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Wuxi Biologics (2269 HK) Bullish business update

• Management guided that limited impact from Pfizer and Merck’s oral Covid-19 treatments is expected as revenues for its Covid-19 related projects for 2021 and 2022 are already locked in, while its non-Covid19 projects should continue to see robust growth in 2022E.
• Current capacity utilization is running at almost full capacity, excluding new acquisitions.
• Fair value is adjusted to HKD152. The firm’s solid operational performance is expected to continue, despite worries over a slowdown in the domestic environment and more stringent regulations.

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Bullish business outlook reiterated

Management held a quick investor call today to address the recent share price weakness following Pfizer and Merck’s strong clinical data posted on their Covid-19 oral treatments, which suggested investor worries about the impact of a potential decline in Covid-19 related projects on CRO players.

The team highlighted that impact from the oral drug development from Pfizer and Merck should be limited on Wuxi Biologics given that revenues for Covid 19 related contracts for 2021 and 2022 are locked in while ma rket demand for Covid 19 vaccines remains stron g. Its non Covid19 projects should also grow more than 70% in 2022.

The firm expects to receive about USD3bn and USD2bn this and next year respectively in Covid-19 related project revenues (vs 1H21’s CNY1.3bn revenues from such projects), and believes its non-Covid project revenues could grow more than 70% in 2022E. The growth drivers will be from its continued successful execution of its win/follow the molecule strategy with high number of integrated projects acquired which will sustain growth, as well as the natural progression of its ongoing projects which will evolve from early to mid and late stages/commercialization. In this regard, the firm believes that there are around 10 projects that have blockbuster potential, which provides the firm with confidence it should see sustained growth into 2023.

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To date, the firm has not observed any potential slowdown from its clients in securing biotech funding and believes there is no overcapacity issue in the global biologics manufacturing space. Management estimates the top 10 players have about 40% market share, amongst the 100+ global CDMOs competing. Wuxi plans to add capacity to capture biologics demand growth and expects to add another ~100kL in capacity next year and further ~430kL by 2024, with capex guided at CNY5bn in FY22E and CNY4-5bn in the following two years. As per management’s recent update, there was about 1513 projects in its pipeline (3Q saw 433 added) as of end September, which included 441 integrated projects (added 30+ in 3Q). 2 CMO projects were also added in 3Q, one from Gloria’s PD-1 and another from a global pharma. Looking ahead, management expects one more CMO project in FY21E, 2-4 yearly in 2022 and 2023, and targets 4-6 yearly in 2024-2025. This implies total CMO projects could come up to 19 by FY2025E. The firm expects to turn positive free cashflow from FY22E.

Current capacity utilization is running at almost full capacity, excluding new acquisitions such as new plants at Suzhou and Hangzhou (both at about 50% utilization due to ramping up of talent recruitment to bring the plants to full operations). The CMO business is expected to contribute half of total revenues in 2023.

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The CRO/CDMO industry in China may see further consolidation near term in the face of increased stringent reg ulations from CDE CDE.

Management believes this could benefit market leaders and cut out lower quality competitors over time. While the recent more stringent CDE guidelines is expected to negatively impact the Chinese healthcare industry for the short term, this should be positive in raising quality standards over the longer run as it creates healthy competition to promote innovation. For domestic clients who can afford Wuxi Biologics’ higher fees, the end goal typically goes beyond the domestic market which means the standards to be adopted for drug development should already be in sync with global requirements. Management highlighted that many of its clients have already started to adopt higher standards some 3 to 5 years ago, and shared that it has seen accelerated growth from its Chinese client base, as opposed to any slowdown in the number of projects won domestically.

The company has also just secured a mRNA non Covid 19 project from a domestic firm, which is meaningful in taking its first step in this area and provides it with an opportunity to validate its capabilities to service more advanced modalities. This opens the door for future such business opportunities given that many firms are working mNRA currently. Overall momentum in China has picked up pace with various modalities under development which include ADC and bispecifics. The firm expects top line growth could come in at ~75% and ~45% for FY21E and FY22E respectively, driven by non-Covid-19 projects (particularly late stage and commercial stage projects) and continued capacity improvements.

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Fair value is slightly lowered to HKD152 (from a prior HKD160) as we adjust our estimates following the latest management call and lift our cost of equity assumption within our discounted cashflow analysis. Overall, we continue to expect a solid operational performance into FY22E despite current worries over slowdown in domestic environment and more stringent regulations. The company’s strong additions to its total backlog should continue to underpin growth visibility, driven by successful execution of its follow-the-molecule and win-the-molecule strategies and continued resilience in outsourcing demand globally.

ESG Updates

The firm still pegs in the top 41% of global peers being covered despite the downgrade in July 2020 from “AA”. While the firm scores well in governance and product safety & quality categories (performance appears to be stronger than peers), its positioning relative to global peers is rated negatively for human capital development and carbon emissions, with more room for improvement cited in areas such as limited policies observed to address issues such as business ethics and corruption. Wuxi Biologics is committed to ICH Q5Q (R1) standards in terms of raw material supplements and conducts regular employee training and quality related audits in its operations, with no major product recalls over the past three years although there was one Form483 (as of November 2020). It has also taken steps to work on its talent management practice and implemented an independent employee engagement program from a third party to track employee satisfaction and retain productivity and staff morale. Fair value of HKD160 is based on DCF valuation, which incorporates the latest guidance of higher growth expectations, long-term growth rate of 3.8%, increased CMO revenue contribution and the company’s higher than domestic peers. BUY. (Research Team)