul-1

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0.7x

4.3x

7.9x

11.5x

15.1x

Source: Thomson Reuters, DBS Vickers Source: Thomson Reuters, DBS Vickers


CSPC Pharmaceutical

Page 21

Peers valuation

M k t PE PE Y ield Y ield P/Bk P/Bk EV /EB IT DA ROE ROEPrice Cap F iscal 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F

Company Name Code HK $ HK $m Y r x x % % x x x x % %China Medical System 867 HK 13 32,334 Dec 17.6 15.0 2.0 2.3 3.7 3.2 13.6 11.8 22.0 22.9

Sino Biophm. 1177 HK 6.24 46,252 Dec 20.8 18.4 1.0 1.1 4.1 3.7 10.5 9.3 22.4 22.13Sbio 1530 HK 7.76 19,651 Dec 18.2 15.4 0.5 0.7 2.5 2.2 13.0 11.4 13.8 14.8Luye Pharma Group 2186 HK 4.9 16,273 Dec 13.7 12.1 0.6 0.7 2.0 1.6 10.3 9.2 15.0 14.9

United Labs. 3933 HK 4.87 7,923 Dec 18.4 17.1 0.0 0.0 1.2 1.2 6.6 6.2 5.9 6.5CSPC Pharmaceutical* 1093 HK 8.98 54,352 Dec 21.1 17.2 1.8 2.3 4.5 3.8 13.0 10.6 22.7 23.7

Source: Thomson Reuters, *DBS Vickers


CSPC Pharmaceutical

Page 22

Growth drivers

The following tables show our expected revenue growth of CSPC’s major products and their drivers. To sum up, those drivers include entry into the reimbursement drug list of more provincial governments, penetration into lower tiered hospitals, increase in the number of patients, expansion of pharmaceutical products’ indications, and lower cost to gain market share.

Expected growth of CSPC’s products’ revenue

9M 16Rev enue(HK $ m)

16E- 19ERev enue

CA GR

F in ished drugs segment 6,632 17%NBP 1,950 24%

Injection 905 31%Capsules 1,045 17%

Oulaining 801 17%Injection 596 17%

Capsules 205 17%Xuanning 343 16%Duomeisu (oncology ) 253 32%

J inyouli (oncology ) 96 33%Others (oncology ) 63 28%

Common generic drugs 3,126 2%Bulk drugs & int ermediat essegment

2,618 2%

Antibotics (API) 1,020 0%V itamin (API) 1,021 0%

Caffeine & others (API) 577 3%T ot al 9,250 11%



CSPC Pharmaceutical

Page 23

Growth drivers of each product

16E-19E Revenue

CAGR

Growth drivers

NBP – injection 31% ‐ The medicine is for treatment of acute ischemic stroke. According to Chinese Center for Disease Control & Prevention, there will be over 2m new stroke patients each year. That can drive the

demand for the medicine.

‐ NBP injections cover c.600 hospitals while NBP capsules cover c.1,300 hospitals. Co-usage of NBP injections and NBP capsules can improve the health of the patients remarkably. Thus, CSPC will

promote NBP injections to the hospitals already prescribing NBP capsules.

‐ Sales network expansion. The drug is included in the public reimbursement drug list in only seven provinces. There is plenty of room to grow.

NBP – capsules 17% ‐ Increase in number of stroke patients.

‐ Originally, the treatment period for NBP capsules was 20 days. Upon CFDA approval, in 2015, the treatment period was lengthened to 76 days. That can boost the sales volume.

‐ CSPC is selling the drug in c.1,300 top-tier hospitals. It is penetrating the mid-tier hospital market.

Oulaining – injection

17% ‐ Sales network expansion

Oulaining – capsules

17% ‐ This is for treatment of a chronic disease. Patients with a chronic disease need to take drugs for a long period. This warrants stable demand for the product.

‐ Sales network expansion. The drug is included in the public reimbursement drug list in only 12

provinces. There is plenty of room to grow.

Xuanning 16% ‐ This is for treatment of a chronic diseases. Patients with chronic diseases need to take drugs for a long period. This warrants stable demand for the product.

‐ According to China Pharmaceutical Association, there are over 360m patients suffering from

hypertension. The association expects the number to grow at 9% annually. That can drive the demand for the drug.

Duomeisu (oncology)

32% ‐ Sales network expansion. The drug is included in the public reimbursement drug list in only two provinces. There is plenty of room to grow.

Jinyouli (oncology)

33% ‐ Medicines with a similar efficacy are mostly short-acting. This implies that patients might take one injection every 2-3 days throughout the treatment period. This medicine is the first approved long-acting growth factor drug. Patients need to take another injection only after 21 days. As it requires

fewer injections within a treatment period, there is less pain and side effects for the patient. Hence, we believe this medicine is able to gain market share.

‐ Sales network expansion. The drug is included in the public reimbursement drug list in only three

provinces. There is plenty of room to grow.

Others (oncology) 28% ‐ Sales network expansion

Common generic drugs

2% ‐ Sales network expansion

Antibiotics 0% *We expect no growth due to industry overcapacity.

Vitamins 0% *We expect no growth due to industry overcapacity.

Caffeine & others 3% ‐ Gaining market share by lowering unit cost via increasing capacity and utilization.

Source: DBS Vickers


CSPC Pharmaceutical

Page 24

Other than the above, there are two more factors that can accelerate CSPC’s earnings growth which we have yet to factor in our estimates:

1. As discussed above in “share price catalysts in 24 months”, if the three products are included in the new NRDL, the growth can accelerate ;

2. CSPC has a pipeline of new products (see the following table). On the back of that pipeline, CSPC could get approval from CFDA to launch one new class 1 product each year from 2018-2022. These can accelerate the company's earnings growth too.

CSPC (1093 HK) new products pipeline 1

Summary of status of R&D pipeline

Candidate Indicat ion(s) Pre-c linical

t rialPhase 1 Phase 2 Phase 3 Regist rat ion

rE4 Diabetes

Compound levamlodipine andatorvastatin calcium tablet

Hypertension,hyperlipidemia

Pinocembrin injection Acute stroke

L-Buty lphthalide tablet andinjection

Acute stroke

Baicalein tablet V iral influenza

DBPR108 Diabetes

SKLB1028 Oncology

Buty lphthalide soft capsule Vasculardementia

Ammoxetine hydrochloride enteric-coated tablets

Antidepressant

6 products

Candidate Pre-c linical

t rialRegist rat ion

Generic drugs

27 products - pending production approval

11 products - undergoing BE study or clinical trial

58 products - granted clinical trial approval

14 products - completed pre-clinicaltrial, pending clinical trial approval

U.S A NDA drugs ( Internat ional regist rat ion)

10 products

2 products

10 products

Clinical t rial

Source: Company

*After completion of all phases of clinical trials (total of 3 phases), the drug will be pending approval from CFDA to be launched.


CSPC Pharmaceutical

Page 25

CSPC (1093 HK) new products pipeline 2

Drug name Drug class Applications Status Expected approval Market size Competitor projects

1 rE4: recombinant GLP-1 receptor agonist injection

(rE4：注射用重組胰

高血糖素樣肽-1受體

激動劑)

Class 1 biopharma-ceutical product

Diabetes Completed Phase II clinical trial

2019 Diabetes medicine market in major hospitals in China reached RMB13.4 billion in 2011, increased by 17.87% from 2010 (Note2). There are approx. 100 million patients with diabetes in China (Note3)

Exenatide liraglutide (chemical method)

2 Compound levamlodipine and atorvastatin calcium tablet: cardiovascular oral formulation

(复方左旋氨氯地平阿

托伐他汀钙片：心血

管口服制剂)

Class 1 chemical drug

HypertensionHyperlipide-mia

Phase III clinical trial

2018 China's antihypertensive drug market has an estimated capacity of RMB30 billion in 2013 (Note4). According to the PDB database, 2012 annual sales of hypertension drugs in hospitals of 22 sample cities reached RMB4.5 billion, with CAGR (2008-2012) around 15.97%. There are over 200 million patients with hypertension in China (Note5).

Amlodipine, nifedipine,

atorvastatin calcium and other CCB class drugs, rosuvastatin

statins and other statins.

3 Pinocembrin injection: cerebral vascular drugs

(注射用匹诺塞林：脑

血管药)


Acute stroke Phase II clinical trial

2020 There are over 2 million new stroke patients each year in China, causing approx. 1.5 million deaths each year; Currently, there are approx. 7 million stroke patients in China. (Note7)

Neuroprotective agents like

Gangliosides, Edaravone;

Cinepazide; Traditional Chinese

medicine like Breviscarpin, Ginkgo

Leaf 4 L-Butylphthalide

tablet & injection

(左旋丁苯酞片、注射

液)


Acute stroke Completed Phase I clinical trial

2021 (Note1)

There are over 2 million new stroke patients each year in China, causing approx. 1.5 million deaths each year; Currently, there are approx. 7 million stroke patients in China. (Note7)

Neuroprotective agents like

Gangliosides, Edaravone;

Cinepazide; Traditional Chinese

medicine like Breviscarpin, Ginkgo

Leaf 5 Baicalein tablets: oral

antiviral

(黄芩素片：口服抗病

毒药物)

Class I TCM

Viral influenza Applying for Phase II & III clinical trial

2020 Anti-influenza virus medicine market sales reached RMB20 billion in 2011. (Note6)

Lianhuaqingwen Qingkailing and anti-

viral pills, anti-virus oral antiviral agents

6 DBPR108 Class 1 chemical drug

Diabetes Phase I clinical trial

2020 Diabetes medicine market in major hospitals in China reached RMB13.4 billion in 2011, increased by 17.87% from 2010 (Note2). There are approx. 100 million patients with diabetes in China (Note3)

Phosphate sitagliptin, vildagliptin, saxagliptin,

alogliptin, Llnagliptin teneligliptin, etc.

7 SKLB1028 Class 1 chemical drug

Oncology Phase I clinical trial

2022 NSCLC medicine market in China reached RMB4 billion in 2011. The market can be over RMB4.5 billion if added AML. (Note8)

Gefitinib, erlotinib, icotinib,

permetrexed, endostatin

8 Butylphthalide soft capsule

(丁苯酞软胶囊)


Vascular dementia

Phase II clinical trial

2022 There are approximately 130 million people over the age of 55 in China and prevalence rate of vascular dementia in this population is 0.8% with annual incidence rate of 0.27 per 100 people. (Note9)

Oxiracetam, piracetam,

memantine hydrochloride,

rivastigmine tartrate 9 Ammoxetine

hydrochloride enteric-coated tablets

(盐酸阿姆西汀肠溶

片)


Anti-depressant Phase I clinical trial

2024 From a research done in 2001-2004, the prevalence rate of depression was 6.1% in China (Note10). The estimated population with depression was over 90 million in China.

Duloxetine, venlafaxine,

desvenlafaxine, escitalopram,

vilazodone

Source: Company

Notes：1. Based on the management of product life cycle; 2. 2012 Diabetes Treatment Market Research Report (Guangzhou); 3. Healthcare and Life Sciences Predictions 2020; 4. IMS; 5. NHFPC ; 6. China Medicine Paper; 7. 2010 Chinese Cerebrovascular Disease Prevention and Treatment Guidelines; 8. Decision Resources; 9. Epidemiological Characteristics of Vascular Dementia among Community-Dwellings Aged 55 Plus in Mainland China: A Meta-analysis of Studies Published between 1980 and 2011; 10. Prevalence, treatment, and associated disability of mental disorders in four provinces in China during 2001–05: an epidemiological survey


CSPC Pharmaceutical

Page 26

Competitive edges

A strong new drugs pipeline. To judge if the products pipeline or the R&D capability of a drug company is strong, we look at the following aspects:

1. Is the drug to be launched an exclusive product in the market ? Exclusiveness is a sign of strong R&D capability. It protects the drug from price cutting risk due to competition from similar products.

One way to answer this question is to see if the drug is classified as class 1 or 2 according to new classification of drugs issued by CFDA in Mar 2016. Class 1: a drug with innovative active ingredient or chemical structure. Class 2: a drug with innovative way to deliver active ingredient.

2. On the back of the pipeline, can the company get approval from China Food & Drug Administration (CFDA) to launch at least one new product a year in next three years to fuel the earnings growth ?

One way to answer this question is to see the stage of clinical trial of the drugs. If the drugs already passed through or will soon pass through final phase of clinical trail (phase 3), it is likely to launch in the market in near term;

We have compared the pipeline of three major drugs manufacturers listed in Hong Kong Stock market: CSPC (1093 HK), 3SBio (1530 HK), Luye (2186 HK). In terms of market cap, they are among the top ten in pharmaceutical universe in the Hong Kong stock market. (see the following table). In our view, CSPC’s pipeline is stronger than the others because: A) it has most number of class 1 drugs going through clinical trial; B) it has most number of class 1 drugs going through clinical trial phase 2 or 3. That implies it could have most class 1 drugs to complete all phases of clinical trial and launch to market in next 5 years. Actually, CSPC targets to get approval from CFDA to launch at least one class 1 drug each year in 2018-22 as discussed.

Comparison of class 1 drugs pipeline

CSPC(1093 HK)

3S Bio(1530 HK)

Luy e(2186 HK)

Number of class 1drug going throughclinical trial

9 5 2

Stage of clinical trial

Phase 1 5 4 1

Phase 2 3 1

Phase 3 1 1

Last update Nov-16 Oct-16 Dec-16

Source: company, DBS Vickers

NBP is better than other medicines for treatment of acute ischemic stroke in many aspects. We estimate NBP (capsules and injection) to contribute c.40% of CSPC’s earnings in 9M16. It is for treatment of acute ischemic stroke. According to Taiwan Stroke Society, there are another five medicines for treatment of acute ischemic stroke as follows: 1. Streptokinase; 2. Urokinase; 3. Tissue plasminagen activator; 4. Recombinate tissue-type plasminogen activator; 5. Edaravone. For items 1-4, the patient must take them within six hours after the onset of acute ischemic stroke. The timeline for NBP is 48 hours. This allows more flexibility for the patients and physicians, particularly for patients living in 2nd or 3rd tier areas who need a longer travelling time to hospitals. Item 5 Edaravone has only one application method, that is injection. Thus, patients can only take the medicines in a hospital or clinic. NBP offers a capsule alternative, and thus the patients can take it at home. This provides NBP the opportunity to gain market share.

Leader in global caffeine market. Global demand for caffeine is 20,000 tons annually, while CSPC's capacity is 10,000 tons. That implies better economies of scale and lower cost relative to other players.


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Risks & concerns

Price-cutting risk. This comes from two sources. Firstly, ASP cuts imposed by the government to save on public medical insurance expenses. The prices of NBP capsules and injections have been lowered by c.15% in the last ten years due to price cuts imposed by the government. Secondly, apart from NBP capsules and injections, CSPC faces competition from other producers for its generic products which made up over 60% of sales in 9M16. Those players could cut prices to compete with CSPC.

Global industry overcapacity of vitamin C. The product made up 11% of total revenue in 9M16. It is facing global industry overcapacity because the global total capacity is 82% bigger than the demand (200,000 tons vs 110,000 tons). Oversupply of vitamin C could impact the product’s ASP.

Financials

Revenue. CSPC’s revenue is driven largely by the finished drugs segment. Among all finished drugs, NBP (capsule & injection), Oulaining (capsule & injection), Xuanning and oncology drugs are the major contributors to this segment, thanks to sales network expansion for those drugs and market share gains resulting from better efficacy of them (see the following charts).

Revenue

5,754 6,716 7,794 9,285 10,776

12,338 4,195

4,239 3,600

3,620 3,641

3,663

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

2013 2014 2015 2016E 2017E 2018E

Finished drugs Bulk drugs & intermediates

HK$m


Finished drugs revenue

0

5,000

10,000

15,000

2013 2014 2015 2016E 2017E 2018E

NBP (capsule & injection) Oulaining (capsule & injection)

Xuanning Oncology drugs

Common generic drugs

HK$m



CSPC Pharmaceutical

Page 28

Gross margin. The overall gross margin has been trending up since 2013 on higher revenue contribution from finished drugs segment. We expect the revenue contribution from finished drugs will increase from 58% in 2013 to over >70% in 2018. As the gross margin of finished drugs segment is higher than bulk drugs & intermediates, so increasing revenue contribution from finished drugs can boost the overall gross margin

In addition, within the finished drugs segment, we have also seen increasing revenue contribution from finished drugs with higher gross margins such as NBP (injection & capsule), Oulaining (injection & capsule), Xuanning, and oncology drugs. The aggregate revenue contribution from these products to finished drugs segment had increased from 33% in 2013 to 48% in 2015.

Gross margin

49%55%

61% 61% 62% 62%

8%12% 14% 14% 15% 15%

31%38%

46% 48% 50% 51%

0%

10%

20%

30%

40%

50%

60%

70%

2013 2014 2015 2016E 2017E 2018E

Finished drugsBulk drugs & intermediatesOverall


Distribution cost as a percentage of sales. The ratio had been trending up in 2013-15, which we believe was due to rising revenue contribution from finished drugs. Unlike bulk drugs and intermediates which are more generic products, the efficacy of each finished drug is very different. This requires a dedicated sales team to introduce and promote the drugs to medical institutes. Therefore, the distribution cost as a percentage of sales of finished drugs is higher than for bulk drugs and intermediates. As revenue contribution from finished drugs has increased, the overall distribution cost as a percentage of sales has risen too.

Distribution cost % in sales

13%

16%

20% 20% 20% 19%

0%

5%

10%

15%

20%

25%

2013 2014 2015 2016E 2017E 2018E


Admin cost as a percentage of sales. This ratio dropped from 6.2% in 2013 to 4.7% in 2015. As a percentage of sales, the admin cost in the antibiotic business is higher than CSPC’s average. The company sold a part of the antibiotic business during the period, which had helped to lower the ratio. The gradual downtrend of the ratio in FY16F-18F is due to better economies of scale.

Administration cost % in sales

6.2%

5.0%4.7% 4.7% 4.5% 4.3%

0%

1%

2%

3%

4%

5%

6%

7%

2013 2014 2015 2016E 2017E 2018E



CSPC Pharmaceutical

Page 29

Net debt to equity ratio. CSPC swung from net debt position in 2013 to net cash position from 2014 onwards. This is mainly thanks to an increase in revenue contribution from the finished drug segment. The profit margin of this segment is much better than that of bulk drugs and intermediates, which we estimate to be >20ppts higher. Therefore, increasing contribution from finished drugs has improved both the earnings and financials of the company.

Net cash (debt)

(66)

301 843

1,478

3,101

4,840

(1,000)

0

1,000

2,000

3,000

4,000

5,000

6,000

2013 2014 2015 2016E 2017E 2018E

HK$m


Cash flow from operations. There was sharp increase in cash inflow from operations in 2014 due to: 1) higher pre-tax profit thanks to an increase in earnings contribution from finished drugs segment; 2) cash outflow for working capital decreased by 89% or HK$658m mainly as a result of a decrease in bills payables, and the increase in bills receivables was much smaller in 2014 than in 2013. We project cash flow from operations to steadily increase to FY18F thanks to the higher earnings growth contributed by the finished drugs business.

Cash flow from operation (HK$ m)

815

1,806

2,251

1,880

3,081 3,365

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2013 2014 2015 2016E 2017E 2018E

HK$m


Cash flow from investment. The cash flow from investments reversed into negative territory from 2014 onwards. In 2013, CSPC disposed the antibiotic business, which led to a cash inflow of c.HK$1bn. From 2014, cash flow from investments turned negative due to capital expenditure. The capex in 2014 and 2015 were c.HK$800m respectively. We project the capex to be c.HK$600m annually in 2016-18 for expansion and upgrade of finished drugs’ production capacity mostly. Part of the capex is allocated on investment of equipment for environment protection.

Cash flow from investment (HK$ m)

624

(745) (712)(587) (583) (573)

(1,000)

(800)

(600)

(400)

(200)

0

200

400

600

800

2013 2014 2015 2016E 2017E 2018E

HK$m



CSPC Pharmaceutical

Page 30

Cash flow from financing. The cash outflow from financing decreased drastically in 2014 as the repayment of bank loans in 2013 was much larger than the years after. We project a gradual increase of cash outflow from financing due to dividend to be paid to shareholders.

