In-depth analysis: cloudy prospects from potential price cuts
- Raised FY22F/23F earnings by 35%/70% and TP by 50%; upgrade to HOLD to factor in sales volume increase driven by release of favourable polices in 1Q22
- Threatened by intensifying competition for concentrated Chinese medicines granules segment (CCMG, 69% of FY21 sales) with competitors increased from 4 in 2021 to 47 in Mar 2022
- Price pressure increasing for finished Chinese medicines segment (18% of FY21A sales) as joint-province tender of these products began in 1Q22 with average price cut of 42%. The tender will continue in future
Raised FY22F – 23F earnings by 35% and 70% and upgrade to HOLD for favourable policies to boost industry sales volume. We raise our annual sales growth in FY22F-23F assumption from 9% and 2% to 21% for both years, and FY22F-23F net margin from 8.3% and 7.2% to 9.2% and 8.5%. This is because we believe the following favourable policies released in Mar 2022 and Dec 2021 can boost the sales volume of Chinese medicines industry.
On 29 Mar 2022, the State Council issued “Development of Chinese medicines industry in the 14th five-year plan” (“The Plan”). We believe various measures in the plan will boost the sales volume of Chinese medicines. For example, the number of Chinese medicine medical institutes will increase from 72.3k in 2020 to 95k in 2025. Another example, the number of beds allocated to Chinese medicines ward in public hospitals will increase from 67.5k in 2020 to 84.3k in 2025. These measures would drive the demand of Chinese medicines.
On 14 Dec 2021, National Healthcare Security Administration issued “Chinese medicines industry: guidance to support inheritance of tradition and innovation” (“The Guidance”). While the price of medical products in public hospitals are not allowed to be marked up over procurement cost when sold to patients, the Guidance stipulates that herbal decoction pieces are allowed to be marked up by 25%. CCMG is classified under herbal decoction pieces. The Guidance encourages public hospitals to sell more of these products.
Previously, our TP was based on a 50% discount to average industry PE due to regulatory risk. The release of favourable policies on industry sales volume has prompted us to believe the risk is reduced. Thus, we have trimmed the discount to 35%. Rolling over to 2022F, and based on 35% discount to industry PE, we derive a target PE of 9x (22F) and TP of HK$4.5. Thanks to the supportive policies, we upgrade to HOLD.
However, share price is stilled clouded by potential price cuts. We upgrade to HOLD instead of BUY because we believe the potential price cuts on CCMG, herbal decoction pieces, finished Chinese medicines will be a drag on the share price performance.
In 2021, CCMG, herbal decoction pieces, finished Chinese medicines made up 69%, 18%, 7% of revenue, or 95% in aggregate. These are all facing increasing price pressure due to:
Firstly, intensifying competition, particularly CCMG. The Government is allowing more players to participate in this industry. The number of players approved by the central government has increased from 5 at the beginning of 2021 to 52 as of Mar 2022 (see: ????????????????????????? – ??????????? (hubei.gov.cn) ), and competition has drastically intensified. The pricing pressure should increase due to this, and thus we expect gross margin of CCMG to drop 0.5ppt annually in 2022-24. Also, the marketing cost will increase to gain or retain market share. Thus, we expect distribution cost as a % of sales to rise 1ppt annually in 2022-24.
Secondly, the National or joint-province tenders imposed by government. This would impact finished Chinese medicines first. In 1Q22, public medical institutes in 19 provinces jointly completed the tender for 182 Chinese medicines, with average price cut of 42%. The National Healthcare Security Administration re-iterated that they will continue this sort of tender. CCMG is classified under herbal decoction pieces. We believe National or joint-province tender will be imposed on this too because:
- There are provinces already doing it. The Shanxi provincial government in Mar 2022 initiated a tender for 21 kinds of herbal decoction pieces, Beijing government started the tender for both herbal decoction pieces and CCMG in Feb 2022;
- Sufficient competition is a criteria for National or joint-province tenders. In terms of number of players in CCMG, finished Chinese medicines, herbal decoction pieces, there are 52, >1600, and >1000. We believe this is sufficient.