China Healthcare:Takeaways from DB Conference

Constructive on 2017 outlook

    Executives attending AC17 were generally more constructive than in 2H16.From a bottom-up perspective, managements remain upbeat while giving 2017guidance slightly above street expectations. From a top-down perspective,both executives and investors expect new risk elements with meaningfulimpact. We expect multiple positive catalysts to materialize in 2017, andhighlight all four top picks that have new product approvals/service ramp-up.

    Positive catalysts may exceed street expectation

    On NRDL revision, executives expect the release either before the CNY or rightafter, ahead of street expectation. We learned that after a formal release of theNRDL, an additional NRDL negotiation would ensue for drugs with high pricessuch as apatinib. We also remind investors that the street does not reflect anyupside for provincial RDL revision. On regulatory approval, we learned thatfuture approvals for innovative compounds may take 3-6 months, much fasterthan the 1-2 years now. On M&A, executives from distribution and hospitalservice sector unanimously expect more opportunities in 2017.

    New challenges emerging; uncertainties with two-invoice system

    While executives from the distribution sector expect positive impact in the longterm, most conceded that part of the indirect sales (IDS) revenue woulddisappear. We highlight that: 1) historic data from the Fujian province suggestthat most big players failed to take market share after the implementation ofthe two-invoice system in Fujian in 2H10; 2) the impact would be associatedwith two elements, magnitude of IDS exposure and conversion to DS (directsales) from IDS. We also believe that the removal of the 15% mark-up is likelyto lead to margin erosion and longer AR for manufacturers. While the street iswell aware of both the risks, we believe it has not factored in the release of thereimbursement pricing, which may have a more significant impact ondistributors and manufacturers than the two-invoice system.

    DB policy survey among executives

    We conducted a survey among executives from 15 H/A listed companiesregarding the impact of recent policies. The key takeaways include: 1) 87% ofthe executives forecast industry growth of 7-9% in 2017; 2) price cut is likely tobe similar to 2016, as suggested by 60% of executives, with the drug tender toremain as the major source of price erosion; 3) 79% of respondents expect afaster approval process from the CFDA; and 4) the majority of the executivesdo not expect additional volume pressure from the implementation of the twoinvoicesystem and removal of the 15% mark-up.

    Top picks are Hengrui, THDB, UM and CBPO; risks

    For CBPO, our TP is based on 31x 2017E EPS. For Universal, our TP is basedon a SOTP valuation, by applying 1.2x on 2017E BVPS of HKD4.73 for medicalequipment leasing and 45x on 2017E EPS of HKD0.09 for hospitalmanagement. For Hengrui, our TP is based on 40.5x 2017E EPS. For THDB, ourTP is based on 50x 2017E core EPS of RMB0.56. Key risks include unfavorablepolicy headwinds, product launch delays and industry growth deceleration.We will host a group client teleconference on conference takeaways at 9:30amHKT, January 16. Dial-in: +852 30512792, passcode: 47508734.