Cash flow from financing (HK$ m)

(1,729)

(747)(605) (621)

(826)(1,003)

(2,000)

(1,800)

(1,600)

(1,400)

(1,200)

(1,000)

(800)

(600)

(400)

(200)

0

2013 2014 2015 2016E 2017E 2018E

HK$m



CSPC Pharmaceutical

Page 31

Management profiles

Name Curren tA ppo in t ment

Prev iou s ex perienc e St ak e in CSPCPharma

(27 J an 2017 )

Mr. CaiDongchen, aged63

Chairman, CEO >Appointed as director in 1998>Chairman of the Nomination Committee of the Company

>A director of certain subsidiaries of the Group>A deputy of the 12th National People's Congress of the People's Republic

of China>Extensiv e technical and management experience in the pharmaceutical

industry

30.61%

Mr. Chak KinMan, aged 51

Executiv e Director >Appointed as director in 2005>A director of certain subsidiaries of the Group

>A certified public accountant of the Hong Kong Institute of Certified PublicAccountants

>A fellow member of the Association of Chartered Certified Accountants>Extensiv e experience in finance, accounting and inv estor relation

0.02%

Mr. PanWeidong, aged47


>Extensiv e experience in finance and accounting

0.17%

Mr. WangShunlong, aged52

Executiv e Director >Appointed as director in 2008>A non-executiv e director of Consun Pharmaceutical Group Limited(01681

HK)>Extensiv e experience in the corporate management and inv estment

planningMr. WangHuaiy u, aged 53


>Extensiv e technical and management experience in the pharmaceuticalindustry

0.25%

Mr. Lu J ianmin,aged 58



0.17%

Mr. WangZhenguo, aged47



0.05%

Mr. Wang J inxu,aged 46


>Extensiv e experience in product research and dev elopment in thepharmaceutical industry

0.05%

Mr. Lu Hua,aged 44


>Extensiv e experience in pharmaceutical engineering, productionmanagement and technical research

0.05%



CSPC Pharmaceutical

Page 32

CRITICAL DATA POINTS TO WATCH

Earnings Drivers:

We expect 11% revenue CAGR in 2016-19, driven by current drugs portfolio. Thanks to CSPC’s sales network expansion and current products being included in more provincial public medical insurance programmes, we project revenue CAGR of 11% in 2016-19. Overall gross margin to increase from 48% in 2016F to 52% in 2019F, thanks to increasing contribution of finished drugs business. The gross margin of the finished drugs segment is higher than the bulk drugs & intermediates segment. On the back of its sales network expansion, we project that the revenue contribution from finished drugs will increase from 58% in 2013 to >70% in 2018F. This drives up overall gross margin. In view of its new products pipeline, CSPC could launch one new product each year in 2018-22. CSPC has a number of new class 1 drugs (drugs with totally new chemical structures or innovative active ingredients) in the pipeline. In light of this, CSPC could get the approval from China Food & Drug Administration to launch one new class 1 product each year from 2018-2022. These developments can help accelerate the company's earnings growth.

Finished drugs

Antibotics (API)

Vitamin (API)

Caffeine & others (API)

SG&A % in sales


0.170.16

0.19

0.16

0.14

0

0

0

0

0

0

0

0

0

0

0

2014A 2015A 2016F 2017F 2018F

-0.03

-0.27

0 0 0

0

0

0

0

0

0

0

0

2014A 2015A 2016F 2017F 2018F

0.11

-0.03

0 0 0

0

0

0

0

0

0

0

0

0

2014A 2015A 2016F 2017F 2018F

-0.01

0.09

0.03 0.03 0.03

0

0

0

0

0

0

0

2014A 2015A 2016F 2017F 2018F

0.24

0.28 0.28 0.28 0.27

0

0

0

0

0

0

0

2014A 2015A 2016F 2017F 2018F


CSPC Pharmaceutical

Page 33

Balance Sheet:

Solid balance sheet since 2013. CSPC turned from net debt position in 2013 to net cash position from 2014 onward. This is mainly thanks to rising revenue contribution from the finished drug segment. The profit margin of this segment is much better than bulk drugs and intermediates. We estimate it is >20ppts higher. Therefore, increasing contribution from finished drugs has improved both the earnings and financials of the company. Share Price Drivers:

Three of the current products are likely to be included in the new version of National Reimbursement Drug List (NRDL) in 2017. They are NBP injections (for treatment of acute ischemic stroke), Jinyouli (for prevention of leucopenia and infections induced by chemotherapy treatment), Oulaining powder injection (for treatment of moderate memory & mental impairments). The inclusion could boost the sales of those drugs. A new drug could get approval from China Food & Drug Administration for launch in 2018. The drug is called “compound levamlodipine & atorvastatin calcium tablet”. CSPC targets to launch it as a class 1 drug (a drug with totally new active ingredient). It is for treatment of hypertension and hyperlipidemia. Very few drugs can deal with the two diseases simultaneously like this one. Thus, we think it can gain market share in the drug market for hypertension.

Key Risks:

Price-cutting resulting from government and competitors. Industry overcapacity for bulk drugs and intermediates.

Company Background:

CSPC was listed on the Hong Kong stock market in 1994. The production of vitamin C supplements and anti-biotics had always been its major business until 2012, when it acquired the finished drugs business of Hony Capital. The finished drugs business is now contributing over 90% of CSPC’s earnings.

Leverage & Asset Turnover (x)

Capital Expenditure

ROE

Forward PE Band

PB Band


0.8

0.8

0.8

0.8

0.8

0.9

0.9

0.9

0.9

0.9

0.9

0.00

0.05

0.10

0.15

0.20

0.25

2014A 2015A 2016F 2017F 2018F

Gross Debt to Equity (LHS) Asset Turnover (RHS)

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

2014A 2015A 2016F 2017F 2018F

Capital Expenditure (-)

HK$m

0.0%

5.0%

10.0%

15.0%

20.0%

2014A 2015A 2016F 2017F 2018F

Avg: 22.5x

+1sd: 25.9x

+2sd: 29.3x

‐1sd: 19.1x

‐2sd: 15.6x14.0

19.0

24.0

29.0

34.0

39.0


(x)

Avg: 4.81x

+1sd: 5.19x

+2sd: 5.56x

‐1sd: 4.43x

‐2sd: 4.05x

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Dec-13 Dec-14 Dec-15 Dec-16

(x)


CSPC Pharmaceutical

Page 34

Key Assumptions

FY Dec 2013A 2014A 2015A 2016F 2017F 2018F

Finished drugs sales Gth % 116.9 16.7 16.0 19.1 16.1 14.5

Antibotics (API) sales Gth % 286.1 -3.1 -27.5 0.0 0.0 0.0 Vitamin (API) sales Gth % 567.3 11.4 -3.3 0.0 0.0 0.0 Caffeine & others (API) sales Gth % -8.7 -1.1 8.5 3.0 3.0 3.0 SG&A % in sales 21.8 24.2 27.6 28.0 27.9 27.2 Source: Company, DBS Vickers

Segmental Breakdown (HK$ m)

FY Dec 2013A 2014A 2015A 2016F 2017F 2018F Revenues (HK$ m) Finished drugs 5,754 6,716 7,794 9,285 10,776 12,338 Antibotics (API) 2,446 2,370 1,718 1,718 1,718 1,718 Vitamin (API) 1,116 1,243 1,203 1,203 1,203 1,203 Caffeine & others (API) 632 626 679 699 720 742 Total 9,949 10,955 11,394 12,905 14,418 16,001 Gross margin (HK$ m) Finished drugs 2,800 3,683 4,717 5,682 6,627 7,649 Antibotics (API) 215 337 294 301 309 309 Vitamin (API) (60) 1 37 42 42 42 Caffeine & others (API) 178 166 173 182 194 200 Total 3,133 4,187 5,221 6,207 7,173 8,201 Gross margin (%) Finished drugs 48.7 54.8 60.5 61.2 61.5 62.0 Antibotics (API) 8.8 14.2 17.1 17.5 18.0 18.0 Vitamin (API) (5.4) 0.1 3.1 3.5 3.5 3.5 Caffeine & others (API) 28.2 26.6 25.5 26.0 27.0 27.0 Total 31.5 38.2 45.8 48.1 49.8 51.3 Source: Company, DBS Vickers


CSPC Pharmaceutical

Page 35

Income Statement (HK$ m) FY Dec 2013A 2014A 2015A 2016F 2017F 2018F Revenue 9,949 10,955 11,394 12,905 14,418 16,001 Cost of Goods Sold (6,816) (6,768) (6,173) (6,698) (7,244) (7,800) Gross Profit 3,133 4,187 5,221 6,207 7,173 8,201 Other Opng (Exp)/Inc (1,959) (2,521) (3,063) (3,535) (3,935) (4,255) Operating Profit 1,174 1,667 2,158 2,672 3,238 3,946 Other Non Opg (Exp)/Inc 0 0 0 0 0 0 Associates & JV Inc (14) 1 2 2 2 2 Net Interest (Exp)/Inc (67) (47) (48) (54) (52) (45) Dividend Income 0 0 0 0 0 1 Exceptional Gain/(Loss) 154 1 0 0 0 0 Pre-tax Profit 1,248 1,621 2,112 2,620 3,188 3,904 Tax (258) (337) (432) (536) (653) (799) Minority Interest (17) (16) (14) (18) (22) (27) Preference Dividend 0 0 0 0 0 0 Net Profit 973 1,268 1,665 2,066 2,514 3,077 Net Profit before Except. 819 1,268 1,665 2,066 2,514 3,078 EBITDA 1,816 2,278 2,765 3,286 3,854 4,561 Growth Revenue Gth (%) N/A 10.1 4.0 13.3 11.7 11.0 EBITDA Gth (%) N/A 25.4 21.4 18.8 17.3 18.3 Opg Profit Gth (%) N/A 42.0 29.5 23.8 21.2 21.9 Net Profit Gth (%) N/A 30.4 31.3 24.1 21.7 22.4 Margins & Ratio Gross Margins (%) 31.5 38.2 45.8 48.1 49.8 51.3 Opg Profit Margin (%) 11.8 15.2 18.9 20.7 22.5 24.7 Net Profit Margin (%) 9.8 11.6 14.6 16.0 17.4 19.2 ROAE (%) 13.9 16.3 19.8 21.8 22.7 23.7 ROA (%) 7.5 10.3 12.8 14.4 15.6 16.9 ROCE (%) 10.2 14.2 17.1 18.9 19.9 21.1 Div Payout Ratio (%) 48.6 46.6 39.0 39.0 39.0 39.0 Net Interest Cover (x) 17.6 35.8 45.1 49.4 62.4 88.6 Source: Company, DBS Vickers


CSPC Pharmaceutical

Page 36

Quarterly Income Statement (HK$ m)

FY Dec 2Q2015 3Q2015 4Q2015 1Q2016 2Q2016 3Q2016

Revenue 2,948 2,773 2,891 2,993 3,153 3,105 Cost of Goods Sold (1,609) (1,492) (1,527) (1,534) (1,576) (1,500) Gross Profit 1,340 1,280 1,364 1,460 1,576 1,605 Other Oper. (Exp)/Inc (786) (730) (827) (823) (903) (929) Operating Profit 554 550 537 637 673 676 Other Non Opg (Exp)/Inc 0 0 0 0 0 0 Associates & JV Inc 3 3 (5) 4 5 11 Net Interest (Exp)/Inc (16) (15) (5) (11) (11) (11) Exceptional Gain/(Loss) N/A (9) 9 0 0 0 Pre-tax Profit N/A 529 536 630 667 676 Tax (115) (104) (111) (121) (137) (138) Minority Interest (4) (4) (3) (4) (3) (3) Net Profit 422 421 422 506 527 535 Net profit bef Except. N/A 430 413 506 527 535 EBITDA 708 691 691 783 822 840 Growth (QoQ) Revenue Gth (%) 6.0 (6.0) 4.3 3.5 5.3 (1.5) EBITDA Gth (%) 5.9 (1.7) (0.7) 13.2 4.9 2.2 Opg Profit Gth (%) 7.0 (0.7) (2.3) 18.6 5.7 0.3 Net Profit Gth (%) 5.3 (0.1) 0.3 19.8 4.3 1.5 Growth (YoY) Revenue Gth (%) N/A N/A N/A 7.6 6.9 12.0 EBITDA Gth (%) N/A N/A N/A 17.0 16.0 20.6 Opg Profit Gth (%) N/A N/A N/A 23.1 21.6 22.9 Net Profit Gth (%) N/A N/A N/A 26.3 25.0 27.0 Margins Gross Margins (%) 45.4 46.2 47.2 48.8 50.0 51.7 Opg Profit Margins (%) 18.8 19.8 18.6 21.3 21.4 21.8 Net Profit Margins (%) 14.3 15.2 14.6 16.9 16.7 17.2 Source: Company, DBS Vickers


CSPC Pharmaceutical

Page 37

Balance Sheet (HK$ m)

FY Dec 2013A 2014A 2015A 2016F 2017F 2018F

Net Fixed Assets 5,509 5,548 5,611 5,632 5,651 5,669 Invts in Associates & JVs 18 75 28 28 28 28 Other LT Assets 301 273 254 221 188 158 Cash & ST Invts 1,274 1,527 2,306 2,978 4,651 6,441 Inventory 1,855 1,806 1,819 2,194 2,163 2,400 Debtors 1,719 1,695 1,548 2,194 2,451 2,720 Other Current Assets 1,524 1,578 1,974 1,974 1,974 1,974 Total Assets 12,201 12,501 13,540 15,221 17,106 19,389 ST Debt 660 624 452 450 465 480 Creditors 936 956 752 903 1,009 1,120 Other Current Liab 2,243 2,023 2,280 2,280 2,280 2,280 LT Debt 680 602 1,011 1,050 1,085 1,120 Other LT Liabilities 85 145 232 232 232 232 Shareholder’s Equity 7,453 8,079 8,738 10,213 11,920 14,016 Minority Interests 144 72 75 92 114 141 Total Cap. & Liab. 12,201 12,501 13,540 15,221 17,106 19,389 Non-Cash Wkg. Capital 1,920 2,100 2,309 3,179 3,299 3,694 Net Cash/(Debt) (66) 301 843 1,478 3,101 4,841 Debtors Turn (avg days) 65.6 56.9 51.9 52.9 58.8 59.0 Creditors Turn (avg days) 62.4 56.1 56.0 49.6 52.6 54.1 Inventory Turn (avg days) 114.9 108.5 118.8 120.3 119.9 115.9 Asset Turnover (x) 0.8 0.9 0.9 0.9 0.9 0.9 Current Ratio (x) 1.7 1.8 2.2 2.6 3.0 3.5 Quick Ratio (x) 0.8 0.9 1.1 1.4 1.9 2.4 Net Debt/Equity (X) 0.0 CASH CASH CASH CASH CASH Net Debt/Equity ex MI (X) 0.0 0.0 (0.1) (0.1) (0.3) (0.3) Capex to Debt (%) 44.5 65.4 55.1 40.0 38.7 37.5 Z-Score (X) 0.0 0.0 0.0 NA NA NA Source: Company, DBS Vickers


CSPC Pharmaceutical

Page 38

Cash Flow Statement (HK$ m) FY Dec 2013A 2014A 2015A 2016F 2017F 2018F

Pre-Tax Profit 1,248 1,621 2,112 2,620 3,188 3,903 Dep. & Amort. 656 610 605 612 614 613 Tax Paid (223) (293) (386) (536) (653) (799) Assoc. & JV Inc/(loss) 14 (1) (2) (2) (2) (2) (Pft)/ Loss on disposal of FAs 0 0 0 0 0 0 Chg in Wkg.Cap. (743) (85) (46) (870) (120) (396) Other Operating CF (138) (46) (33) 56 54 46 Net Operating CF 815 1,806 2,251 1,880 3,081 3,366 Capital Exp.(net) (597) (802) (806) (600) (600) (600) Other Invts.(net) (65) 23 53 0 0 0 Invts in Assoc. & JV 243 12 36 0 0 0 Div from Assoc & JV 0 0 0 0 0 0 Other Investing CF 1,043 22 5 13 17 27 Net Investing CF 624 (745) (712) (587) (583) (573) Div Paid (383) (473) (591) (591) (807) (981) Chg in Gross Debt (948) (63) 263 37 50 50 Capital Issues 0 0 0 0 0 0 Other Financing CF (399) (211) (277) (67) (69) (71) Net Financing CF (1,729) (747) (605) (621) (826) (1,003) Currency Adjustments 28 (34) (103) 0 0 0 Chg in Cash (262) 281 831 672 1,673 1,790 Opg CFPS (HK$) 0.28 0.32 0.39 0.47 0.54 0.64 Free CFPS (HK$) 0.04 0.17 0.24 0.22 0.42 0.47 Source: Company, DBS Vickers

ASIAN INSIGHTS VICKERS SECURITIESed- JS / sa- DL

BUY

Last Traded Price ( 15 Feb 2017):HK$3.86 (HSI : 23,995) Price Target 12-mth: HK$5.60 (45% upside) Potential Catalyst: Faster growth of concentrated Chinese medicine granules sales, M&A Where we differ: more bearish than consensus for lower assumption on finished C hinese medicines sales growth Analyst Mark Kong +852 2820 4619 [email protected]

Price Relative

Forecasts and Valuation FY Dec (RMB m) 2015A 2016F 2017F 2018FTurnover 3,709 6,553 7,626 8,878 EBITDA 825 1,556 1,804 2,088 Pre-tax Profit 769 1,207 1,440 1,679 Net Profit 622 902 1,080 1,267 Net Pft (Pre Ex) (core profit) 536 902 1,080 1,268 Net Profit Gth (Pre-ex) (%) 29.8 68.1 19.8 17.2 EPS (RMB) 0.17 0.20 0.24 0.29 EPS (HK$) 0.19 0.23 0.28 0.32 Core EPS (HK$) 0.16 0.23 0.28 0.32 Core EPS (RMB) 0.15 0.20 0.24 0.29 EPS Gth (%) 3.4 19.9 20.6 17.3 Core EPS Gth (%) (10.8) 39.0 20.6 17.4 Diluted EPS (HK$) 0.19 0.23 0.28 0.32 DPS (HK$) 0.00 0.09 0.11 0.13 BV Per Share (HK$) 2.81 3.02 3.19 3.39 PE (X) 20.2 16.9 14.0 11.9 Core PE (X) 23.5 16.9 14.0 11.9 P/Cash Flow (X) 24.3 10.2 20.1 9.9 P/Free CF (X) 44.6 14.0 147.1 17.3 EV/EBITDA (X) 16.5 10.0 8.8 7.5 Net Div Yield (%) 0.0 2.4 2.9 3.4 P/Book Value (X) 1.4 1.3 1.2 1.1 Net Debt/Equity (X) 0.0 CASH CASH CASH ROAE (%) 8.7 7.9 8.9 9.8 Earnings Rev (%): Nil Nil Nil Consensus EPS (RMB) 0.22 0.26 0.31 Other Broker Recs: B: 8 S: 0 H: 3 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Rising with CCMG increasing popularity Maintain BUY as the company is the largest concentrated Chinese medicine granule (CCMG) maker in China. The company is the largest CCMG maker with c.50% market share. We expect CCMG to contribute over 60% of the company’s earnings in 2016-20. Derived from herbs, it dissolves instantly in water as a drink, unlike herbal medicines which require a long decoction process. It is much more convenient. Replacement of herbal medicines to drive CCMG sales growth. As mentioned above, CCMG offers more convenience relative to herbal medicines. This convenience enables the CCMG market to grow at a >30% CAGR (2010-15). The CAGR should remain strong at >20% (2014-20). China’s CCMG market only equaled to 4-5% of the herbal medicine market in 2014 (HK: 11%, Taiwan & Japan: >50%). Hence, there is ample room to grow. The group is expanding sales network and capacity to capture the opportunities. Public hospitals are more incentivized to promote CCMG. For decades, public hospitals have been generating net income by selling drugs. They were allowed to mark up by 15% over procurement cost in selling drugs so they can generate net income. However, the government is gradually removing the mark-up. In the long run, hospitals can no longer generate net income by selling drugs. But this is not the case for CCMG. Hospitals can still mark up to make money in selling CCMG. This provides incentive for them to promote CCMG. Valuation: Our TP of HK$5.60 is based on 20x 17F PE, representing c.20% premium over pharmaceutical industry average. The premium is mainly due to the sales growth of CCMG industry being stronger than the pharmaceutical industry, and the company is the largest player in this field. Key Risks to Our View:

It is possible that the PRC government may allow more players to enter the CCMG industry, although the timing is still uncertain.

