Tianjin Zhongxin Pharmaceutical Group - Negatives likely priced in

■ At 70% of our full year forecast, Tianjin Zhongxin’s 9M15 core net profit was slightly below our expectations, due mainly to lower contribution by associates.

■ 9M15 headline net profit rose 30% yoy, boosted by one-off gains. Excluding one-offs, 9M15 core net profit declined 3.9% yoy.

■ We cut FY15-17F core EPS by 7-9% to reflect lower GPM due to the expected intensifying competition in the public tendering process for pharmaceuticals.

Maintain Add, with lower DCF-based target price of US$1.40 (rollover to end-CY16).

9M revenue fell 1.2% yoy due to lower sales of Western medicine
In 9M15, group revenue fell 1.2% yoy to Rmb5.03bn (9M14: Rmb5.09bn) due to the decline in sales of low-margin Western medicines (mostly owned by third-parties. As the group only has the distributorship, it earns lower margins on these products). As a result, the group’s overall gross margin (GPM) improved 0.7% pt to 31.0% in 9M15 (9M14: 30.3%). In 9M15, gross profit rose 1.1% yoy to Rmb1.56bn (9M14: Rmb1.54bn).

Net profit boosted by one-offs, offset by lower associate profit
Headline net profit rose 30% yoy to Rmb337m in 9M15 (9M14: Rmb274m), boosted by one-off gains of Rmb116m from the disposal of its equity interests of 30% in Baxter Healthcare and 40% in Hualida Biotech but partially offset by lower contribution from the 25%-owned Sino-American Tianjin Smithkline & French Lab. Excluding the one-offs, the group’s core net profit declined 3.9% yoy to Rmb244m in 9M15 (9M14: Rmb254m).

Margins may be pressured by stiffer competition in FY15-17
Management highlighted the uncertainty related to the government’s procurement policy for pharmaceuticals. Based on our rough estimates, c.50% of the group’s traditional Chinese medicine (TCM) sales in 9M15 came from generic products (more vulnerable to likely stiffer competition in the new public tendering process). We cautiously cut FY15-17 EPS by 7-9% to incorporate the expected downward pressure on margins.

Expansion projects on track
The group raised Rmb814m via a placement in the A-share market in Jul 2015 to finance:

1) upgrading of its marketing and sales network,

2) construction of Bozhou Industrial Park, and

3) development of vegetable beverage projects.

To date, Rmb33m of the capital raised has been invested and the remainder is expected to be deployed in FY15-17. Based on management’s IRR guidance of 15-20%, we estimate that the investments will generate operating profit of Rmb120m-160m p.a. in FY18 onwards.

Technical Analysis
Daily Chart
More compelling valuations than China and Hong Kong peers
Tianjin’s S-share currently trades at 63% discount to its A-share. The S-share’s CY16 P/E of 14.6x is more compelling than the 16.7x average of its Hong Kong peers and 26.6x of its China peers. Organic earnings growth from the rising pharmaceutical demand in China is a key potential re-rating catalyst. (Read Report)

Source : CIMB Research

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