Tianjin ZhongXin Pharmaceutical Group Corporation - UOB Kay Hian 2017-08-02: Reforms Could Unlock Deep Value In This TCM Giant

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TIANJIN ZHONG XIN PHARM GROUP T14.SI

Tianjin ZhongXin Pharmaceutical Group Corporation (TIAN SP) - Reforms Could Unlock Deep Value In This TCM Giant

• A renowned TCM pharmaceutical giant, Tianjin ZhongXin Pharmaceutical Group Corporation (TJZX) presents a unique opportunity with a deep discount between its A- and S-shares. 
• The latest reforms could unlock great value with a delisting possible while its strong brand equity and R&D efforts (851 patents) make it a winner in a growing TCM pie. 
• We expect ASP hikes to lead to a 14.9% net profit CAGR in 2016-19 with 2018 net cash of US$0.17/share and 4.3% yield. 
• Initiate coverage with BUY and US$1.66 target price, based on 15.5x peer average FY18F PE.

INVESTMENT HIGHLIGHTS

Initiate coverage with BUY and PE-based target price of US$1.66, implying a 65.6% upside. 

• At 9.4x 2018F PE, Tianjin Zhong Xin Pharmaceutical Group Corporation (TJZX) trades at a significant 39.4% discount to regional peers (15.5x 2018 PE) and a massive ~61% discount to its A-shares listed in Shanghai (23.8x 2018F PE, currently Rmb17.1 or US$2.55).

Renowned TCM giant with superb brand equity and 851 patents. 

• TJZX is a renowned Traditional Chinese Medicine (TCM) giant that started in 1955. Boasting a complete industrial and product chain, it is among the top four TCM product exporters in China. 
• Its brand portfolio includes three-centuries-old brands hailed as China’s Time-honoured Brands. Along with 851 patents, its products include hundreds of drugs - including four designated as “National Treasures”, with the Su Xiao Jiu Xin Pill classified as a “National Secret” and others considered “Confidential to the State”. 
• 85 of its drugs are also on the Essential Drug List (which hospitals are required to stock) and 271 under the national medical insurance system.

ASP hikes to lead 14.9% CAGR profit growth for 2016-19. 

• With hospitals in 20 (out of 23) provinces accepting a 30% price increase on TJZX’s top drug (OTC prices will increase 20%), TJZX could achieve 14.9% profit CAGR for 2016-19. 
• The Su Xiao Jiu Xin Pill accounted for close to 30% of 2016 revenue. Demand for the pill should hold steady given low price elasticity and there is room for further price hikes even while still qualifying as a low-cost drug ( < Rmb5/day) 

SOE reforms could unlock deep value of S-shares with possible delisting. 

• The latest round of SOE reforms has opened up several possibilities with some already in progress: 
  1. Increase in dividends is likely to continue with a dividend payout floor, 
  2. delisting of S-shares, 
  3. asset restructuring, and 
  4. greater private ownership. This could unlock the deep value of the S-shares. 

TCM reforms enlarge overall pie, tapping on Belt and Road for global growth.

• China is making TCM a national strategy, intending to grow it as a key pillar of its healthcare system, complemented by Western medicine. 
• Tapping on China’s broader Belt and Road Initiative, there are plans to increase TCM exports with the aim of receiving US FDA and EU EMA approval. 
• While the increased interest will bring about new competition, TJZX’s tremendous brand equity acts as an economic moat that should allow it to capture more of this enlarged pie. 

Robust cash flow and healthy balance sheet sustain dividend yield. 

• With its robust cash flow generation, TJZX is running at US$0.17/share 2018F net cash balance (16% of its current price). This should sustain an attractive 2018F dividend yield of 4.3%.

Initiate coverage with BUY and target price of US$1.66 based on 15.5x 2018F PE.

• On the back of China’s supportive policy for TCM, we like TJZX for its: 
  1. strong portfolio of Time-honoured Brands, 
  2. solid market positioning of its core product, 
  3. beneficiary of China’s Law on TCM, 
  4. potential M&A as a result of China’s ongoing SOE reform, and 
  5. attractive valuation and dividend yield at 9.4x 2018F PE and 4.3% 2018F yield. 

We value TJZX at US$1.66, pegged to peers’ average of 15.5x 2018F PE.

• TCM plays an important role in Chinese society and the Chinese Central Government hopes to ensure the longevity and significance of TCM through its promotion, as well as integration with Western medicine. 
• China’s removal of price caps for most medicine back in 2015 and the recent passing of legislation to raise the status of TCM are a boon for the TCM industry amid rising costs and previously-capped medicine prices. 

We project profit attributable to shareholders to grow at 14.9% CAGR for 2016-19.

• We expect a surge in revenue and an accompanying margin expansion based on: 
  1. implementation efforts of higher hospital tender prices for its key product Su Xiao Jiu Xin pill, 
  2. favourable government policies on and investments in TCM R&D, 
  3. changing consumer perception of TCM, 
  4. wider applications of key products, and 
  5. increased demand for TCM due to high incidence of chronic diseases arising from an ageing population. 

Profit forecast conservative compared to Bloomberg consensus. 

• Our profit forecast remains conservative compared to the Bloomberg consensus average and leaves much room for upside as average Bloomberg profit forecast for 2017 is Rmb566m (UOBKH: Rmb467m) and for 2018 is Rmb685m (UOBKH: Rmb551m). 

Peer Comparison 

Fair value at 15.5x 2018F PE. 

• The region’s listed TCM peers are trading at an average of 15.5x 2018F PE. Although TJZX boasts a respectable ROE along with a net cash position, it is trading at a much cheaper valuation in terms of PE, P/B and yield. On an ex-net cash basis, TJZX is trading at only 7.9x 2018F PE. 
• We attribute peers’ higher PE trading range to TJZX’s lower visibility among investors, resulting in a lack of understanding of its operating environment and its core value in the Singapore market. The depressed valuation could have been further compounded by the negative connotations surrounding Chinese companies listed on the Singapore Exchange (SGX). 
• Given TJZX’s status as an SOE with a portfolio of well-recognised brands and strong market positioning, it is more than fair for TJZX to trade at 15.5x 2018F PE, or on a par with non-A-share peers. 

Closest Chinese peer is Tasly, held by private shareholders. 

• In terms of business, one of its closest China-listed peers is Tasly Pharmaceutical (600535). However, unlike TJZX which is an SOE, Tasly is owned by private shareholders. Tasly has seen more aggressive growth and employee-motivation strategies than a more conservative TJZX (whose very strict credit terms are not conducive to fast growth but result in healthy cash flows). 
• Sanity check required as discounts for other dual-listed A-shares average only 21.2%. Comparing TJZX’s A-shares listed on the Shanghai Stock Exchange (SSE) and S-shares listed on the SGX), S-shares (at US$1.005) are trading at a 61.3% discount to A-shares (at Rmb17.46, or US$2.60). 
• We opine it is time for a sanity check as the discounts between pharmaceutical firms’ A-shares and their dual-listed foreign bourses shares are only 12.5-30.0% compared with TJZX’s 61.3%. As the Singapore market has a better understanding of TJZX, this discount should narrow to a more reasonable level. 

Edison Chen UOB Kay Hian | Yeo Hai Wei UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-02

UOB Kay Hian SGX Stock Analyst Report BUY Initiate BUY 1.66 Same 1.66