At A Glance Issued Capital (m shrs) 4,432 Mkt. Cap (HK$m/US$m) 17,133 / 2,208

Major Shareholders CNPGC (%) 36.0 Top management of the company (%) 16.8

Free Float (%) 47.2 3m Avg. Daily Val. (US$m) 3.4 ICB Industry : Health Care / Pharmaceuticals & Biotechnology

90

140

190

240

290

340

390

1.5

2.5

3.5

4.5

5.5

6.5

7.5


Relative IndexHK$

China Traditional Chinese Medicine (LHS) Relative HSI (RHS)



China Traditional Chinese Medicine Version 4 | Bloomberg: 570 HK Equity | Reuters: 0570.HK



Page 40

Company Guide

China Traditional Chinese Medicine


Earnings Drivers:

Largest concentrated Chinese medicine granule (CCMG) maker in China with c.50% market share . CCMG is in fact an advanced form of herbal Chinese medicine. Herbal Chinese medicines are basically processed herbs which must be decocted into soup for use. Unlike herbal Chinese medicines, CCMG is more convenient as it does not require a time consuming decoction process because it can instantly dissolve in hot water for use. Doctors will prescribe different combinations of CCMG based on the condition of the patient. Due to its convenience, CCMG’s market size in China has expanded by 41% CAGR in 2010-14. We project this market to expand by >20% CAGR in 2014-20 underpinned by gradual replacement of herbal Chinese medicines, inclusion of CCMG in more reimbursable drug lists of provincial insurance program, and increase of Chinese medicines hospitals in rural areas. CTCM will benefit from these trends. CTCM plans to double CCMG’s capacity gradually over the next 2-3 years to capture the growth. We believe there are only five licensed players to enjoy the strong growth of CCMG before 2020. There are currently only five licensed players to enjoy the strong CCMG industry growth. Government issued a consultation paper in Dec 2015 touching on allowing more players to produce CCMG, and this raised concerns that competition will intensify in the future. Our view is that there will be no new entrants before 2020 as there is still no unified product quality standard for CCMG in China. Based on “Development Strategy of Chinese Medicines (2016-30)” (中醫葯發展戰略規劃綱要 2016-30年), the government intends to have a set of unified standards before opening up the market. There are over 600 CCMG products in the market. According to our discussions with two CCMG makers, namely, CTCM and Pura (1498 HK), it would take at least three years to set the standards. The process has not started yet. Assuming it starts in 1Q17, it would complete only in 2020. This implies that we are unlikely to see any new entrants to the CCMG industry before 2020. The market size of CCMG could be even bigger after 2020. Assuming the market does open in 2020 and there is more competition, the size of the industry should grow much faster than before. Legally, CCMG is still regarded as a ‘trial product’. Hence, it is only allowed to be sold in mid & top tier hospitals, and there are only five licensed players. If the trial run ends in 2020 and the government opens up the market, we believe the government will allow more new players as well as more medical institutes to sell the product. As such, the growth of CCMG market size should accelerate after that.

Finished drugs - revenue growth %

Concentrated Chinese medicine granule - revenue growth %

Finished drugs - gross margin %

Concentrated Chinese Medicine Granule - gross margin %


90

3

-25

4 2

-28

-8

13

33

53

73

93

113

2014A 2015A 2016F 2017F 2018F

360

22 22

0

50

100

150

200

250

300

350

400

2016F 2017F 2018F

62 60.5

53 52.5 52

0

10

20

30

40

50

60

70

2014A 2015A 2016F 2017F 2018F

0 55.4 57 57

0

10

20

30

40

50

60

2015A 2016F 2017F 2018F


Page 41

Company Guide


Balance Sheet:

Significant increase of total asset. Total assets increase in 2013 and 2015 were due to the acquisition of Tongjitang in 2013 and the acquisition of Tianjiang Pharm in 2015. Significant increase of shareholder’s equity. The substantial increases in shareholder’s equity in 2013 and 2015 were due to the issuances of new shares to finance the acquisitions of Tongjitang and Tianjiang Pharm respectively. Share Price Drivers:

Acceleration of CCMG business growth Operation efficiency enhancement to boost profit margin M&A

Key Risks:

Volatility of raw material costs Volatility of raw material prices (over 600 kinds of herbs) along with a sales arrangement that prohibits the timely adjustment of product ASPs could affect its gross margin. Possibly more competitors to emerge in future It is possible that the PRC government may allow more players to enter the CCMG industry.

Company Background:

China Traditional Chinese Medicine (CTCM) is one of the leaders in the Chinese medicine industry. It is the largest concentrated Chinese medicine granule (CCMG) maker with 53% market share in 2014 (there are only five licensed players in the CCMG industry). CCMG is a processed form of traditional Chinese herbal medicine. Herbal medicines require a time-consuming decoction process, while CCMG can be instantly dissolved in hot water for consumption. Doctors can prescribe different combinations of CCMG for different ailments. CTCM also owns a portfolio of exclusive Chinese medicines (contributing 68% of CTCM’s revenue in 2014). CTCM's parent company is a state-owned enterprise held by the Central government: China National Pharmaceutical Group Corp (which owns a 36% stake in CTCM)


Capital Expenditure

ROE

Forward PE Band

PB Band


0.3

0.4

0.4

0.5

0.5

0.6

0.6

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

2014A 2015A 2016F 2017F 2018F


0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

2014A 2015A 2016F 2017F 2018F


RMBm

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2014A 2015A 2016F 2017F 2018F

Avg: 19.6x

+1sd: 24.7x

+2sd: 29.8x

‐1sd: 14.5x

‐2sd: 9.4x8.4

13.4

18.4

23.4

28.4

33.4


(x)

Avg: 2.31x

+1sd: 3.17x

+2sd: 4.03x

‐1sd: 1.45x

‐2sd: 0.59x0.5

1.5

2.5

3.5

4.5

5.5


(x)


Page 42

Company Guide


Key Assumptions

FY Dec 2014A 2015A 2016F 2017F 2018F Finished drugs - revenue growth %

90.0 3.0 (25.0) 4.0 2.0

Concentrated Chinese medicine granule - revenue growth %

N/A N/A 360.3 22.0 22.0

Finished drugs - gross margin % 62.0 60.5 53.0 52.5 52.0

Concentrated Chinese Medicine Granule - gross margin %

N/A 55.4 57.0 57.0 57.0


Segmental Breakdown (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Revenues (RMB m) Finished drugs 2,650 2,731 2,048 2,130 2,172 Concentrated Chinese Medicine Granules

0 979 4,505 5,497 6,706

Total 2,650 3,709 6,553 7,626 8,878 Gross margin (RMB m) Finished drugs 1,643 1,651 1,085 1,118 1,130 Concentrated Chinese Medicine Granules

0 542 2,568 3,133 3,822

Total 1,643 2,194 3,653 4,251 4,952 Gross margin Margins (%) Finished drugs 62.0 60.5 53.0 52.5 52.0 Concentrated Chinese Medicine Granules

N/A 55.4 57.0 57.0 57.0

Total 62.0 59.1 55.8 55.7 55.8 Source: Company, DBS Vickers


Page 43

Company Guide


Income Statement (RMB m) FY Dec 2014A 2015A 2016F 2017F 2018F Revenue 2,650 3,709 6,553 7,626 8,878 Cost of Goods Sold (1,007) (1,515) (2,900) (3,375) (3,926) Gross Profit 1,643 2,194 3,653 4,251 4,952 Other Opng (Exp)/Inc (1,125) (1,581) (2,418) (2,784) (3,241) Operating Profit 518 613 1,235 1,468 1,711 Other Non Opg (Exp)/Inc 32 46 17 17 17 Associates & JV Inc 0 (2) 0 0 0 Net Interest (Exp)/Inc (61) 26 (46) (45) (52) Dividend Income 0 0 0 0 1 Exceptional Gain/(Loss) 0 85 0 0 1 Pre-tax Profit 489 769 1,207 1,440 1,679 Tax (70) (118) (199) (230) (251) Minority Interest (6) (29) (106) (129) (158) Preference Dividend 0 0 0 0 0 Net Profit 413 622 902 1,080 1,267 Net Profit before Except. 413 536 902 1,080 1,268 EBITDA 658 825 1,556 1,804 2,088 Growth Revenue Gth (%) 90.0 40.0 76.7 16.4 16.4 EBITDA Gth (%) 97.3 25.4 88.6 16.0 15.7 Opg Profit Gth (%) 108.3 18.3 101.4 18.8 16.6 Net Profit Gth (%) 108.1 50.5 45.0 19.8 17.3 Margins & Ratio Gross Margins (%) 62.0 59.1 55.8 55.7 55.8 Opg Profit Margin (%) 19.6 16.5 18.9 19.2 19.3 Net Profit Margin (%) 15.6 16.8 13.8 14.2 14.3 ROAE (%) 13.9 8.7 7.9 8.9 9.8 ROA (%) 7.9 5.3 4.8 5.5 6.1

ROCE (%) 9.8 5.2 6.5 7.4 8.3 Div Payout Ratio (%) 0.0 0.0 40.0 40.0 40.0 Net Interest Cover (x) 8.5 NM 26.7 32.4 32.7 Source: Company, DBS Vickers

Interim Income Statement (RMB m)

FY Dec 1H2014 2H2014 1H2015 2H2015 1H2016 Revenue 1,240 1,411 1,422 2,287 3,199 Cost of Goods Sold (479) (528) (565) (950) (1,366) Gross Profit 760 883 857 1,337 1,834 Other Oper. (Exp)/Inc (511) (613) (569) (1,012) (1,164) Operating Profit 249 269 288 325 669 Other Non Opg (Exp)/Inc 9 23 13 33 16 Associates & JV Inc 0 0 0 (2) 1 Net Interest (Exp)/Inc (33) (28) (10) 36 (21) Exceptional Gain/(Loss) 0 0 0 85 0 Pre-tax Profit 225 264 291 478 666 Tax (36) (34) (47) (71) (120) Minority Interest 0 (5) (10) (20) (54) Net Profit 189 224 235 387 491 Net profit bef Except. 189 224 235 302 492

Growth Revenue Gth (%) 139.8 60.7 14.7 62.1 125.0 Opg Profit Gth (%) 200.5 62.3 15.7 20.8 132.5 Net Profit Gth (%) 199.5 65.6 24.3 72.6 109.2

Margins Gross Margins (%) 61.3 62.6 60.2 58.5 57.3 Opg Profit Margins (%) 20.1 19.1 20.2 14.2 20.9 Net Profit Margins (%) 15.2 15.9 16.5 16.9 15.3 Source: Company, DBS Vickers


Page 44

Company Guide


Balance Sheet (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Net Fixed Assets 960 1,800 2,032 2,493 2,910 Invts in Associates & JVs 0 88 88 88 88 Other LT Assets 2,277 9,468 9,333 9,204 9,079 Cash & ST Invts 440 2,138 3,006 2,717 3,065 Inventory 418 1,236 1,311 1,525 1,776 Debtors 544 2,091 1,966 2,669 2,841 Other Current Assets 693 1,407 1,407 1,407 1,407

Total Assets 5,332 18,229 19,144 20,103 21,165 ST Debt

502 1,600 1,125 1,148 1,148 Creditors 133 509 590 686 799 Other Current Liab 499 2,382 2,382 2,382 2,382 LT Debt 671 850 1,375 1,403 1,403 Other LT Liabilities 270 1,050 1,050 1,050 1,050 Shareholder’s Equity 3,184 11,129 11,807 12,491 13,282 Minority Interests 73 708 814 943 1,101 Total Cap. & Liab. 5,332 18,229 19,144 20,103 21,165 Non-Cash Wkg. Capital 1,023 1,844 1,712 2,533 2,843 Net Cash/(Debt) (732) (312) 506 167 514 Debtors Turn (avg days) 65.0 129.7 113.0 110.9 113.3 Creditors Turn (avg days) 57.9 86.9 77.2 76.2 76.0 Inventory Turn (avg days) 167.0 223.8 179.0 169.4 168.8 Asset Turnover (x) 0.5 0.3 0.4 0.4 0.4 Current Ratio (x) 1.8 1.5 1.9 2.0 2.1 Quick Ratio (x) 0.9 0.9 1.2 1.3 1.4 Net Debt/Equity (X) 0.2 0.0 CASH CASH CASH Net Debt/Equity ex MI (X) 0.2 0.0 CASH CASH CASH Capex to Debt (%) 7.8 9.7 16.0 25.5 25.5 Z-Score (X) NA NA NA NA NA Source: Company, DBS Vickers


Page 45

Company Guide


Cash Flow Statement (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Pre-Tax Profit 489 769 1,207 1,440 1,677 Dep. & Amort. 107 167 303 319 359 Tax Paid (93) (149) (199) (230) (251) Assoc. & JV Inc/(loss) 0 2 0 0 0 (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. (252) (195) 132 (821) (310) Other Operating CF 73 (75) 46 45 52

Net Operating CF 325 519 1,488 753 1,527 Capital Exp.(net) (91) (237) (400) (650) (650) Other Invts.(net) (1) (536) 0 0 0 Invts in Assoc. & JV 0 (88) 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF 11 (6,297) 27 30 24 Net Investing CF (81) (7,158) (373) (620) (626) Div Paid 0 0 (224) (396) (477) Chg in Gross Debt (72) 1,202 50 50 1 Capital Issues 0 7,200 0 0 0 Other Financing CF (77) (72) (74) (75) (77) Net Financing CF (150) 8,330 (247) (421) (553) Currency Adjustments 0 (28) 0 0 0 Chg in Cash 94 1,662 868 (289) 348 Opg CFPS (RMB) 0.23 0.19 0.30 0.36 0.41 Free CFPS (RMB) 0.09 0.08 0.24 0.02 0.20 Source: Company, DBS Vickers

Target Price & Ratings History

Source: DBS Vickers

Analyst: Mark Kong

12

3 4

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Feb

-16

Mar

-16

Ap

r-16

May

-16

Jun-

16

Jul-

16

Au

g-1

6

Sep-

16

Oct

-16

No

v-16

Dec

-16

Jan

-17

Feb

-17

HK$S.No. Da te Clos ing 12-mth Ra ting

Pric e Ta rge tPri c e

1: 23-Mar-16 HK$4.07 HK$6.70 Buy2: 10-Jun-16 HK$3.22 HK$5.80 Buy3: 25-Aug-16 HK$3.57 HK$6.50 Buy4: 23-Jan-17 HK$3.60 HK$5.60 Buy

Page 46 ed-TH / sa- DL

DBSV's discussion of the issuer in this report will not be continuously followed. Accordingly, this report is being provided as a stand-alone analysis and recipients of this report should not expect additional reports relating to this issuer, unless so decided by DBSV

NOT RATED Last Traded Price ( 15 Feb 2017):HK$8.65 (HSI : 23,995) Potential Catalyst: acquisition to boost earnings growth Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation F Y Dec (HK $m) 2013A 2014A 2015A

Turnov er 116,951 135,749 146,568EBITDA 9,225 9,638 10,497Pre-tax Profit 6,913 6,923 8,050Net Profit 2,640 2,646 2,850Net Pft (Pre Ex.) 2,640 2,646 2,850EPS (HK$) 0.67 0.57 0.62EPS Gth (%) n.a. (14.9) 8.8Diluted EPS (HK$) 0.67 0.57 0.62DPS (HK$) - - - BV Per Share (HK$) 3.89 4.43 4.86PE (X) 12.9 15.2 14.0P/Cash F low (X) 13.7 15.6 9.1P/F ree CF (x) 139.8 73.5 12.7EV /EBITDA (X) 6.9 7.8 7.2Net Div Yield (%) - - - P/Book V alue (X) 2.2 2.0 1.8Net Debt/Equity (X) 0.8 0.9 0.8ROAE (%) n.a. 13.7 13.3


Principal Business: Pharmaceutical manufacturing and distribution


Trading opportunity on government-led market consolidation

The 2nd largest drug distributor in China with expected earnings CAGR of 19% in 16F-18F based on consensus

There will be trading opportunities throughout 2017 whenever the government reiterates its intention to consolidate the pharmaceutical distribution market. It is positive for large players like China Resources Pharma (CRP)

The 2nd largest drug distributor in China. CRP is the 2nd largest pharmaceutical distributor in China with 7.7% market share in 2015. We estimate that pharmaceutical distribution contributes c.50% of its earnings while the other half is from drug manufacturing. Most of the drugs produced by CRP are sold to drug stores. Excluding one-off expenses in 2016, we estimate CRP’s core earnings in 2016 to be c.HK$2.9bn. Bloomberg consensus estimates its earnings CAGR to be 19% in 2016-2018, driven by sales network expansion and acquisitions.

Trading opportunity on government’s intention to consolidate pharmaceutical distribution market. Although current 16F PE of 19x should have priced in the consensus expected earnings CAGR, there will be trading opportunities throughout the year. In China, drug producers sell their drugs to public medical institutes (the largest drug sales channel accounting for >60% of total drug sales) through layers of distributors. The government wants to reduce the number to only one distributor between them so as to save on middlemen cost for the whole industry. Large distributors will gain market share due to this policy and the government reiterated that in late Jan 2017. Thus, the share price of the largest drug distributor Sinopharm (1099 HK) is up 18% year-to-date. We believe the government will continue to reiterate the policy going forward like it did last year and benefit distributors yet again. CRP is a better beneficiary of this theme than Sinopharm as: 1) It is a laggard. Its share price has stayed almost the same year-to-date; 2) Its 17F PE is lower than Sinopharm's (c.16x vs c.18x) but it deserves a higher PE as its EPS growth could be faster through M&A. CRP will spend 45% of its IPO proceeds raised in 2016 (c.HK$14bn) for M&A. That could surprise the market in the future.


