20180917-中国银河国际证券-康哲药业-00867.HK-ASP_pressure+concerns_about_the_business_model_downgrade_to_HOLD_5页_1mb

Summary of China Medical System (867.HK)

Core Content

China Medical System (CMS) is a contracted sales organization (CSO) primarily involved in the promotion and marketing of pharmaceutical products, with its key products being Deanxit and Plendil. These products account for approximately 43% of CMS's total revenue and are expected to be affected by the Group Procurement Organization (GPO) policy. The GPO may lead to ASP (Average Selling Price) cuts, which could negatively impact CMS's earnings. Additionally, the company's business model, which relies heavily on academic promotion and marketing to drive drug volume, is at risk due to the potential reduction in secured volume under GPO.

Main Concerns and Key Points

• ASP Pressure: Deanxit and Plendil are not directly listed in the first-round GPO list, but are expected to face ASP cuts once they complete the consistency evaluation.
• Business Model Risk: The CSO model is vulnerable to GPO's impact on secured volume, which could significantly reduce the value of CMS's operations.
• Scenario Analysis:
  • Optimistic Case: If CMS can secure a 30% volume increase and upstream manufacturers lower ex-factory prices by 20%, combined with a 20% reduction in selling expenses, a 40% ASP cut could be largely offset.
  • Worst Case: If CMS does not accept ASP cuts and sacrifices secured volume, operating profit in 2019E may be revised down by 14%.
  • Best Strategy: Accepting ASP cuts is preferable, as it allows for potential negotiation and mitigation of losses compared to sacrificing volume.

Key Financials (2016A–2020E)

Earnings Impact Scenarios

• Scenario 1 (ASP Cut + Volume Increase):
  • Case 1: -40% ASP cut, 10% volume increase → -14.6% revenue impact
  • Case 2: -40% ASP cut, 20% volume increase → -12.0% revenue impact
  • Case 3: -40% ASP cut, 30% volume increase → -9.5% revenue impact
  • Case 4: -40% ASP cut, 40% volume increase → -6.3% revenue impact
• Scenario 2 (No ASP Cut + Sacrificed Volume):
  • Case 1: 15% selling expense saving → moderate GPM decline
  • Case 2: 40% selling expense saving → more significant GPM decline

Investment Recommendation

• Rating: HOLD (Downgraded from BUY)
• Reason: Due to the potential systematic de-rating risks from the GPO policy, especially for the CSO model.
• Target Price: HK$12.1 (11x 2019E PER, 2 standard deviations below historical average)
• Current Price: HK$10.58 (as of Sep 14, 2018)
• Price Performance: +14.4% from current price to target price

Market and Company Overview

• Market Cap: USD 3,352m
• Shares Outstanding: 2,487.2m
• Auditor: Deloitte
• Free Float: 49.7%
• Major Shareholder: Lam Kong (46.04%)
• Key Ratios:
  • Growth:
    • Sales: 37.9% (2016A), 9.1% (2017A), 17.3% (2018E), 16.3% (2019E), 14.7% (2020E)
    • EBIT: 40.5% (2016A), 20.7% (2017A), 24.3% (2018E), 14.8% (2019E), 14.0% (2020E)
    • EBITDA: 46.4% (2016A), 19.8% (2017A), 24.7% (2018E), 14.0% (2019E), 13.3% (2020E)
  • Profitability:
    • Gross margin: 59.4% (2016A), 65.0% (2017A), 58.8% (2018E), 58.4% (2019E), 58.2% (2020E)
    • Core net profit margin: 28.5% (2016A), 31.3% (2017A), 32.9% (2018E), 32.9% (2019E), 32.5% (2020E)
    • ROE: 22.3% (2016A), 22.9% (2017A), 23.9% (2018E), 23.6% (2019E), 22.9% (2020E)
• Balance Sheet Ratios:
  • Current ratio: 1.0 (2016A), 4.5 (2017A), 4.7 (2018E), 5.7 (2019E), 6.8 (2020E)
  • Quick ratio: 0.9 (2016A), 3.8 (2017A), 4.0 (2018E), 5.0 (2019E), 6.0 (2020E)
  • Cash ratio: 0.1 (2016A), 1.3 (2017A), 1.9 (2018E), 2.8 (2019E), 3.8 (2020E)
  • Total debt to equity ratio: 26.0% (2016A), 0.9% (2017A), 2.5% (2018E), 2.0% (2019E), 1.8% (2020E)

Analyst Notes

• Analyst: Harry He
• Head of Research: Wong Chi Man, CFA
• Contact: Harry He – (852) 3698-6320, harryhe@chinastock.com.hk
• Investment Thesis: The downgrade to HOLD reflects concerns about the potential negative impact of GPO on CMS's core business model and earnings. Investors are advised to avoid CMS until there is more clarity on the policy side.

Disclaimer and Disclosure

• This report is issued by Galaxy International Securities and is not intended for distribution in jurisdictions where it may be unlawful.
• The report contains opinions and estimates that may not reflect those of China Galaxy International or its subsidiaries.
• The company may have financial interests in the subject company, and certain individuals may hold positions or have interests in the company.
• The analyst certifies that the views expressed are their personal views and not influenced by compensation or trading activities.