Major Shareholders China Resources National Corporation (%) 53.0 Beijing State-own Capital (%) 20.6


82

102

122

142

162

182

202

222

7.5

8.0

8.5

9.0

9.5

10.0

Oct-16 Jan-17

Relative IndexHK$

China Resources Pharma (LHS) Relative HSI (RHS)

China Pharmaceutical Sector

China Resources Pharma

Bloomberg: 3320 HK Equity | Reuters: 3320.HK Refer to important disclosures at the end of this report


China Resources Pharma

Page 47

Income Statement (HK$m) Balance Sheet (HK$m)

FY De c 2013A 2014A 2015A

Revenue 116,951 135,749 146,568Cost of Goods Sold (96,802) (114,259) (123,369)Gross Pro fi t 20 ,149 21 ,490 23,199Other Opg (Exp)/Inc (12,120) (13,205) (14,048)Ope ra ting Profi t 8 ,029 8 ,285 9,151Other Non Opg (Exp)/Inc 467 562 660Associates & JV Inc 55 65 58Net Interest (Exp)/Inc (1,638) (1,989) (1,819)Exceptional Gain/(Loss) - - - Pre -ta x Profi t 6 ,913 6 ,923 8,050Tax (1,458) (1,431) (1,968)Minority Interest (2,815) (2,846) (3,232)Preference Dividend - - - Ne t Profi t 2 ,640 2 ,646 2,850Net Profit before Except. 2,640 2,646 2,850EBITDA 9,225 9,638 10,497Revenue Gth (%) - 16.1 8.0EBITDA Gth (%) - 4.5 9 Opg Profit Gth (%) - 3.2 10.4Effective Tax Rate (%) 21.1 20.7 24.4

FY De c 2013A 2014A 2015A

Net Fixed Assets 14,842 15,506 14,899Invts in Assocs & JVs 405 395 441Other LT Assets 20,779 21,620 22,952Cash & ST Invts 16,932 18,998 18,689Inventory 12,198 15,711 15,252Debtors 31,049 37,100 41,318Other Current Assets 8,618 12,468 13,598Tota l Asse ts 104,823 121 ,798 127,149

ST Debt 20,162 20,351 24,335Creditors 21,315 24,331 22,990Other Current Liab 17,421 20,791 24,898LT Debt 11,054 16,912 12,883Other LT Liabilities 2,222 2,262 2,196Shareholder's Equity 17,988 20,516 22,502Minority Interests 14,660 16,634 17,343Tota l Ca p. & Lia b . 104,823 121 ,798 127,149

Non-Cash Wkg. Cap 13,130 20,157 22,280 Net Cash/(Debt) (14,284) (18,265) (18,529)

Cash Flow Statement (HK$m) Rates & Ratio

FY De c 2013A 2014A 2015A

Pre-Tax Profit 6,913 6,923 8,050 Dep. & Amort. 1,196 1,353 1,346 Tax Paid - - -Assoc. & JV Inc/(loss) (49) (65) (58) (Pft)/ Loss on disposal of FAs 120 189 359 Non-Cash Wkg. Cap. (3,887) (3,953) (2,284) Other Operating CF - - -Ne t Ope ra ting CF 2,509 2 ,561 4 ,393 Capital Exp. (net) (2,264) (2,015) (1,246) Other Invts. (net) (3,540) (5,823) (2,353) Invts. in Assoc. & JV - - (70) Div from Assoc. & JV - - - Other Investing CF (243) (585) (618) Ne t Inve st ing CF (6 ,048) (8 ,424) (4 ,287) Div Paid - - - Chg in Gross Debt 2,587 6,482 2,433 Capital Issues 5,282 - - Other Financing CF (1,848) (2,058) (3,060) Ne t Fina nc ing CF 6,021 4 ,424 (627) Chg in Cash 2,482 (1,439) (521)

FY De c 2013A 2014A 2015A

Gross Margin (%) 17.2 15.8 15.8Opg Profit Margin (%) 6.9 6.1 6.2Net Profit Margin (%) 2.3 1.9 1.9ROAE (%) n.a. 13.7 13.3ROA (%) 2.5 2.3 2.3ROCE (%) n.a. 11.8 11.3Div Payout Ratio (%) n.m. n.m. n.m.Interest Cover (x) 4.9 4.2 5.0Asset Turnover (x) 1.1 1.2 1.2Debtors Turn (days) 96.9 91.6 97.6Creditors Turn (days) 80.4 72.9 70.0Inventory Turn (days) 46.0 44.6 45.8Current Ratio (x) 1.2 1.3 1.2Quick Ratio (x) 1.0 1.0 1.0Net Debt/Equity (X) 0.8 0.9 0.8Capex to Debt (%) 7.3 5.4 3.3N. Cash/(Debt)PS (HK$) (3.09) (3.95) (4.00)Opg CFPS (HK$) 0.63 0.55 0.95Free CFPS (HK$) 0.06 0.12 0.68

Interim Income Statement (HK$m) Segmental Breakdown (HK$m)

FY De c 1H15 2H15 1H16

Revenue 71,263 75,305 75,616Cost of Goods Sold (59,786) (63,583) (63,862)Gross Profi t 11 ,477 11,722 11,753Other Oper. (Exp)/Inc (6,589) (7,458) (6,869)Ope ra ting Profi t 4 ,887 4,264 4,884Other Non Opg (Exp)/Inc 1,091 (393) 72Associates & JV Inc 20 32Net Interest (Exp)/Inc (905) (913) (759)Exceptional Gain/(Loss) - - - Pre -ta x Profi t 5 ,093 2,958 4,229Tax (1,231) (737) (1,048)Minority Interest (1,580) (1,652) (1,544)Ne t Profi t 2 ,282 568 1,636Net profit bef Except. 2,282 568 1,636

FY De c 2013A 2014A 2015A

Re ve nue sPharmaceuticals-Distribution 91,652 111,790 121,191Pharmaceuticals-Manufacturing - - 21,607Pharmaceuticals-Retail 2,601 3,040 3,651Others 1,861 1,205 119Pharmaceuticals-Manufacturing 20,837 19,714 -Tota l 116 ,951 135 ,749 146 ,568

Source: Bloomberg Finance L.P.



NOT RATED

Last Traded Price ( 15 Feb 2017):HK$4.90 (HSI : 23,995) Potential Catalyst: More products to be included in the new version of National Reimbursement Drug List Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation F Y Dec (RM B m) 2012A 2013A 2014A 2015A

Turnov er 2,136 2,515 2,544 2,563EBITDA 365 506 830 946Pre-tax Profit 255 383 726 898Net Profit 169 310 606 755Net Pft (Pre Ex.) 169 310 606 755EPS (RMB) n.a. 0.11 0.20 0.23EPS (HK$) n.a. 0.13 0.23 0.26EPS Gth (%) n.a. n.a. 76.1 12.4Diluted EPS (HK$) n.a. 0.11 0.20 0.23DPS (HK$) n.a. - - - BV Per Share (HK$) n.a. 4.06 1.67 1.93PE (X) n.a. 37.7 21.4 19.0P/Cash F low (X) n.a. 26.4 24.3 29.9P/F ree CF (x) n.a. 65.9 49.1 52.0EV /EBITDA (X) n.a. 24.2 13.5 12.5Net Div Yield (%) n.a. - - - P/Book V alue (X) n.a. 1.2 2.9 2.5Net Debt/Equity (X) 0.1 0.2 Cash CashROAE (%) 12.3 19.2 18.1 14.3


Principal Business: Healthcare


Trading opportunity on two catalysts

Current valuation of 14x 17F PE has largely reflected the potential annual EPS growth of 10-15% in future

Two catalysts might accelerate the growth: 1) Likely inclusion of the flagship drug Lipusu in new National Reimbursement Drug List (NRDL) this year; 2) Likely removal of public insurance reimbursement limit on the drug CMNa

Heavily reliant on oncology drugs. Luye generated 60% of its sales in 1H16 from oncology drugs. Lipusu (a drug for treatment of cancers) is the largest contributor with estimated revenue contribution of c.40%. Drugs for cardiovascular system and alimentary tract & metabolism made up 21% and 17% of revenue in 1H16.

Trading opportunity on two catalysts. Luye targets to grow its earnings by 10-15% per annum by sales network expansion. Trading at 14x 17F PE based on Bloomberg, it should have reflected the potential earnings growth (excluding net cash of c.HK$2bn as of Jun 16, its 17F PE is 12x). But there are two catalysts which may accelerate the growth and boost its share price: 1) China aims to issue a new NRDL for public medical insurance in 2017. Lipusu might be included in it as it is already included in the public reimbursement drug list in 26 provinces. This could prompt consensus to raise their 18F earnings estimates by 7% or c.Rmb85m; 2) We estimate that CMNa contributes c.10% of Luye’s sales. It is a sensitizer in connection with radiotherapy for tumors. It is in the NRDL but classified as a drug only reimbursable for work injuries. Employers rarely certify their employees’ job nature as being tumor-causing, thereby limiting the sales of CMNa. Luye is in talks with the government to remove this limitation in the new NRDL.

Long-term concerns. To reduce side effects, Lipusu uses liposome as a mean to deliver the active ingredient paclitaxel. A competing medicine for Lipusu called Abraxane that delivers paclitaxel through albumin which can reduce side effects more effectively than liposome. However, as Lipusu’s ASP is 80% below Abraxane's, the former is still competitive. But Abraxane has gone off-patent recently and we estimate that at least four players are applying to produce the generic version of Abraxane at a much lower price. This could pose a threat to Lipusu.


Major Shareholders Liu Dian Bo (%) 45.7 Ping An Insurance (%) 16.5 CITIC PE Funds Limited (%) 5.9


72

92

112

132

152

172

192

212

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Relative IndexHK$

Luye Pharma Group Ltd (LHS) Relative HSI (RHS)


Luye Pharma Group Ltd



Luye Pharma Group Ltd

Page 49

Income Statement (RMBm) Balance Sheet (RMBm)

FY De c 2012A 2013A 2014A 2015A

Revenue 2,136 2,515 2,544 2,563Cost of Goods Sold (352) (414) (483) (476)Gross Profi t 1 ,784 2,102 2,061 2,087Other Opg (Exp)/Inc (1,503) (1,696) (1,343) (1,256)Ope ra ting Profi t 281 405 719 831Other Non Opg (Exp)/Inc (2) (2) 21 61Associates & JV Inc 1 1 0 0Net Interest (Exp)/Inc (25) (21) (14) 6Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 255 383 726 898Tax (80) (55) (111) (133)Minority Interest (7) (17) (9) (10)Preference Dividend - - - - Ne t Profi t 169 310 606 755Net Profit before Except. 169 310 606 755EBITDA 365 506 830 946Revenue Gth (%) 20.4 17.8 1.1 0.8EBITDA Gth (%) 22.8 38.8 64.0 14 Opg Profit Gth (%) 28.6 44.3 77.3 15.6Effective Tax Rate (%) 31.3 14.4 15.3 14.9

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 966 1,113 1,286 1,382Invts in Assocs & JVs 5 5 5 4Other LT Assets 619 617 1,313 595Cash & ST Invts 364 343 2,177 3,206Inventory 143 235 251 286Debtors 514 536 914 1,193Other Current Assets 68 539 183 386Tota l Asse ts 2 ,678 3,387 6,131 7,053

ST Debt 445 736 305 502Creditors 50 56 56 73Other Current Liab 389 511 528 470LT Debt 26 9 1 0Other LT Liabilities 184 177 204 207Shareholder's Equity 1,460 1,769 4,908 5,664Minority Interests 123 129 130 136Tota l Ca p. & Lia b . 2 ,678 3,387 6,131 7,053

Non-Cash Wkg. Cap 285 742 765 1,322 Net Cash/(Debt) (107) (402) 1,872 2,704

Cash Flow Statement (RMBm) Rates & Ratio

FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 255 383 726 898 Dep. & Amort. 84 100 111 115 Tax Paid (71) (78) (103) (111) Assoc. & JV Inc/(loss) (1) (1) (0) (0) (Pft)/ Loss on disposal of FAs 2 1 25 1 Non-Cash Wkg. Cap. (106) 38 (376) (412) Other Operating CF (6) (1) 150 (10) Ne t Ope ra ting CF 157 443 533 481 Capital Exp. (net) (146) (265) (269) (204) Other Invts. (net) (2) (318) (2,919) 356 Invts. in Assoc. & JV - - - - Div from Assoc. & JV - - - - Other Investing CF 9 25 (9) 3 Ne t Inve sting CF (139) (557) (3 ,197) 154 Div Paid - - - - Chg in Gross Debt 15 275 (440) 197 Capital Issues - - 3,139 - Other Financing CF 80 (191) (217) (140) Ne t Fina nc ing CF 95 84 2 ,483 57 Chg in Cash 113 (31) (181) 692

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 83.5 83.6 81.0 81.4Opg Profit Margin (%) 13.2 16.1 28.3 32.4Net Profit Margin (%) 7.9 12.3 23.8 29.4ROAE (%) 12.3 19.2 18.1 14.3ROA (%) 6.6 10.2 12.7 11.4ROCE (%) 9.6 14.4 15.0 12.0Div Payout Ratio (%) n.m. n.m. n.m. n.m.Interest Cover (x) 11.3 19.4 50.0 n.a.Asset Turnover (x) 0.8 0.8 0.5 0.4Debtors Turn (days) 82.8 76.2 104.0 150.0Creditors Turn (days) 43.8 46.9 42.4 49.4Inventory Turn (days) 129.1 166.6 183.8 205.9Current Ratio (x) 1.2 1.3 4.0 4.9Quick Ratio (x) 1.1 1.1 3.7 4.6Net Debt/Equity (X) 0.1 0.2 Cash CashCapex to Debt (%) 31.1 35.6 88.0 40.6N. Cash/(Debt)PS (RMB) n.a. (0.82) 0.56 0.81Opg CFPS (RMB) n.a. 0.16 0.18 0.14Free CFPS (RMB) n.a. 0.07 0.09 0.08

Interim Income Statement (RMBm) Segmental Breakdown (RMBm)

FY De c 2H14 1H15 2H15 1H16

Revenue 1,607 1,403 812 1,489Cost of Goods Sold (232) (262) (213) (230)Gross Profi t 1 ,375 1 ,140 599 1,259Other Oper. (Exp)/Inc (1,015) (717) (206) (780)Ope ra ting Profi t 360 424 393 479Other Non Opg (Exp)/Inc 14 34 40 5Associates & JV Inc 1 2Net Interest (Exp)/Inc 5 (1) 8 5Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 379 457 441 491Tax (50) (63) (70) (68)Minority Interest (4) (9) (2) 1Ne t Profi t 324 385 369 425Net profit bef Except. 324 385 369 425

FY De c 2012A 2013A 2014A 2015A

Re ve nue sOncology Drugs 941 1,102 1,319 1,395Cardiovascular Drugs 631 723 661 621

451 575 444 468

Others 113 115 120 78Tota l 2 ,136 2 ,515 2 ,544 2 ,563

Alimentary tract and metabolism Drugs


ASIAN INSIGHTS VICKERS SECURITIESed- CK/ sa- PY

HOLD

Last Traded Price ( 15 Feb 2017):HK$36.80 (HSI : 23,995) Price Target 12-mth: HK$36.40 (-1% downside) Potential Catalyst: Market share gain, operating and interest cost cut Where we differ: Our cost to income % is more prudent Analyst Mark Kong +852 2820 4619 [email protected]

Price Relative

Forecasts and Valuation FY Dec (RMB m) 2015A 2016F 2017F 2018F Turnover 227,069 256,588 289,945 327,638 EBITDA 10,403 11,957 13,173 14,897 Pre-tax Profit 7,411 9,125 10,074 11,598 Net Profit 3,761 4,742 5,237 6,027 Net Pft (Pre Ex) (core profit)

3,762 4,744 5,240 6,031

Net Profit Gth (Pre-ex) (%)

30.8 26.1 10.4 15.1

EPS (RMB) 1.36 1.71 1.89 2.18 EPS (HK$) 1.54 1.94 2.14 2.47 Core EPS (HK$) 1.54 1.94 2.14 2.47 Core EPS (RMB) 1.36 1.71 1.89 2.18 EPS Gth (%) 19.3 26.1 10.4 15.1 Core EPS Gth (%) 19.3 26.1 10.4 15.1 Diluted EPS (HK$) 1.54 1.94 2.14 2.47 DPS (HK$) 0.42 0.52 0.58 0.67 BV Per Share (HK$) 12.30 13.82 15.44 17.33 PE (X) 24.0 19.0 17.2 14.9 Core PE (X) 23.9 19.0 17.2 14.9 P/Cash Flow (X) 6.6 18.1 16.0 20.9 P/Free CF (X) 7.7 25.2 21.3 31.0 EV/EBITDA (X) 10.1 8.9 8.2 7.5 Net Div Yield (%) 1.1 1.4 1.6 1.8 P/Book Value (X) 3.0 2.7 2.4 2.1 Net Debt/Equity (X) 0.1 0.1 0.1 0.1 ROAE (%) 13.1 14.9 14.6 15.1 Earnings Rev (%): Nil Nil Nil Consensus EPS (RMB) 1.66 1.89 2.16 Other Broker Recs: B: 7 S: 0 H: 8 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Further penetration into 2nd & 3rd cities The largest pharmaceutical distributor in China. Pharmaceutical distribution makes up over 90% of Sinopharm’s revenue. Sinopharm is the largest pharmaceutical distributor in China with 10-15% market share. It is also the only distributor with sales network covering 31 provinces. Leveraging on its extensive sales network, Sinopharm is penetrating into the hospitals in 2nd & 3rd tier cities by lowering product ASPs through bulk procurement. Thanks to market share gain through penetration into 2nd & 3rd tier cities, we believe the company's revenue growth can outpace the industry growth by 2ppts at least. Also, enlarging revenue size provides more room for Sinopharm to lower operating cost (selling & admin) as a % of sales. We project the ratio to drop from 4.27% in 2015 to 4.13% in 2018F. Down-trending interest rates to lower net interest cost % in sales. China's government is lowering interest rates to support economic growth. This is favourable to Sinopharm. Net interest expense erased over 20% of Sinopharm's EBIT and >50% of its borrowings are short-term debts (due within one year). Falling interest rates allow Sinopharm to lower its interest costs through continuous refinancing. We project its net interest cost % in sales to drop from 0.88% in 2015 to 0.64% in 2018F. State-owned enterprise (SOE) reform could be a share price catalyst. Sinopharm’s parent company (China National Pharmaceutical Group Corp) is a SOE directly under the central government. It has been chosen by the central government to carry out reforms for major subsidiaries to strengthen its operations, including Sinopharm. Possible measures from reform include operation efficiency enhancement and optimization of incentive program for staffs. Announcements of any progress can be a share price catalyst. Valuation: Our TP of HK$36.4 is based on 17x 12-month forward PE, representing a 5% premium to the healthcare sector average. The stock deserves a premium valuation for its faster-than-industry sales growth and SOE reform. Key Risks to Our View:

Decelerating pharmaceutical industry sales growth resulting from public hospitals’ budget control may impact the revenue growth of Sinopharm.

At A Glance Issued Capital - H shares (m shs) 1,193 - Non H shares (m shs) 1,574 H shs as a % of Total 43 Total Mkt. Cap (HK$m/US$m) 101,829 / 13,144 Major Shareholders

CNPGC (%) 56.9 Major H Shareholders (%)

JPMorgan Chase & Co. (%) 18.0 Oppenheimer Developing Markets Fund (%) 9.0 BlackRock, Inc. (%) 8.0

H Shares-Free Float (%) 65.1 3m Avg. Daily Val. (US$m) 19.0 ICB Industry : Health Care / Pharmaceuticals & Biotechnology

71

91

111

131

151

171

191

211

16.5

21.5

26.5

31.5

36.5

41.5


Relative IndexHK$

Sinopharm Group (LHS) Relative HSI (RHS)



Sinopharm Group Version 3 | Bloomberg: 1099 HK EQUITY | Reuters: 1099.HK



Page 51

Company Guide

Sinopharm Group


Earnings Drivers:

Penetration into hospitals in 2nd & 3rd tier cities to drive revenue growth. We believe Sinopharm’s revenue growth in FY16F/17F/18F will be c.1/c.1/c.1ppts higher than industry growth. This is attributable to penetration into hospitals in 2nd and 3rd tier cities. Not many pharmaceutical distributors can apply this strategy because Sinopharm is the largest pharmaceutical distributor. It is the only one with sales network covering 31 provinces. Without such an extensive network, it is difficult to penetrate into 2nd & 3rd tier cities. Also, leveraging on its huge procurement size, Sinopharm is able to lower procurement cost and ASP to gain market share. Better economic scale to lower administration cost % in sales. The amount of operating cost (selling & admin) is relatively stable. As revenue grows, the operating cost % in sales could continue to drop. On the back of enlarging revenue size and more stringent cost control, we project the ratio to drop from 4.27% in 2015 to 4.13% in 2018F. Falling interest rates in China to cut net interest cost % in sales. Net interest expense is a significant cost item for Sinopharm. It erases over 20% of the company's EBIT every year. China's government is lowering interest rates to boost economic growth and Sinopharm can benefit from this trend because >50% of its borrowings are short-term debts (due within one year). Down-trending interest rates allow Sinopharm to lower its interest costs through continuous refinancing. We project its net interest cost % in sales to drop from 0.88% in 2015 to 0.64% in 2018F.

Revenue growth %

Gross Margin %

SG&A % in revenue


19.9

13.5 13 13 13

0

5

10

15

20

25

2014A 2015A 2016F 2017F 2018F

8.16 8.2 8.1 8.1 8.1

0

1

2

3

4

5

6

7

8

9

2014A 2015A 2016F 2017F 2018F

4.33 4.27 4.19 4.15 4.13

0

1

1

2

2

3

3

4

4

5

5

2014A 2015A 2016F 2017F 2018F


Page 52

Company Guide

Sinopharm Group

Balance Sheet:

Account receivables turnover days lengthening. Sinopharm is growing its business through further penetration into hospitals of 2nd and 3rd tier cities. The financial status of those hospitals is weaker. Thus, many of them ask for longer credit terms which may keep the account receivables turnover days of Sinopharm at high level. Share Price Drivers:

State-owned enterprise (SOE) reform. Sinopharm’s parent company (China National Pharmaceutical Group Corp) is an SOE directly under the central government. It has been chosen by the central government to carry out reforms for major subsidiaries to strengthen its operations. Announcements of any progress can be a share price catalyst. Market share gain due to implementation of “Two-invoice system”. For decades, drug manufacturers sell their drugs to hospitals through many layers of distributors. But the government intends to implement “Two-invoice system”, i.e. drug manufacturers can sell their drugs to hospitals through only one distributor. Thus, there will be only two invoices issued, i.e. one from drug manufacturer to the distributor and another one from the distributor to hospital. Under the system, drug manufacturers will likely assign large distributors like Sinopharm. So, implementation of this system will benefit Sinopharm .

Key Risks:

State-owned enterprise (SOE) reform is the major risk to our view We believe the earnings growth deceleration could drag Sinopharm’s share price performance. However, its parent company China National Pharmaceutical Group Corporation is one of the SOEs chosen by the Central government to carry out SOE reform to optimise operations. Any positive news related to SOE reform could boost the share price of Sinopharm, which is an upside risk to our view.

Company Background:

The largest pharmaceutical distributor in China with 10-15% market share.


Capital Expenditure

ROE

Forward PE Band

PB Band


1.7

1.8

1.8

1.9

1.9

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

2014A 2015A 2016F 2017F 2018F


0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0

5,000.0

2014A 2015A 2016F 2017F 2018F


RMBm

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2014A 2015A 2016F 2017F 2018F

Avg: 16.3x

+1sd: 18.3x

+2sd: 20.4x

‐1sd: 14.3x

‐2sd: 12.2x

10.9

12.9

14.9

16.9

18.9

20.9

22.9

24.9


(x)

Avg: 2.27x

+1sd: 2.61x

+2sd: 2.95x

‐1sd: 1.94x

‐2sd: 1.6x

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4


(x)


Page 53

Company Guide

Sinopharm Group

Key Assumptions

FY Dec 2014A 2015A 2016F 2017F 2018F Revenue growth % 19.9 13.5 13.0 13.0 13.0 Gross Margin % 8.2 8.2 8.1 8.1 8.1 SG&A % in revenue 4.3 4.3 4.2 4.1 4.1 Source: Company, DBS Vickers

Segmental Breakdown (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Revenues (RMB m) Pharmaceutical distribution 190,133 213,994 241,813 273,249 308,771

Retail pharmacy 5,902 8,715 9,848 11,128 12,575 Other business operations 4,096 4,361 4,928 5,568 6,292 Total 200,131 227,069 256,588 289,945 327,639 EBIT (RMB m) Pharmaceutical distribution 7,176 8,355 9,397 10,724 12,178

Retail pharmacy 219 216 243 277 315 Other business operations 482 618 673 768 872 Total 7,876 9,189 10,312 11,769 13,364 EBIT Margins (%) Pharmaceutical distribution

3.8 3.9 3.9 3.9 3.9

Retail pharmacy 3.7 2.5 2.5 2.5 2.5 Other business operations 11.8 14.2 13.7 13.8 13.9 Total 3.9 4.0 4.0 4.1 4.1 Source: Company, DBS Vickers

Income Statement (RMB m) FY Dec 2014A 2015A 2016F 2017F 2018F Revenue 200,131 227,069 256,588 289,945 327,638 Cost of Goods Sold (183,803) (208,452) (235,805) (266,459) (301,099) Gross Profit 16,328 18,618 20,784 23,486 26,539 Other Opng (Exp)/Inc (8,466) (9,448) (10,471) (11,717) (13,174) Operating Profit 7,862 9,169 10,312 11,769 13,364 Other Non Opg (Exp)/Inc 39 62 427 69 78 Associates & JV Inc 163 165 186 212 241 Net Interest (Exp)/Inc (2,129) (1,987) (1,802) (1,978) (2,089) Dividend Income 0 1 2 3 4 Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 5,935 7,411 9,125 10,074 11,598 Tax (1,383) (1,713) (2,100) (2,317) (2,668) Minority Interest (1,677) (1,936) (2,281) (2,518) (2,898) Preference Dividend 0 0 0 0 0 Net Profit 2,875 3,761 4,742 5,237 6,027 Net Profit before Except. 2,875 3,762 4,744 5,240 6,031 EBITDA 8,899 10,403 11,957 13,173 14,897 Growth Revenue Gth (%) 19.9 13.5 13.0 13.0 13.0 EBITDA Gth (%) 27.9 16.9 14.9 10.2 13.1 Opg Profit Gth (%) 28.8 16.6 12.5 14.1 13.6 Net Profit Gth (%) 27.8 30.8 26.1 10.4 15.1 Margins & Ratio Gross Margins (%) 8.2 8.2 8.1 8.1 8.1 Opg Profit Margin (%) 3.9 4.0 4.0 4.1 4.1 Net Profit Margin (%) 1.4 1.7 1.8 1.8 1.8 ROAE (%) 11.7 13.1 14.9 14.6 15.1 ROA (%) 2.5 2.8 3.3 3.3 3.5

ROCE (%) 9.8 10.1 10.7 11.3 11.8 Div Payout Ratio (%) 26.9 27.2 27.0 27.0 27.0 Net Interest Cover (x) 3.7 4.6 5.7 5.9 6.4 Source: Company, DBS Vickers


Page 54

Company Guide

Sinopharm Group

Interim Income Statement (RMB m)

FY Dec 1H2014 2H2014 1H2015 2H2015 1H2016 Revenue 94,836 105,296 111,057 116,012 125,888 Cost of Goods Sold (86,979) (96,824) (101,918) (106,534) (115,665) Gross Profit 7,857 8,471 9,139 9,478 10,223 Other Oper. (Exp)/Inc (3,935) (4,531) (4,517) (4,931) (5,035) Operating Profit 3,922 3,940 4,622 4,547 5,188 Other Non Opg (Exp)/Inc 12 27 68 (5) 427 Associates & JV Inc 77 86 91 74 105 Net Interest (Exp)/Inc (1,006) (1,123) (1,027) (960) (891) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 3,004 2,930 3,754 3,656 4,829 Tax (696) (687) (865) (848) (1,099) Minority Interest (843) (834) (975) (961) (1,201) Net Profit 1,465 1,409 1,914 1,847 2,529 Net profit bef Except. 1,465 1,409 1,914 1,847 2,529 Growth Revenue Gth (%) 18.4 21.3 17.1 10.2 13.4 Opg Profit Gth (%) 30.8 26.9 17.8 15.4 12.3 Net Profit Gth (%) 27.2 28.3 30.6 31.0 32.2 Margins Gross Margins (%) 8.3 8.0 8.2 8.2 8.1 Opg Profit Margins (%) 4.1 3.7 4.2 3.9 4.1 Net Profit Margins (%) 1.5 1.3 1.7 1.6 2.0 Source: Company, DBS Vickers

Balance Sheet (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Net Fixed Assets 7,464 8,035 8,695 9,271 9,761 Invts in Associates & JVs 930 1,133 1,208 1,292 1,389 Other LT Assets 9,989 12,347 12,136 11,921 11,703 Cash & ST Invts 19,384 24,371 24,592 25,508 24,693 Inventory 20,309 22,349 25,458 28,563 32,481 Debtors 66,098 64,624 73,864 82,627 94,208 Other Current Assets 4,481 5,409 6,132 6,818 7,725

Total Assets 128,656 138,267 152,086 166,001 181,960 ST Debt

25,233 28,204 28,404 28,604 28,804 Creditors 40,691 42,946 50,084 56,500 63,940 Other Current Liab 20,096 23,532 24,771 25,896 27,183 LT Debt 4,223 608 608 608 608 Other LT Liabilities 2,124 2,321 2,018 2,221 2,321 Shareholder’s Equity 27,382 30,052 33,772 37,729 42,342 Minority Interests 8,908 10,604 12,429 14,443 16,762 Total Cap. & Liab. 128,656 138,267 152,086 166,001 181,960 Non-Cash Wkg. Capital 30,101 25,903 30,600 35,613 43,291 Net Cash/(Debt) (10,071) (4,441) (4,420) (3,704) (4,719) Debtors Turn (avg days) 107.5 105.1 98.5 98.5 98.5 Creditors Turn (avg days) 74.4 73.6 72.3 73.3 73.3 Inventory Turn (avg days) 36.9 37.5 37.2 37.2 37.1 Asset Turnover (x) 1.7 1.7 1.8 1.8 1.9 Current Ratio (x) 1.3 1.2 1.3 1.3 1.3 Quick Ratio (x) 1.0 0.9 1.0 1.0 1.0 Net Debt/Equity (X) 0.3 0.1 0.1 0.1 0.1 Net Debt/Equity ex MI (X) 0.4 0.1 0.1 0.1 0.1 Capex to Debt (%) 15.7 6.3 4.8 4.8 4.8 Z-Score (X) 2.6 2.7 2.8 2.9 2.9 Source: Company, DBS Vickers


Page 55

Company Guide

Sinopharm Group

Cash Flow Statement (RMB m)

FY Dec 2014A 2015A 2016F 2017F 2018F Pre-Tax Profit 5,935 7,410 9,123 10,071 11,594 Dep. & Amort. 835 1,005 1,031 1,121 1,211 Tax Paid (1,383) (1,713) (2,100) (2,317) (2,668) Assoc. & JV Inc/(loss) (163) (165) (186) (212) (241) (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. (7,449) 4,536 (4,697) (5,013) (7,679) Other Operating CF 7,785 2,488 1,802 1,978 2,089

Net Operating CF 5,561 13,560 4,973 5,629 4,306 Capital Exp.(net) (4,612) (1,809) (1,400) (1,400) (1,401) Other Invts.(net) 0 0 0 0 0 Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 98 99 111 127 144 Other Investing CF 156 114 (68) 441 351 Net Investing CF (4,358) (1,596) (1,357) (832) (906) Div Paid (601) (772) (1,021) (1,280) (1,414) Chg in Gross Debt 4,314 (643) 200 200 200 Capital Issues 3,292 (319) 0 0 0 Other Financing CF (6,983) (5,594) (2,573) (2,800) (3,002) Net Financing CF 22 (7,328) (3,395) (3,881) (4,216) Currency Adjustments 5 51 0 0 1 Chg in Cash 1,230 4,687 222 916 (814) Opg CFPS (RMB) 5.16 3.26 3.49 3.85 4.33 Free CFPS (RMB) 0.38 4.25 1.29 1.53 1.05 Source: Company, DBS Vickers

Target Price & Ratings History

Source: DBS Vickers

Analyst: Mark Kong

1 2

3

25.0

27.0

29.0

31.0

33.0

35.0

37.0

39.0

41.0

43.0

Feb

-16

Mar

-16

Ap

r-16

May

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep-

16

Oct

-16

No

v-16

Dec

-16

Jan

-17

Feb

-17

HK$S.No. Da te Clos ing 12-mth Ra ting

Pric e Ta rge tPri c e

1: 30-Mar-16 HK$32.20 HK$32.00 Hold2: 26-Apr-16 HK$34.65 HK$32.00 Hold3: 23-Aug-16 HK$39.70 HK$36.40 Hold

Page 56 ed-TH JS CK / sa- DL


NOT RATED

Last Traded Price ( 15 Feb 2017):HK$7.76 (HSI : 23,995) Potential Catalyst: Launch of new drugs Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation F Y Dec (RMB m) 2012A 2013A 2014A 2015A

Turnover 656 875 1,131 1,673EBITDA 138 257 391 571Pre-tax Profit 130 209 360 588Net Profit 102 96 292 526Net Pft (Pre Ex.) 102 96 292 526EPS (RMB) n.a. n.a. n.a. 0.23EPS (HK$) n.a. n.a. n.a. 0.26EPS Gth (%) n.a. n.a. n.a. n.a.Diluted EPS (HK$) n.a. n.a. n.a. 0.23DPS (HK$) - - - - BV Per Share (HK$) n.a. n.a. n.a. 2.53PE (X) n.a. n.a. n.a. 29.8P/Cash F low (X) n.a. n.a. n.a. 33.4P/F ree CF (x) n.a. n.a. n.a. 38.5EV /EBITDA (X) n.a. n.a. n.a. 25.4Net Div Yield (%) - - - - P/Book Value (X) n.a. n.a. n.a. 3.1Net Debt/Equity (X) Cash Cash 0.5 CashROAE (%) n.a. 7.9 29.1 16.1




Outlook in 2017 largely hinges on new drugs from overseas

Three products manufactured by the group contributed

>80% revenue in 1H16

Earnings growth in 2017-18 dependent on success of sales of drugs from foreign drug maker AstraZeneca.

Three products contributed >80% revenue in 1H16. In 1H16, 81% of the group’s revenue was contributed by three drugs manufactured by the group: 31% from TPIAO (an exclusive medicine for treatment of thrombocytopenia, with 44.4% market share in this category of drugs in 1Q16), 27% from EPIAO (generic medicine for treatment of anemia), 23% from Yisaipu (generic medicine for treatment of rheumatoid arthritis).

Earnings growth in 2017 -18 largely dependent on drugs from overseas manufacturer, AstraZeneca. Bloomberg consensus projects the group’s earnings to grow by 38% in FY17F and 21% in FY18F. We believe that growth would be mainly driven by Byetta and Bydureon (for treatment of diabetes). Both products are produced by AstraZeneca, and are exclusive products in China. The group secured the sales rights of both products for US$100m in Oct 2016. We believe Byetta is already being sold in China and generated sales of c.US$14.6m in 2015 (equaled to 5% of 3SBio’s revenue in 2015). The import drug license for Bydureon is still pending from the Chinese government. A successful application for Bydureon is crucial to drive the group’s earnings growth. As Bydureon is already sold in 42 countries including Europe, we believe the drug will be approved for use in China ultimately.

Current valuation looks undemanding. Based on Bloomberg, the stock is now trading at 23x FY16E PE. Relative to its projected EPS growth of 38% in FY17F and 21% in FY18F, the current valuation looks undemanding.


Major Shareholders CITIC Securities Company Limited (%) 28.3 Xing Lily (%) 23.7 BlackRock, Inc. (%) 5.7


83

103

123

143

163

183

203

6.4

7.4

8.4

9.4

10.4

11.4

Jun-15 Nov-15 Apr-16 Sep-16 Feb-17

Relative IndexHK$

3SBio Inc (LHS) Relative HSI (RHS)


3SBio Inc



3SBio Inc

Page 57


FY De c 2012A 2013A 2014A 2015A

Revenue 656 875 1,131 1,673Cost of Goods Sold (71) (83) (87) (242)Gross Pro fi t 586 792 1,043 1,431Other Opg (Exp)/Inc (479) (575) (686) (940)Ope ra t ing Profi t 107 217 357 491Other Non Opg (Exp)/Inc (2) (21) 10 86Associates & JV Inc (0) (5) (1) 4Net Interest (Exp)/Inc 26 18 (5) 7Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 130 209 360 588Tax (29) (113) (68) (62)Minority Interest (0) (0) - 0Preference Dividend - - - - Ne t Profi t 102 96 292 526Net Profit before Except. 102 96 292 526EBITDA 138 257 391 571Revenue Gth (%) - 33.4 29.2 48.0EBITDA Gth (%) - 86.8 52.0 46 Opg Profit Gth (%) - 102.9 64.7 37.5Effective Tax Rate (%) 21.9 54.0 19.0 10.5

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 241 275 460 542Invts in Assocs & JVs 8 4 4 1,729Other LT Assets 112 64 899 1,596Cash & ST Invts 875 528 164 1,381Inventory 35 50 100 134Debtors 175 226 348 550Other Current Assets 30 121 331 698Tota l Asse ts 1 ,476 1,268 2,306 6,630

ST Debt 617 405Creditors 4 7 26 34Other Current Liab 81 83 609 333LT DebtOther LT Liabilities 13 97 111 222Shareholder's Equity 1,368 1,071 932 5,624Minority Interests 11 11 11 11Tota l Ca p. & Lia b . 1 ,476 1,268 2,306 6,630

Non-Cash Wkg. Cap 156 309 145 1,014 Net Cash/(Debt) 875 528 (454) 976


FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 130 209 360 588 Dep. & Amort. 31 41 34 80 Tax Paid (36) (49) (133) (66) Assoc. & JV Inc/(loss) 0 5 1 (4) (Pft)/ Loss on disposal of FAs 0 0 0 1 Non-Cash Wkg. Cap. (4) (71) 26 (60) Other Operating CF 52 106 103 (77) Ne t Ope ra t ing CF 174 239 391 463Capital Exp. (net) (48) (39) (20) (61) Other Invts. (net) (191) 489 (301) (1,348) Invts. in Assoc. & JV - - - (1,364) Div from Assoc. & JV - - - - Other Investing CF 9 10 (2) (509) Ne t Inve s ting CF (231) 459 (322) (3 ,282)Div Paid - - - - Chg in Gross Debt - - 589 (282) Capital Issues 1 2 - 3,954 Other Financing CF (0) (593) (819) 339 Ne t Fina nc ing CF 0 (590) (229) 4 ,011Chg in Cash (57) 108 (161) 1,192

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 89.3 90.5 92.3 85.5Opg Profit Margin (%) 16.3 24.8 31.6 29.3Net Profit Margin (%) 15.5 11.0 25.8 31.5ROAE (%) n.a. 7.9 29.1 16.1ROA (%) 6.9 7.0 16.3 11.8ROCE (%) n.a. 7.8 20.4 11.1Div Payout Ratio (%) n.m. n.m. n.m. n.m.Interest Cover (x) n.a. n.a. 70.1 n.a.Asset Turnover (x) 0.4 0.6 0.6 0.4Debtors Turn (days) 97.1 83.6 92.7 97.9Creditors Turn (days) 19.5 23.7 68.2 45.3Inventory Turn (days) 183.4 188.5 314.8 177.1Current Ratio (x) 13.2 10.3 0.8 3.6Quick Ratio (x) 12.8 9.8 0.7 3.4Net Debt/Equity (X) Cash Cash 0.5 CashCapex to Debt (%) n.m. n.m. 3.2 15.1N. Cash/(Debt)PS (RMB) n.a. n.a. n.a. 0.39Opg CFPS (RMB) n.a. n.a. n.a. 0.21Free CFPS (RMB) n.a. n.a. n.a. 0.18


FY De c 2H14 1H15 2H15 1H16

Revenue 574 790 883 1,305Cost of Goods Sold (43) (100) (142) (172)Gross Profi t 531 690 741 1,133Other Oper. (Exp)/Inc (413) (417) (523) (713)Ope ra ting Profi t 117 273 218 420Other Non Opg (Exp)/Inc 9 19 71 2Associates & JV Inc - - - (9)Net Interest (Exp)/Inc 3 (14) 21 (61)Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 130 278 310 353Tax (32) (36) (26) (63)Minority Interest (0) (0) 0 (3)Ne t Profi t 99 242 284 287Net profit bef Except. 99 242 284 287

FY De c 2011A 2012A 2014A 2015A

Re ve nue s656 875 1,131 1,673

Tota l 656 875 1,131 1 ,673

Sale of Pharmaceuticals Products.


Page 58 ed-JS / sa- DL


NOT RATED

Last Traded Price ( 15 Feb 2017):HK$13.00 (HSI : 23,995) Potential Catalyst: launch of new products Analyst Mark Kong +852 2820 4619 [email protected] Price Relative


Turnover 1,779 2,249 2,945 3,553EBITDA 614 729 1,160 1,148Pre-tax Profit 596 685 1,130 1,064Net Profit 537 636 1,046 996Net Pft (Pre Ex.) 537 636 1,046 996EPS (RMB) 0.22 0.26 0.43 0.40EPS (HK$) 0.25 0.30 0.49 0.46EPS Gth (%) 29.9 18.6 64.3 (6.8)Diluted EPS (HK$) 0.22 0.26 0.43 0.40DPS (HK$) 0.10 0.12 0.16 0.18BV Per Share (HK$) 1.31 1.53 1.87 2.41PE (X) 51.7 43.6 26.5 28.4P/Cash F low (X) 60.6 74.5 31.6 46.6P/F ree CF (x) 114.9 n.m. 53.3 145.7EV /EBITDA (X) 44.7 37.8 24.1 24.7Net Div Yield (%) 0.8 0.9 1.2 1.4 P/Book V alue (X) 9.9 8.5 6.9 5.4Net Debt/Equity (X) Cash Cash 0.1 CashROAE (%) 20.5 21.0 28.8 21.4


Principal Business: Pharmaceutical manufacturing and distribution Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Positives mostly priced in

Drugs from overseas markets contributed >70% of sales in 1H16.

Current valuation has priced in most positives

Sales growth for “Deanxit”, which contributed 26% of revenue in 1H16, is facing deceleration

Introducing drugs from overseas markets to China. The basic business model of the group is to look for drugs overseas, secure the distribution rights from the producer, then introduce them into China to generate sales. It has at least five major drugs from this source in its portfolio. The drugs are from Europe, covering therapeutic areas including depression, hypertension, cholesterol related diseases, immune system, diarrhea. They made up 71% of the group’s revenue in 1H16. The rest of the revenue came from drugs which the group wholly or partly owns. Driven by sales network expansion into more provinces for new drugs launched in 2015 and 1H16, Bloomberg consensus expects the EPS CAGR to be 20% in 2016-18. The revenue contribution from those drugs increased from 10% in 2015 to 25% in 1H16. The group has a pipeline of drugs for launch. Based on our discussions with the group, we think the impact from those drugs should not be meaningful on the group’s earnings in the coming three years.

Current valuation has priced in most positives. In 1H16, the group gained the sales rights to a drug called “Plendil” (cardiovascular drug) from AstraZeneca for US$310m. The drug contributed 15% of the group’s revenue in 1H16. We believe the launch of this product triggered the 46% share price surge in the last 12 months. Trading at 22x FY16F PE with a 20% expected EPS CAGR in 2016-18, we believe the current share price level should have priced in most positives.

Sales growth decelerating for its largest contributor “Deanxit”. Deanxit (chemical name: flupentixol & melitracen tablets) is an antidepressant drug which contributed 26% of the group’s revenue in 1H16. Sales growth had been decelerating from 28% in 2012 to 4% in 1H16 due to price cuts imposed in Guangdong province. Potential ASP cut will still be a concern. This drug was introduced by a manufacturer in Denmark but is prohibited for sale in Demark and the U.S. The group explained that Demark prohibits the sale of compound preparations like Deanxit. U.S. does not approve of old generation antidepressants.


Major Shareholders Lam Kong (%) 50.8 Chen Hongbing (%) 5.2


74

94

114

134

154

174

194

214

5.2

7.2

9.2

11.2

13.2

15.2


Relative IndexHK$

China Medical System (LHS) Relative HSI (RHS)


China Medical System



China Medical System

Page 59


FY De c 2012A 2013A 2014A 2015A

Revenue 1,779 2,249 2,945 3,553Cost of Goods Sold (732) (1,023) (1,291) (1,507)Gross Profi t 1 ,046 1,226 1,655 2,046Other Opg (Exp)/Inc (465) (536) (538) (977)Ope ra ting Profi t 581 691 1,116 1,069Other Non Opg (Exp)/Inc (4) (28) (5) 9Associates & JV Inc - - - - Net Interest (Exp)/Inc 20 23 18 (14)Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 596 685 1,130 1,064Tax (59) (50) (87) (68)Minority Interest (1) 1 3 (1)Preference Dividend - - - - Ne t Profi t 537 636 1,046 996Net Profit before Except. 537 636 1,046 996EBITDA 614 729 1,160 1,148Revenue Gth (%) 30.8 26.5 31.0 20.7EBITDA Gth (%) 42.8 18.6 59.2 (1) Opg Profit Gth (%) 44.2 18.9 61.6 (4.3)Effective Tax Rate (%) 9.9 7.3 7.7 6.4

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 91 278 305 387Invts in Assocs & JVs 7 6 1,308 1,322Other LT Assets 1,541 1,670 1,746 2,574Cash & ST Invts 668 488 244 509Inventory 97 167 189 385Debtors 493 539 733 970Other Current Assets 550 769 379 251Tota l Asse ts 3 ,447 3,918 4,905 6,398

ST Debt 404 314 484 464Creditors 60 68 79 96Other Current Liab 118 209 225 344LT DebtOther LT Liabilities 52 50 126 142Shareholder's Equity 2,795 3,264 3,991 5,296Minority Interests 17 13 56Tota l Ca p. & Lia b . 3 ,447 3,918 4,905 6,398

Non-Cash Wkg. Cap 961 1,199 998 1,167 Net Cash/(Debt) 264 174 (241) 45


FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 596 685 1,130 1,064 Dep. & Amort. 34 38 44 79 Tax Paid (65) (53) (67) (107) Assoc. & JV Inc/(loss) (0) (1) 1 (17) (Pft)/ Loss on disposal of FAs 0 2 1 - Non-Cash Wkg. Cap. (114) (327) (34) (424) Other Operating CF 7 28 (196) 12 Ne t Ope ra ting CF 457 372 877 608 Capital Exp. (net) (36) (148) (65) (43) Other Invts. (net) (119) (79) (369) (995) Invts. in Assoc. & JV - - (785) - Div from Assoc. & JV - - - - Other Investing CF (212) 12 239 167 Ne t Inve s ting CF (368) (214) (980) (871) Div Paid (180) (243) (291) (370) Chg in Gross Debt 152 (93) 159 (58) Capital Issues - - - 679 Other Financing CF (4) (7) (9) (2) Ne t Fina nc ing CF (31) (343) (141) 249 Chg in Cash 58 (186) (244) (14)

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 58.8 54.5 56.2 57.6Opg Profit Margin (%) 32.7 30.7 37.9 30.1Net Profit Margin (%) 30.2 28.3 35.5 28.0ROAE (%) 20.5 21.0 28.8 21.4ROA (%) 16.7 17.3 23.7 17.6ROCE (%) 17.4 18.6 25.1 19.1Div Payout Ratio (%) 33.5 38.1 27.8 37.1Interest Cover (x) n.a. n.a. n.a. 76.0Asset Turnover (x) 0.6 0.6 0.7 0.6Debtors Turn (days) 91.9 83.7 78.8 87.5Creditors Turn (days) 31.8 22.8 20.8 21.2Inventory Turn (days) 57.1 47.0 50.4 69.6Current Ratio (x) 3.1 3.3 2.0 2.3Quick Ratio (x) 2.9 3.0 1.7 1.9Net Debt/Equity (X) Cash Cash 0.1 CashCapex to Debt (%) 9.0 47.0 13.5 9.4N. Cash/(Debt)PS (RMB) 0.11 0.07 (0.10) 0.02Opg CFPS (RMB) 0.19 0.15 0.36 0.25Free CFPS (RMB) 0.10 (0.01) 0.22 0.08


FY De c 2H14 1H15 2H15 1H16

Revenue 1,578 1,676 1,877 2,177Cost of Goods Sold (661) (718) (789) (908)Gross Profi t 918 958 1,088 1,270Other Oper. (Exp)/Inc (239) (425) (552) (543)Ope ra ting Profi t 678 532 536 727Other Non Opg (Exp)/Inc (1) 9 0 (22)Associates & JV Inc - - - - Net Interest (Exp)/Inc 8 (9) (5) (6)Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 686 533 531 698Tax (53) (39) (29) (44)Minority Interest 1 (2) (0)Ne t Profi t 633 495 501 654Net profit bef Except. 633 495 501 654

FY De c 2012A 2013A 2014A 2015A

Re ve nue sLicensed Drugs Sales 1,779 2,233 2,945 3,553Tota l 1 ,779 2,233 2,945 3,553


Page 60 ed-TH JS CK / sa- DL


NOT RATED

Last Traded Price ( 15 Feb 2017):HK$26.80 (HSI : 23,995) Potential Catalyst: Acquisition of healthcare company Analyst Mark Kong +852 2820 4619 [email protected] Price Relative


Turnov er 7,278 9,921 11,938 12,502EBITDA 1,923 2,273 2,655 3,253Pre-tax Profit 2,123 2,314 2,718 3,372Net Profit 1,564 1,583 2,113 2,460Net Pft (Pre Ex.) 1,564 1,583 2,113 2,460EPS (RMB) 0.80 0.71 0.92 1.07EPS (HK$) 0.91 0.80 1.04 1.21EPS Gth (%) 31.1 (11.3) 29.6 16.3Diluted EPS (HK$) 0.80 0.71 0.92 1.06DPS (HK$) 0.24 0.31 0.32 0.36BV Per Share (HK$) 6.82 7.72 8.14 8.87PE (X) 29.6 33.3 25.7 22.1P/Cash F low (X) 71.1 55.3 49.9 35.9P/F ree CF (x) n.a. n.a. n.a. n.a.EV /EBITDA (X) 25.3 25.6 23.4 19.8Net Div Yield (%) 0.9 1.1 1.2 1.4 P/Book V alue (X) 3.9 3.5 3.3 3.0Net Debt/Equity (X) 0.0 0.2 0.3 0.4ROAE (%) 13.5 11.0 13.2 14.2




Well diversified healthcare player Diversified player with exposure to drug manufacturing &

distribution, medical devices, and hospitals

Expect 15% earnings CAGR in next three years

Share price has surged 20% in one month, and should have priced in most positives

Diversified player in healthcare industry. The group has exposure to different aspects in the healthcare industry. In 1H16, it generated 70% of its revenue from drug manufacturing, 11% from medical services, and 19% from medical devices. The group indirectly holds a stake of close to 28% in China’s largest drug distributor Sinopharm (1099 HK). Sinopharm is regarded as associate company, and contributed earnings before interest & tax (EBIT) of c.Rmb695m, which made up 36% of the group’s EBIT in 1H16.

Targets revenue of core businesses to grow at 15% CAGR in next three years. During a meeting with investors, the group expressed a target to grow the revenue of its core businesses by 15% CAGR in next three years. This should be mainly driven by contribution from new products like rabies vaccine (launch planned for this year) and profit contribution from the Indian drug maker Glandpharma which was acquired last year. We have assumed that the cost-to-income ratio will remain the same, and hence, earnings should grow at same pace (15% CAGR).

Most positives priced in. Assuming earnings in FY16 will grow at the same rate in 9M16 which is c.11%, the group should be able to record net profit of c.Rmb2.7bn. This implies that the stock is trading at 20x FY16E PE at the current price. Relative to its target of earnings growth of 15% p.a. in the next three years, this valuation would have priced in most of the positives. The stock price has surged by close to 20% in the last one month. At A Glance Issued Capital - H shares (m shs) 403 - Non H shrs (m shs) 2,011 H shs as a % of Total 17 Total Mkt. Cap (HK$m/US$m) 67,151 / 8,654 Major Shareholders

Fosun International (%) 38.6 Major H Shareholders (%)

The Capital Group Companies, Inc. (%) 12.0 The Prudential Insurance Company of America (%) 8.2 EARNEST Partners, LLC (%) 6.4 Wellington Management Group LLP (%) 6.0 Credit Suisse Group AG (%) 5.9

H Shares-Free Float (%) 61.6 3m Avg. Daily Val. (US$m) 4.6

90

140

190

240

290

10.5

15.5

20.5

25.5

30.5

35.5


Relative IndexHK$

Shanghai Fosun Pharmaceutical (LHS) Relative HSI (RHS)


Shanghai Fosun Pharmaceutical



Shanghai Fosun Pharmaceutical

Page 61

Income Statement (RMB m) Balance Sheet (RMB m)

FY De c 2 0 1 2 A 2 0 1 3 A 2 0 1 4 A 2 0 1 5 A

Revenue 7,278 9,921 11,938 12,502Cost of Goods Sold (4,127) (5,543) (6,719) (6,308)Gro s s Pro fi t 3 ,151 4 ,37 8 5 ,2 20 6 ,194Other Opg (Exp)/Inc (1,524) (2,526) (3,128) (3,598)O p e ra t in g Pro fi t 1 ,6 2 8 1 ,8 5 2 2 ,0 9 2 2 ,5 9 6Other Non Opg (Exp)/Inc (785) (35) 42 71Associates & JV Inc 1,621 782 929 1,119Net Interest (Exp)/Inc (341) (287) (345) (414)Exceptiona l Gain/(Loss) - - - - P re -ta x Pro fi t 2 ,1 2 3 2 ,3 1 4 2 ,7 1 8 3 ,3 7 2Tax (284) (358) (348) (501)Minority Interest (275) (373) (257) (411)Preference Dividend - - - - Ne t P ro fi t 1 ,5 6 4 1 ,5 8 3 2 ,1 1 3 2 ,4 6 0Net Profit before Except. 1,564 1,583 2,113 2,460EBITDA 1,923 2,273 2,655 3,253Revenue Gth (%) 13.1 36.3 20.3 4.7EBITDA Gth (%) 27.5 18.2 16.8 23 Opg Profit Gth (%) 25.2 13.8 12.9 24.1Effective Tax Rate (%) 13.4 15.5 12.8 14.9

FY De c 2 01 2 A 20 1 3A 2 0 14 A 2 01 5A

Net Fixed Assets 4,045 5,710 6,557 6,819Invts in Assocs & JVs 7,920 8,884 11,849 13,863Other LT Assets 5,103 7,838 8,210 9,137Cash & ST Invts 5,110 2,911 3,221 3,579Inventory 1,273 1,614 1,605 1,649Debtors 1,075 1,460 1,977 2,147Other Current Assets 923 1,001 1,862 951To ta l As s e ts 25 ,4 50 2 9 ,41 8 35 ,2 79 38 ,1 45

ST Debt 1,375 1,424 4,939 7,323Creditors 755 958 834 973Other Current Liab 1,764 2,896 3,764 2,643LT Debt 4,280 4,200 3,857 3,572Other LT Liabilitie s 2,029 2,333 2,839 3,021Shareholder's Equity 13,502 15,275 16,618 18,125Minority Interests 1,746 2,332 2,428 2,488To ta l Ca p . & Li a b . 25 ,4 50 2 9 ,41 8 35 ,2 79 38 ,1 45

Non-Cash Wkg. Cap 753 221 845 1,131 Net Cash/(Debt) (545) (2,713) (5,575) (7,316)

Cash Flow Statement (RMB m) Rates & Ratio

FY De c 20 12 A 2 01 3A 2 01 4A 20 15 A

Pre-Tax Profit 2,123 2,314 2,718 3,372 Dep. & Amort. 295 420 563 657 Tax Pa id (228) (335) (399) (334) Assoc. & JV Inc/(loss) (808) (772) (910) (1,107) (Pft)/ Loss on disposa l of FAs 9 6 127 22 Non-Cash Wkg. Cap. (83) (253) (514) (267) Other Operating CF (656) (422) (499) (818) Ne t O p e ra t ing CF 652 95 8 1 ,0 86 1 ,5 24 Capita l Exp. (net) - - - -Other Invts. (net) - - - -Invts. in Assoc. & JV (133) (180) (1,604) (1,411) Div from Assoc. & JV - - - - Other Investing CF 50 - (155) 3 Ne t In ve s t i ng CF (1 ,273 ) (2 ,08 4 ) (2 ,7 04 ) (2 ,2 78 ) Div Pa id (190) (470) (623) (654) Chg in Gross Debt (356) 321 2,965 1,960 Capita l Issues 3,099 - 1,408 28 Other Financing CF (189) (481) (1,538) (292) Ne t Fin a nc ing CF 2 ,363 (63 0 ) 2 ,2 12 1 ,0 42 Chg in Cash 1,743 (1,755) 594 288

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 43.3 44.1 43.7 49.5Opg Profit Margin (%) 22.4 18.7 17.5 20.8Net Profit Margin (%) 21.5 16.0 17.7 19.7ROAE (%) 13.5 11.0 13.2 14.2ROA (%) 6.6 5.8 6.5 6.7ROCE (%) 7.2 7.0 7.1 7.3Div Payout Ratio (%) 12.2 29.7 29.5 26.6Interest Cover (x) 4.8 6.5 6.1 6.3Asset Turnover (x) 0.3 0.4 0.4 0.3Debtors Turn (days) 55.7 46.6 52.5 60.2Creditors Turn (days) 65.9 56.4 48.7 52.3Inventory Turn (days) 106.0 95.1 87.4 94.1Current Ratio (x) 2.2 1.3 0.9 0.8Quick Ratio (x) 1.8 1.0 0.7 0.6Net Debt/Equity (X) 0.0 0.2 0.3 0.4Capex to Debt (%) n.m. n.m. n.m. n.m.N. Cash/(Debt)PS (RMB) (0.24) (1.21) (2.41) (3.16)Opg CFPS (RMB) 0.33 0.43 0.47 0.66Free CFPS (RMB) n.m. n.m. n.m. n.m.

Interim Income Statement (RMB m) Segmental Breakdown (RMB m) / Key Assumptions

FY De c 2H14 1H15 2H15 1H16

Revenue 6,436 5,871 6,631 6,878Cost of Goods Sold (3,532) (2,929) (3,379) (3,229)Gro s s Pro fi t 2 ,904 2 ,942 3 ,252 3 ,649Other Oper. (Exp)/Inc (1,780) (1,583) (2,015) (2,254)O pe ra t ing Pro fi t 1 ,124 1 ,359 1 ,238 1 ,396Other Non Opg (Exp)/Inc 422 24 540 16Associates & JV Inc 626 716Net Interest (Exp)/Inc (187) (198) (216) (198)Exceptional Gain/(Loss) - - - - P re -ta x Pro fi t 1 ,359 1 ,810 1 ,562 1 ,930Tax (142) (294) (207) (181)Minority Interest (122) (213) (198) (248)Ne t Pro fi t 1 ,095 1 ,303 1 ,157 1 ,500Net profit bef Except. 1,095 1,303 1,157 1,500

FY De c 2 01 2A 20 13 A 20 14 A 20 15 A

Re ve n ue sMedicine Manufacturing 4,678 6,524 7,265 8,843Medica l Appliance 1,059 1,407 1,931 2,244Medica l Services 160 475 1,186 1,377Others 16 14 14 38Medicine Business 1,427.82 1,502.01 1,542.07 -Other Operating Income - - - -Sa les Tax (62) - - -To ta l 7 ,27 8 9 ,92 1 1 1 ,938 1 2 ,502




NOT RATED

Last Traded Price ( 15 Feb 2017):HK$19.92 (HSI : 23,995) Potential Catalyst: Market share gain in pharmaceutical distribution Analyst Mark Kong +852 2820 4619 [email protected] Price Relative


Turnov er 68,078 78,017 92,399 105,517EBITDA 3,173 3,305 3,749 4,377Pre-tax Profit 3,088 3,226 3,800 4,172Net Profit 2,053 2,214 2,591 2,877Net Pft (Pre Ex.) 2,053 2,214 2,591 2,877EPS (RMB) 0.76 0.82 0.96 1.07EPS (HK$) 0.86 0.93 1.09 1.21EPS Gth (%) (9.5) 8.3 16.6 11.5Diluted EPS (HK$) 0.76 0.82 0.96 1.07DPS (HK$) 0.27 0.29 0.33 0.37BV Per Share (HK$) 10.38 10.93 11.72 12.60PE (X) 23.1 21.4 18.3 16.4P/Cash F low (X) 54.4 60.8 45.2 48.1P/F ree CF (x) n.a. n.a. n.a. n.a.EV /EBITDA (X) 14.0 14.1 13.5 12.4Net Div Yield (%) 1.4 1.5 1.6 1.9 P/Book V alue (X) 1.9 1.8 1.7 1.6Net Debt/Equity (X) Cash Cash 0.0 0.1ROAE (%) 8.6 8.8 9.6 10.0




Most positives are priced in The 3rd largest pharmaceutical distributor in China

Expect 12-14% EPS growth in next three years mainly driven by pharmaceutical distribution

However, we believe most positives are already priced in current valuation

The 3rd largest pharmaceutical distributor in China. The group is the 3rd largest pharmaceutical distributor in China with 7.3% market share in 2015. Pharmaceutical distribution contributed 85% of revenue and 62% of operating profit in 1H16, while the rest was mainly from finished drug manufacturing.

Expect 12-14% EPS growth in next three years mainly driven by pharmaceutical distribution. We estimate the growth to be mainly driven by the market share gain in pharmaceutical distribution, riding on the government’s policy of reducing layers in distribution. In China, drug producers sell their drugs to public medical institutes (the largest drug sales channel accounting for >60% of total drug sales) through layers of distributors. The government wants to reduce the number to only one distributor between them so as to save on middlemen cost for the whole industry. Large distributors like the group will gain market share due to this policy and the government reiterated that in late January 2017. Assuming pharmaceutical distribution and manufacturing contribute 60% and 40% of the group’s earnings and assuming the earnings growth of both segments to be 20% and 5% annually in next 3 years, we believe the group can achieve 12-14% EPS growth in the next three years.

Most positives are already priced in. Due to the favorable policy described above, the share price of the group has already surged by 43% in the last 12 months. Assuming 1x PEG is a reasonable level, current 17F PE of c.13x based on our estimates has already reached 1x PEG. So, we believe it should have priced in most positives. At A Glance Issued Capital - H shares (m shs) 766 - Non H shrs (m shs) 1,923 H shs as a % of Total 28 Total Mkt. Cap (HK$m/US$m) 61,194 /7,887 Major Shareholders

Shanghai Industrial (%) 34.9 Major H Shareholders (%)

JPMorgan Chase & Co. (%) 10.6 Social Security (%) 9.1 BlackRock, Inc. (%) 7.4 AllianceBernstein L.P. (%) 5.0

H Shares-Free Float (%) 67.8 3m Avg. Daily Val. (US$m) 5.1

78

98

118

138

158

178

198

218

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0

30.0

32.0


Relative IndexHK$

Shanghai Pharmaceuticals (LHS) Relative HSI (RHS)


Shanghai Pharmaceuticals



Shanghai Pharmaceuticals

Page 63

Income Statement (RMB m) Balance Sheet (RMB m) FY De c 2 0 1 2 A 2 0 1 3 A 2 0 1 4 A 2 0 1 5 A

Revenue 68,078 78,017 92,399 105,517Cost of Goods Sold (58,980) (67,980) (81,223) (92,979)Gro s s Pro fi t 9 ,0 9 8 10 ,03 7 11 ,176 1 2 ,538Other Opg (Exp)/Inc (6,507) (7,281) (8,112) (8,906)O p e ra t in g Pro fi t 2 ,5 9 1 2 ,7 5 6 3 ,0 6 3 3 ,6 3 1Other Non Opg (Exp)/Inc 399 185 702 522Associates & JV Inc 268 457 413 495Net Interest (Exp)/Inc (170) (172) (379) (476)Exceptiona l Ga in/(Loss) - - - - P re - ta x Pro fi t 3 ,0 8 8 3 ,2 2 6 3 ,8 0 0 4 ,1 7 2Tax (627) (628) (808) (807)Minority Interest (408) (384) (401) (487)Preference Dividend - - - - Ne t P ro fi t 2 ,0 5 3 2 ,2 1 4 2 ,5 9 1 2 ,8 7 7Net Profit before Except. 2,053 2,214 2,591 2,877EBITDA 3,173 3,305 3,749 4,377Revenue Gth (%) 24.0 14.6 18.4 14.2EBITDA Gth (%) 9.7 4.2 13.4 17 Opg Profit Gth (%) 8.9 6.4 11.2 18.5Effective Tax Rate (%) 20.3 19.5 21.3 19.4

FY De c 20 1 2 A 2 0 1 3A 20 1 4 A 2 0 1 5 A

Net Fixed Assets 5,329 5,734 6,293 7,504Invts in Assocs & JVs 2,545 2,697 2,746 3,637Other LT Assets 4,393 5,366 6,643 7,618Cash & ST Invts 13,304 12,646 11,191 11,279Inventory 9,810 10,997 13,088 15,091Debtors 13,501 16,567 21,267 25,181Other Current Assets 2,187 2,306 3,112 4,035To ta l As se ts 5 1 ,0 6 9 5 6 ,3 12 6 4 ,3 4 1 7 4 ,3 4 4

ST Debt 7,331 8,647 11,239 14,162Creditors 11,745 14,153 16,690 20,188Other Current Liab 3,022 2,903 4,074 5,077LT Debt 41 125 105 93Other LT Liabilities 1,229 1,482 1,133 1,016Shareholder's Equity 24,639 25,954 27,822 29,930Minority Interests 3,062 3,047 3,277 3,878To ta l Ca p . & Li a b . 5 1 ,0 6 9 5 6 ,3 12 6 4 ,3 4 1 7 4 ,3 4 4

Non-Cash Wkg. Cap 10,731 12,813 16,704 19,042 Net Cash/(Debt) 5,932 3,874 (154) (2,976)

Cash Flow Statement (RMB m) Rates & Ratio FY De c 20 1 2 A 2 01 3 A 2 0 14 A 2 0 1 5A

Pre-Tax Profit 3,088 3,226 3,800 4,172 Dep. & Amort. 582 550 685 746 Tax Pa id (660) (2,552) (699) (851) Assoc. & JV Inc/(loss) - - - -(Pft)/ Loss on disposa l of FAs 20 36 152 388 Non-Cash Wkg. Cap. (1,986) (2,249) (2,339) (2,704) Other Operating CF (175) 1,768 (553) (766) Ne t O p e ra t in g CF 8 69 7 79 1 ,0 4 7 9 8 4 Capita l Exp. (net) - - - -Other Invts. (net) - - - -Invts. in Assoc. & JV (52) (589) (327) (90) Div from Assoc. & JV - - - - Other Investing CF 492 - 107 10 Ne t In ve s t in g CF (5 81 ) (1 ,1 4 1 ) (2 ,1 0 8 ) (2 ,1 4 3 ) Div Pa id (696) (613) (1,024) (1,030) Chg in Gross Debt (812) 1,090 807 2,163 Capita l Issues - - - - Other Financing CF (34) (771) (177) 113 Ne t Fin a n c in g CF (1 ,5 42 ) (2 94 ) (3 9 4 ) 1 ,2 4 6 Chg in Cash (1,254) (656) (1,455) 87

FY De c 2012 A 201 3A 201 4A 201 5A

Gross Margin (%) 13.4 12.9 12.1 11.9Opg Profit Margin (%) 3.8 3.5 3.3 3.4Net Profit Margin (%) 3.0 2.8 2.8 2.7ROAE (%) 8.6 8.8 9.6 10.0ROA (%) 4.2 4.1 4.3 4.1ROCE (%) 6.4 6.4 6.3 6.8Div Payout Ratio (%) 33.9 27.7 39.5 35.8Interest Cover (x) 15.2 16.1 8.1 7.6Asset Turnover (x) 1.4 1.5 1.5 1.5Debtors Turn (days) 69.6 70.3 74.7 80.3Creditors Turn (days) 68.1 69.5 69.3 72.4Inventory Turn (days) 56.0 55.9 54.1 55.3Current Ratio (x) 1.8 1.7 1.5 1.4Quick Ratio (x) 1.3 1.2 1.1 1.0Net Debt/Equity (X) Cash Cash 0.0 0.1Capex to Debt (%) n.m. n.m. n.m. n.m.N. Cash/(Debt)PS (RMB) 2.21 1.44 (0.06) (1.11)Opg CFPS (RMB) 0.32 0.29 0.39 0.37Free CFPS (RMB) n.m. n.m. n.m. n.m.

Interim Income Statement (RMB m) Segmental Breakdown (RMB m) / Key Assumptions FY De c 2H14 1H15 2H15 1H1 6

Revenue 48,386 50,950 54,567 59,545Cost of Goods Sold (42,674) (44,800) (48,179) (52,484)Gro s s P ro fi t 5 ,71 2 6 ,15 0 6 ,38 8 7 ,06 1Other Oper. (Exp)/Inc (4,391) (4,174) (4,733) (4,824)O p e ra t ing Pro fi t 1 ,32 1 1 ,97 6 1 ,65 5 2 ,23 7Other Non Opg (Exp)/Inc - - - 246Associates & JV Inc 217 352Net Interest (Exp)/Inc - - - (253)Exceptional Ga in/(Loss) - - - - Pre -ta x Pro fi t 1 ,88 3 2 ,12 5 2 ,04 7 2 ,58 2Tax (405) (370) (438) (481)Minority Interest (204) (221) (267) (368)Ne t Pro fi t 1 ,27 3 1 ,53 4 1 ,34 3 1 ,73 2Net profit bef Except. 1,273 1,534 1,343 1,732

FY De c 2 0 1 2 A 2 0 1 3 A 2 0 1 4 A 2 0 1 5 A

R e ve n u e sDistribution 56,823 65,527 79,226 90,196Pharmaceutica l Products Manufacturing

8,140 9,364 9,485 10,135

Reta il 2,742 2,952 3,309 4,756Other 374 379 379 428




NOT RATED

Last Traded Price ( 15 Feb 2017):HK$2.47 (HSI : 23,995) Potential Catalyst: launch of new drugs Analyst Mark Kong +852 2820 4619 [email protected] Price Relative


Turnov er 3,043 2,586 3,084 3,167EBITDA 1,179 1,691 2,187 2,955Pre-tax Profit 1,166 1,603 2,073 2,842Net Profit 904 1,285 1,671 2,062Net Pft (Pre Ex.) 904 1,285 1,671 2,062EPS (RMB) 0.09 0.12 0.16 0.20EPS (HK$) 0.10 0.14 0.18 0.23EPS Gth (%) 9.9 42.0 30.0 23.4Diluted EPS (HK$) 0.09 0.12 0.16 0.20DPS (HK$) 0.05 0.06 0.03 0.07BV Per Share (HK$) 0.78 0.86 1.02 1.21PE (X) 25.0 17.6 13.5 11.0P/Cash F low (X) 19.3 13.7 12.2 13.2P/F ree CF (x) n.m. 79.7 17.2 22.1EV /EBITDA (X) 17.2 12.0 9.0 6.3Net Div Yield (%) 2.0 2.3 1.2 2.7 P/Book V alue (X) 3.2 2.9 2.4 2.0Net Debt/Equity (X) Cash Cash Cash CashROAE (%) 12.9 17.2 19.5 20.2




Rebuilding confidence takes time

Largest producer of prescription drugs for cardiovascular

diseases with 11.93% market share according to IMS

Trading suspension in 2015-16 and changes of auditors have impacted market’s confidence on the stock

Largest producer of prescription drugs for cardiovascular diseases. According to IMS, Sihuan is the largest producer of prescription drugs for cardiovascular diseases with 11.93% market share in 1H16. Sihuan generated 95% of 1H16 revenue from cardiovascular drugs. Due to price cuts on drugs, increase in distribution cost as a percentage of sales and lower investment income compared to 1H15, 1H16 earnings fell by 49%. Based on Bloomberg consensus, the stock is now trading at 13x FY16E PE with earnings projected to grow by 8% in FY17F and 6% in FY18F driven by an increase in the number of patients and penetration into lower tiered hospitals.

Trading suspension in 2015-16 and changes in auditors impacted market’s confidence on the stock. On 27 Mar 2015, Sihuan announced a trading suspension and delay of FY14A results announcement. This was because the auditor at that time, PricewaterhouseCoopers (PwC), need more time to audit the financials, particularly relating to booking of sales and distribution costs in the past. Sihuan released FY14A results in Aug 2015 but PWC expressed that it could not obtain sufficient audit evidence to provide a basis for an audit opinion on part of Sihuan’s financials. In Jan 2016, Sihuan changed its auditor to Crowe Horwath which is a non-big four firm. On 29 Feb 2016, Sihuan resumed trading and the share price plunged by 55% that day. Although Sihuan has changed its auditor to another big four firm (Ernst & Young) in Jul 2016, the past events have substantially impacted market confidence on the stock.


Major Shareholders Guo Weicheng (%) 66.8 MSPEA Pharma Holdings B.V. (%) 7.5


82

132

182

232

282

332

382

1.3

2.3

3.3

4.3

5.3

6.3


Relative IndexHK$

Sihuan Pharmaceutical Holdings (LHS) Relative HSI (RHS)


Sihuan Pharmaceutical Holdings



Sihuan Pharmaceutical Holdings

Page 65


FY De c 2012A 2013A 2014A 2015A

Revenue 3,043 2,586 3,084 3,167Cost of Goods Sold (753) (1,131) (973) (939)Gross Pro fi t 2 ,289 1,455 2,111 2,228Other Opg (Exp)/Inc (1,242) 42 (132) 466Ope ra t ing Profi t 1 ,048 1,497 1,979 2,694Other Non Opg (Exp)/Inc 4 22 (12) 5Associates & JV Inc (6) (7) (5) 33Net Interest (Exp)/Inc 120 90 111 110Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 1 ,166 1,603 2,073 2,842Tax (244) (311) (389) (797)Minority Interest (17) (7) (14) 18Preference Dividend - - - - Ne t Profi t 904 1,285 1,671 2,062Net Profit before Except. 904 1,285 1,671 2,062EBITDA 1,179 1,691 2,187 2,955Revenue Gth (%) 35.7 (15.0) 19.2 2.7EBITDA Gth (%) 8.7 43.4 29.3 35 Opg Profit Gth (%) 5.8 42.9 32.2 36.1Effective Tax Rate (%) 20.9 19.4 18.7 28.0

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 1,090 1,780 2,066 2,648Invts in Assocs & JVs 41 34 358 1,189Other LT Assets 4,308 3,035 3,272 3,037Cash & ST Invts 3,160 2,603 2,936 4,242Inventory 91 101 177 233Debtors 600 868 533 526Other Current Assets 170 1,676 1,981 447Tota l Asse ts 9 ,459 10,097 11,323 12,321

ST Debt 767 181Creditors 36 31 41 73Other Current Liab 1,047 1,717 1,652 861LT Debt 6 6 4 8Other LT Liabilities 416 226 220 187Shareholder's Equity 7,084 7,821 9,292 11,096Minority Interests 103 115 114 96Tota l Ca p. & Lia b . 9 ,459 10,097 11,323 12,321

Non-Cash Wkg. Cap (223) 898 998 271 Net Cash/(Debt) 2,387 2,417 2,932 4,233


FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 1,166 1,603 2,073 2,842 Dep. & Amort. 131 194 208 261 Tax Paid (238) (340) (250) (647) Assoc. & JV Inc/(loss) - - - -(Pft)/ Loss on disposal of FAs 4 1 15 0 Non-Cash Wkg. Cap. 107 175 (194) (145) Other Operating CF (1) 19 8 (598) Ne t Ope ra ting CF 1,170 1,652 1,861 1,713Capital Exp. (net) (529) (846) (302) (410) Other Invts. (net) (2,359) 268 (1,087) 18 Invts. in Assoc. & JV - - (329) (99) Div from Assoc. & JV - - - - Other Investing CF - - - (41) Ne t Inve sting CF (2 ,888) (578) (1 ,718) (531)Div Paid (662) (523) (244) (280) Chg in Gross Debt 767 (523) (183) 5 Capital Issues - - 42 - Other Financing CF 4 5 - 16 Ne t Fina nc ing CF 109 (1 ,041) (385) (259)Chg in Cash (1,609) 34 (242) 923

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 75.2 56.3 68.5 70.3Opg Profit Margin (%) 34.4 57.9 64.2 85.1Net Profit Margin (%) 29.7 49.7 54.2 65.1ROAE (%) 12.9 17.2 19.5 20.2ROA (%) 9.9 13.1 15.6 17.4ROCE (%) 10.8 14.6 18.1 18.6Div Payout Ratio (%) 73.2 40.7 14.6 13.6Interest Cover (x) n.a. n.a. n.a. n.a.Asset Turnover (x) 0.3 0.3 0.3 0.3Debtors Turn (days) 59.2 103.5 82.9 61.0Creditors Turn (days) 15.9 10.8 13.4 22.0Inventory Turn (days) 36.1 31.1 52.2 79.7Current Ratio (x) 2.2 2.7 3.3 5.8Quick Ratio (x) 2.1 2.7 3.2 5.6Net Debt/Equity (X) Cash Cash Cash CashCapex to Debt (%) 68.5 453.2 8623.7 4952.0N. Cash/(Debt)PS (RMB) 0.23 0.23 0.28 0.41Opg CFPS (RMB) 0.11 0.16 0.18 0.17Free CFPS (RMB) (0.00) 0.03 0.13 0.10


FY De c 2H14 1H15 2H15 1H16

Revenue 1,084 1,774 1,394 1,388Cost of Goods Sold (569) (495) (444) (460)Gross Profi t 515 1,279 949 927Other Oper. (Exp)/Inc 506 320 146 (98)Ope ra ting Profi t 1 ,021 1,599 1,096 829Other Non Opg (Exp)/Inc - - - -Associates & JV Inc - 12 - - Net Interest (Exp)/Inc - - - -Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 1 ,066 1,682 1,159 890Tax (213) (241) (556) (173)Minority Interest (11) 10 8 18Ne t Pro fi t 841 1,452 611 736Net profit bef Except. 841 1,452 611 736


F Y Dec 2012A 2013A 2014A 2015A

Rev enues Cardio-cerebral Vascular Drugs 2,631 2,310 2,745 2,952 Others 304 173 210 189 Central Nervous System 14 15 20 23 Anti-infective Drugs 36 15 23 3 Metabolism Drug 58 73 86 -Total 3,043 2,586 3,084 3,167

Page 66 ed- JS / sa- DL


NOT RATED

Last Traded Price ( 15 Feb 2017):HK$6.24 (HSI : 23,995) Price Target 12-mth: n.a. Potential Catalyst: launch of new drugs Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation F Y Dec (HK $m) 2012A 2013A 2014A 2015A

Turnov er 7,497 9,901 12,378 14,550EBITDA 1,603 2,004 2,651 3,322Pre-tax Profit 1,723 2,137 2,801 3,444Net Profit 891 1,037 1,513 1,779Net Pft (Pre Ex.) 891 1,037 1,513 1,779EPS (HK$) 0.12 0.14 0.20 0.34EPS Gth (%) 92.8 16.4 45.9 66.3Diluted EPS (HK$) 0.12 0.14 0.20 0.34DPS (HK$) 0.03 0.03 0.04 0.06BV Per Share (HK$) 0.62 0.74 0.89 1.05PE (X) 51.9 44.6 30.6 18.4P/Cash F low (X) 29.4 27.1 18.7 11.2P/F ree CF (x) 44.2 48.4 27.1 17.3EV /EBITDA (X) 28.0 22.4 17.0 9.5Net Div Yield (%) 0.5 0.5 0.6 0.9 P/Book V alue (X) 10.1 8.4 7.0 6.0Net Debt/Equity (X) Cash Cash Cash CashROAE (%) 21.2 20.6 25.0 24.8


Principal Business: Leading pharmaceutical company for hepatitis and cardio cerebral medicines. It is also engaged in the coal to chemical project in PRC Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Stretched valuation A finished maker with significant portion of revenue from

hepatitis medicines

Current valuation has priced in most positives

The group’s investment in stock market is a concern

A finished maker with significant portion of revenue from hepatitis medicines. In 9M16, the group generated 46% of its revenue from hepatitis medicines, 11% from oncology medicines, 10% from cardio-cerebral medicines, 9% from analgesic medicines, 7% from orthopedic medicines. In the pipeline of the group, a total of 438 pharmaceutical products have obtained clinical approvals, or are under clinical trials, or applying for production approval.

Current valuation has priced in most positives. According to Bloomberg consensus, the expected earnings CAGR in 2016-19 for the company is 9%. Trading at 23x 16F PE now, we believe the valuation has priced in most positives.

The group’s investment in stock market is a concern. On 7 January 2016, the group announced its subscription of 1.9bn shares of China Cinda (1359 HK) at HK$3.05 per share. Total consideration of the deal was c.HK$5.8bn,which equaled the sum of the group’s net profits from 2011-15. The asset to be subscribed is unrelated to the group’s major business, hence raising market concerns whether the group can handle it well. The group’s share price dropped by 27% in two days after the announcement. In 8-20 January 2016, the CEO and two executive directors purchased c.71m shares of the group in the market for HK$393m. On 4 February 2016, the group called off the China Cinda deal and compensated HK$10m to the company. This has caused the market to be concerned that the group may misuse its financial resources on non-core businesses going forward.


Major Shareholders Cheng Cheung Ling (%) 25.1 Tse Ping (%) 16.5 JPMorgan Chase & Co. (%) 5.0


84

134

184

234

284

2.5

3.5

4.5

5.5

6.5

7.5

8.5


Relative IndexHK$

Sino Biopharmaceutical (LHS) Relative HSI (RHS)


Sino Biopharmaceutical

Bloomberg: 1177 HK EQUITY | Reuters: 1177.HK Refer to important disclosures at the end of this report


Sino Biopharmaceutical

Page 67


FY De c 2012A 2013A 2014A 2015A

Revenue 7,497 9,901 12,378 14,550Cost of Goods Sold (1,611) (2,228) (2,921) (3,250)Gross Profi t 5 ,886 7,673 9,458 11,301Other Opg (Exp)/Inc (4,465) (5,896) (7,072) (8,315)Ope ra ting Profi t 1 ,421 1,777 2,386 2,985Other Non Opg (Exp)/Inc 16 56 8 120Associates & JV Inc 240 238 337 325Net Interest (Exp)/Inc 45 66 70 13Exceptional Gain/(Loss) - - - - Pre -ta x Pro fi t 1 ,723 2,137 2,801 3,444Tax (305) (355) (440) (533)Minority Interest (527) (745) (848) (1,132)Preference Dividend - - - - Ne t Profi t 891 1,037 1,513 1,779Net Profit before Except. 891 1,037 1,513 1,779EBITDA 1,603 2,004 2,651 3,322Revenue Gth (%) 29.7 32.1 25.0 17.5EBITDA Gth (%) 47.4 25.0 32.3 25 Opg Profit Gth (%) 49.8 25.0 34.3 25.1Effective Tax Rate (%) 17.7 16.6 15.7 15.5

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 1,849 2,300 2,680 3,520Invts in Assocs & JVs 726 1,119 1,361 1,258Other LT Assets 529 723 1,942 1,769Cash & ST Invts 2,667 3,120 4,998 5,592Inventory 553 805 902 950Debtors 1,134 1,583 1,890 1,866Other Current Assets 244 319 391 1,528Tota l Asse ts 7 ,701 9 ,969 14 ,164 16,483

ST Debt 21 74 435 1,420Creditors 295 475 775 768Other Current Liab 1,479 2,031 2,651 3,336LT Debt 20 1,289 306Other LT Liabilities 102 164 196 209Shareholder's Equity 4,582 5,487 6,611 7,756Minority Interests 1,203 1,738 2,208 2,687Tota l Ca p . & Lia b . 7 ,701 9 ,969 14 ,164 16,483

Non-Cash Wkg. Cap 157 201 (244) 240 Net Cash/(Debt) 2,626 3,046 3,274 3,866


FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 1,723 2,137 2,801 3,444 Dep. & Amort. 182 228 266 337 Tax Paid (388) (349) (331) (568) Assoc. & JV Inc/(loss) (240) (238) (337) (325) (Pft)/ Loss on disposal of FAs 29 19 9 9 Non-Cash Wkg. Cap. 149 (115) 30 (445) Other Operating CF 120 23 37 467 Ne t Ope ra t ing CF 1,575 1 ,704 2 ,475 2 ,918 Capital Exp. (net) (332) (501) (447) (735) Other Invts. (net) 60 (201) (1,735) (2,660) Invts. in Assoc. & JV - (120) - (127) Div from Assoc. & JV - - - - Other Investing CF (2) (1) (824) 982 Ne t Inve s ting CF (274) (823) (3 ,006) (2 ,541)Div Paid (198) (247) (321) (296) Chg in Gross Debt (44) - 1,637 2 Capital Issues - - - - Other Financing CF (270) (260) (508) (719) Ne t Fina nc ing CF (512) (507) 808 (1 ,014)Chg in Cash 789 374 277 (636)

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 78.5 77.5 76.4 77.7Opg Profit Margin (%) 19.0 17.9 19.3 20.5Net Profit Margin (%) 11.9 10.5 12.2 12.2ROAE (%) 21.2 20.6 25.0 24.8ROA (%) 12.7 11.7 12.5 11.6ROCE (%) 26.7 28.4 28.2 27.7Div Payout Ratio (%) 22.2 23.8 21.2 16.7Interest Cover (x) n.a. n.a. n.a. n.a.Asset Turnover (x) 1.1 1.1 1.0 0.9Debtors Turn (days) 49.9 50.1 51.2 47.1Creditors Turn (days) 58.5 63.1 78.1 86.6Inventory Turn (days) 113.9 111.3 106.7 104.0Current Ratio (x) 2.6 2.3 2.1 1.8Quick Ratio (x) 2.3 1.9 1.9 1.6Net Debt/Equity (X) Cash Cash Cash CashCapex to Debt (%) 808.5 675.2 25.9 42.6N. Cash/(Debt)PS (HK$) 0.35 0.41 0.44 0.52Opg CFPS (HK$) 0.21 0.23 0.33 0.56Free CFPS (HK$) 0.14 0.13 0.23 0.36


FY De c 2H14 1H15 2H15 1H16

Revenue 6,465 7,443 7,107 8,040Cost of Goods Sold (1,629) (1,704) (1,546) (1,706)Gross Profi t 4 ,836 5,739 5,562 6,334Other Oper. (Exp)/Inc (3,391) (4,562) (3,753) (4,952)Ope ra ting Profi t 1 ,445 1,177 1,808 1,382Other Non Opg (Exp)/Inc 188 116 141 33Associates & JV Inc - 188 - 205Net Interest (Exp)/Inc 35 (10) 23 (15)Exceptional Gain/(Loss) - - - - Pre -ta x Pro fi t 1 ,668 1,471 1,973 1,605Tax (217) (257) (276) (239)Minority Interest (570) (287) (846) (357)Ne t Profi t 881 928 851 1,009Net profit bef Except. 881 928 851 1,009

FY De c 2012A 2013A 2014A 2015A

Re ve nue sChinese Medicines 7,283 9,657 11,951 14,046Others 214 244 427 504Tota l 7,497 9,901 12,378 14,550




NOT RATED

Last Traded Price ( 15 Feb 2017):HK$4.87 (HSI : 23,995) Potential Catalyst: launch of new products, ASP increase of bulk drugs and intermediates Analyst Mark Kong +852 2820 4619 [email protected] Price Relative

Forecasts and Valuation F Y Dec (HK $m) 2012A 2013A 2014A 2015A

Turnov er 7,022 7,648 8,030 7,695EBITDA 985 1,639 1,723 1,458Pre-tax Profit 248 901 664 235Net Profit 162 48 681 110Net Pft (Pre Ex.) 162 48 681 110EPS (HK$) 0.11 0.03 0.42 0.07EPS Gth (%) 45.8 (72.4) 1,319.0 (83.8)Diluted EPS (HK$) 0.11 0.03 0.42 0.07DPS (HK$) - - - - BV Per Share (HK$) 3.75 3.98 4.28 4.13PE (X) 45.5 165.1 11.6 71.8P/Cash F low (X) 24.7 7.4 5.7 5.3P/F ree CF (x) n.m. n.m. 11.3 10.4EV /EBITDA (X) 14.0 9.4 8.8 9.4Net Div Yield (%) - - - - P/Book V alue (X) 1.3 1.2 1.1 1.2Net Debt/Equity (X) 1.1 1.2 1.0 0.9ROAE (%) 2.9 0.8 10.1 1.6


Principal Business: The United Laboratories produces and distributes pharmaceutical products. The company's products include finished products, APIs, intermediates and capsules. Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Stretched valuation

A bulk drugs & intermediates producer that intends to improve prospects by lifting sales mix of finished drugs; this has increased from 33% in 2013 to 39% in 1H16

Trading at 19x 17F PE, the valuation seems stretched given the foreign currency risk and potential losses in the bulk drugs & intermediates business for industry overcapacity

The group intends to improve business prospects by shifting focus to finished drugs. Bulk drugs & intermediates makes up over 50% of the group’s revenue. But, this segment is facing industry overcapacity. Hence, to improve business prospects, the group has been increasing the revenue contribution of finished drugs from 33% in 2013 to 39% in 1H16. The insulin series is a finished drug product which has achieved the fastest growth with sales contribution surging from 1.5% in 2013 to 5.3% in 1H16. However, losses incurred by bulk drugs & intermediates and fair value loss on forwards contracts resulted in a net loss of HK$15m in 1H16 for the group.

Stretched valuation. According to Bloomberg, the stock is trading at 19x 17F PE. In our view, this valuation can only be justified if the group can achieve at least 19% earnings CAGR in next five years. We have doubts on this for two reasons: firstly, bulk drugs & intermediates made up 61% of revenue in 1H16. Due to a substantial overcapacity in the industry, this division may continue to incur losses which would drag overall earnings growth; secondly, as at Dec 2016, we estimate the group has close to HK$2bn of debt dominated in US$ or HK$. The group generates most of its revenue in Rmb. As US$ and HK$ are appreciating relative to Rmb, there may be losses incurred as a result. These debts stem from: a) out of borrowings of c.HK$5.2bn as at Jun 16, c.30% were dominated in HK$ and other foreign currencies; b) as at Dec 2016, the company issued convertible bonds to raise US$130m (due 2021, 4.5%, conversion price HK$4.86 per share,c.207m new shares will be issued upon full conversion which equals to c.12.75% of current share number)


Major Shareholders Choy Kam Lok (%) 73.3


67

87

107

127

147

167

187

207

2.3

2.8

3.3

3.8

4.3

4.8

5.3

5.8

6.3

6.8


Relative IndexHK$

United Laboratories (LHS) Relative HSI (RHS)


United Laboratories

Bloomberg: 3933 HK EQUITY | Reuters: 3933.HK Refer to important disclosures at the end of this report


United Laboratories

Page 69


FY De c 2012A 2013A 2014A 2015A

Revenue 7,022 7,648 8,030 7,695Cost of Goods Sold (4,904) (5,011) (4,801) (4,733)Gross Profi t 2 ,117 2,638 3,228 2,961Other Opg (Exp)/Inc (1,673) (1,573) (2,219) (2,324)Ope ra ting Profi t 445 1,065 1,010 637Other Non Opg (Exp)/Inc (1) 12 (6) (96)Associates & JV Inc - - - - Net Interest (Exp)/Inc (195) (176) (340) (306)Exceptional Gain/(Loss) - - - - Pre -ta x Profi t 248 901 664 235Tax (86) (853) 18 (125)Minority Interest - - - - Preference Dividend - - - - Ne t Profi t 162 48 681 110Net Profit before Except. 162 48 681 110EBITDA 985 1,639 1,723 1,458Revenue Gth (%) 9.6 8.9 5.0 (4.2)EBITDA Gth (%) 28.4 66.5 5.1 (15) Opg Profit Gth (%) 43.6 139.5 (5.2) (36.9)Effective Tax Rate (%) 34.8 94.7 (2.6) 53.1

FY De c 2012A 2013A 2014A 2015A

Net Fixed Assets 8,524 9,921 10,204 9,810Invts in Assocs & JVsOther LT Assets 1,007 3,137 2,091 1,837Cash & ST Invts 646 1,081 1,003 1,115Inventory 1,814 1,272 1,418 1,415Debtors 2,182 2,745 2,585 1,976Other Current Assets 1,969 1,444 1,617 1,255Tota l Asse ts 16,142 19,600 18,918 17,408

ST Debt 6,044 6,446 6,036 5,549Creditors 1,269 1,041 1,288 1,060Other Current Liab 1,646 2,377 1,591 1,849LT Debt 1,023 2,165 2,163 1,420Other LT Liabilities 65 1,090 871 811Shareholder's Equity 6,095 6,482 6,969 6,719Minority InterestsTota l Ca p. & Lia b . 16 ,142 19,600 18,918 17,408

Non-Cash Wkg. Cap 3,050 2,044 2,742 1,737 Net Cash/(Debt) (6,421) (7,530) (7,196) (5,855)


FY De c 2012A 2013A 2014A 2015A

Pre-Tax Profit 248 901 664 235 Dep. & Amort. 540 575 713 821 Tax Paid (106) (117) (170) (166) Assoc. & JV Inc/(loss) - - - -(Pft)/ Loss on disposal of FAs 27 50 83 90 Non-Cash Wkg. Cap. (226) 443 194 431 Other Operating CF (185) (787) (92) 76 Ne t Ope ra ting CF 299 1 ,065 1 ,392 1 ,488Capital Exp. (net) (2,740) (2,046) (692) (723) Other Invts. (net) (659) 433 (265) 250 Invts. in Assoc. & JV - - - - Div from Assoc. & JV - - - - Other Investing CF (111) 8 (226) 54 Ne t Inve s ting CF (3 ,510) (1 ,604) (1 ,183) (419)Div Paid - - - - Chg in Gross Debt 2,208 1,054 (198) (851) Capital Issues 700 - - - Other Financing CF 0 (80) (89) (106) Ne t Fina nc ing CF 2,909 974 (286) (957) Chg in Cash (302) 435 (78) 111

FY De c 2012A 2013A 2014A 2015A

Gross Margin (%) 30.2 34.5 40.2 38.5Opg Profit Margin (%) 6.3 13.9 12.6 8.3Net Profit Margin (%) 2.3 0.6 8.5 1.4ROAE (%) 2.9 0.8 10.1 1.6ROA (%) 1.2 0.3 3.5 0.6ROCE (%) 2.5 0.4 6.4 2.0Div Payout Ratio (%) n.m. n.m. n.m. n.m.Interest Cover (x) 2.3 6.1 3.0 2.1Asset Turnover (x) 0.5 0.4 0.4 0.4Debtors Turn (days) 109.9 117.6 121.1 108.2Creditors Turn (days) 95.7 84.1 88.5 90.5Inventory Turn (days) 124.7 112.4 102.2 109.2Current Ratio (x) 0.7 0.7 0.7 0.7Quick Ratio (x) 0.5 0.5 0.6 0.5Net Debt/Equity (X) 1.1 1.2 1.0 0.9Capex to Debt (%) 38.8 23.8 8.4 10.4N. Cash/(Debt)PS (HK$) (3.95) (4.63) (4.42) (3.60)Opg CFPS (HK$) 0.20 0.65 0.86 0.91Free CFPS (HK$) (1.61) (0.60) 0.43 0.47


FY De c 2H14 1H15 2H15 1H16

Revenue 4,329 4,062 3,632 3,504Cost of Goods Sold (2,641) (2,424) (2,309) (2,221)Gross Profi t 1 ,687 1,638 1,323 1,282Other Oper. (Exp)/Inc (1,639) (1,246) (1,078) (991)Ope ra t ing Profi t 49 392 246 291Other Non Opg (Exp)/Inc 15 23 (119) (60)Associates & JV Inc - - - - Net Interest (Exp)/Inc (191) (155) (151) (131)Exceptional Gain/(Loss) - - - - Pre -ta x Profi t (127) 259 (24) 100Tax 98 21 (146) (115)Minority Interest - - - - Ne t Profi t (29 ) 280 (170) (15)Net profit bef Except. (29) 280 (170) (15)

FY De c 2012A 2013A 2014A 2015A

Re ve nue sBulk Medicine 3,298 3,467 3,940 3,272Tota l 3 ,298 3,467 3,940 3,272




Page 70

DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows:

STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

BUY (>15% total return over the next 12 months for small caps, >10% for large caps)

HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends Completed Date: 16 Feb 2017 15:23:15 (HKT) Dissemination Date: 16 Feb 2017 17:25:21 (HKT) GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Vickers (Hong Kong) Limited (“DBSVHK”). This report is solely intended for the clients of DBS Bank Ltd., DBS Vickers Securities (Singapore) Pte Ltd. (“DBSVS”) and DBSVHK, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVHK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., DBSVS and DBSVHK, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”)) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may not contain all material information concerning the company (or companies) referred to in this report and the DBS Group is under no obligation to update the information in this report. This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and (b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments

stated therein. Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBS Vickers Securities (USA) Inc ("DBSVUSA"), a U.S.-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making.



Page 71

ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. As of 16 February 2017, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately.

COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBSVHK and its subsidiaries do not have a proprietary position in the securities recommended/mentioned in this report as of 15 Feb

2017.

2. Compensation for investment banking services: DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively.

3. Disclosure of previous investment recommendation produced: DBS Bank Ltd, DBSVS, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA may have published other investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12 months. Please contact the primary analyst listed in the first page of this report to view previous investment recommendations published by DBS Bank Ltd, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA in the preceding 12 months.

RESTRICTIONS ON DISTRIBUTION

General This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

Australia This report is being distributed in Australia by DBS Bank Ltd. (“DBS”) or DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”) or DBS Vickers (Hong Kong) Limited (“DBSVHK”), which are exempted from the requirement to hold an Australian Financial Services Licence under the Corporation Act 2001 (“CA”) in respect of financial services provided to the recipients. Both DBS and DBSVS are regulated by the Monetary Authority of Singapore under the laws of Singapore, and DBSVHK is regulated by the Securities and Futures Commission of Hong Kong under the laws of Hong Kong, which differ from Australian laws. Distribution of this report is intended only for “wholesale investors” within the meaning of the CA.

Hong Kong This report is being distributed in Hong Kong by DBSVHK which is licensed and regulated by the Hong Kong Securities and Futures Commission.

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Malaysia This report is distributed in Malaysia by AllianceDBS Research Sdn Bhd ("ADBSR"). Recipients of this report, received from ADBSR are to contact the undersigned at 603-2604 3333 in respect of any matters arising from or in connection with this report. In addition to the General Disclosure/Disclaimer found at the preceding page, recipients of this report are advised that ADBSR (the preparer of this report), its holding company Alliance Investment Bank Berhad, their respective connected and associated corporations, affiliates, their directors, officers, employees, agents and parties related or associated with any of them may have positions in, and may effect transactions in the securities mentioned herein and may also perform or seek to perform broking, investment banking/corporate advisory and other services for the subject companies. They may also have received compensation and/or seek to obtain compensation for broking, investment banking/corporate advisory and other services from the subject companies.

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Thailand This report is being distributed in Thailand by DBS Vickers Securities (Thailand) Co Ltd. Research reports distributed are

only intended for institutional clients only and no other person may act upon it.

United Kingdom

This report is produced by DBSVHK which is regulated by the Securities and Futures Commission of Hong Kong. This report is disseminated in the United Kingdom by DBS Vickers Securities (UK) Ltd (“DBSVUK”). DBSVUK is authorised and regulated by the Financial Conduct Authority in the United Kingdom. In respect of the United Kingdom, this report is solely intended for the clients of DBSVUK, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVUK. This communication is directed at persons having professional experience in matters relating to investments. Any investment activity following from this communication will only be engaged in with such persons. Persons who do not have professional experience in matters relating to investments should not rely on this communication.

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As i a n Eq u i t i e s Sa l e s , Sa l e s Tra d i n g a n d R e s e a rc h Co n ta c ts

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Sa l e s Tra d i n g Co n ta c t s Te l : Ema i l :Singapore Vivian Goh 65-6398 6927 viviangohkb@dbsvicke rs.comHong Kong Franco Law 852-2971 1828 [email protected] rs.comLondon Cha rle s Davie s 44-20-7618 1883 cha rle sdavie [email protected] York Brenda Wong 1-212-826 3558 [email protected] rs.com

R e s e a rc h Co n ta c t s Te l : Ema i l :Regiona l Timothy Wong 65-6682 3691 [email protected] Janice Chua 65-6682 3692 [email protected] Kong Carol Wu 852-2863 8841 ca [email protected] rs.comMa laysia Wong Ming Tek 603-2604 3970 mingtek@a lliancedbs.comTha iland Chanpen Sirithana ra ttanakul 662-657 7824 [email protected] rs.comIndonesia Mayna rd Pria ja ya Arif 6221 3003 4930 mayna rd.a [email protected] rs.com

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