Tianjin Zhongxin Pharmaceutical Group (TIAN SP) - UOB Kay Hian 2018-04-02: 4Q17 Results Above Expectations, Anticipating A Stellar 2018

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TIANJIN ZHONG XIN PHARM GROUP T14.SI

Tianjin Zhongxin Pharmaceutical Group Corporation (TIAN SP) - 4Q17 Results Above Expectations, Anticipating A Stellar 2018

• Tianjin Zhongxin Pharmaceutical Group’s (TJZX, 天津中新药业) 4Q17 profit beat expectations, surging 63.7% y-o-y and exceeding our 17 forecast by 4.5%. This is the first quarter where benefits from the long-awaited price hike for its key drug have kicked in, and results should sustain. In view of the:
  1. favourable industry outlook,
  2. ongoing price hike for TJZX's key drug, and
  3. fresh initiatives by the new management team, 
  we anticipate a stellar 2018 and beyond. 
• Maintain BUY with target price raised to US$1.66, pegged to peer average of 14.1x 2018F PE.

RESULTS

4Q17: Net profit surged, exceeding full-year expectation. 

• Buoyed by strong margin expansion, Tianjin Zhongxin Pharmaceutical Group’s (TJZX) 4Q17 PATMI surged 63.7% y-o-y to Rmb118.2m, bringing full-year PATMI to Rmb473.3m, which is 4.5% above our forecast.

Revenue decline expected as TJZX focuses on high-margin segment. 

• In line with expectations, revenue for distribution business decreased 9.9% y-o-y while that of the drug manufacturing business increased 4.7% y-o-y. As previously explained, in view of the two-ticket system (which eliminates the unnecessary drug distribution middleman), TJZX had been scaling down its drug distribution segment (2016: ~10% gross margins) while focusing on its key profit driver – its drug manufacturing segment (2016: ~55% gross margins).

Price hike for key product boosted margins. 

• 4Q17 was the first quarter where the price hike for TJZX’s key product Su Xiao (速效救心丸) began to benefit the company. As a result, gross margin for the drug manufacturing business increased to beyond 60%, lifting 4Q17 blended gross margin to 41.3% (+6.3 ppt y-o-y).

STOCK IMPACT

This is just the beginning. 

• With 4Q17’s stellar results vindicating our thesis, and demonstrating how well Su Xiao’s price hike benefits TJZX, investors should expect more to come in the subsequent years. As management had previously explained, the price hike impact will be gradual with meaningful impact to be seen in 2018 and the full impact in 2019. 
• Furthermore, the new management team has rejuvenated the sales force and cultivated new channels such as e-commerce to drive sales volume. As such, we reiterate our view that TJZX is on the cusp of a multi-year growth story.

Focus on major products set to pay off. 

• Management’s strategy of focusing on major products has started to pay off, with revenue for its top 11 products growing 12.31% y-o-y to Rmb1.9b. Beside Su Xiao, we also see Tong Mai (通脉养心丸) and Wei Chang An (胃 肠安丸) becoming new star drugs that see deeper product penetration into new retail channels, thereby serving as key future profit drivers.

Consolidation of overlapping business departments drove margins higher to make up for decline in distribution business. 

• Through economies of scale, the consolidation of procurement processes of Bozhou Industrial Park, No. 6 Chinese Medicine Plant and Tianjin Chinese Medicinal Slices Co are beginning to show results in the form of lower cost of raw materials. 
• In 2017, raw material costs dropped to Rmb755.0m (-5.34% y-o-y) from Rmb797.5m in 2016. The margin expansion of drug manufacturing more than made up for the revenue decline in the distribution business (which was beset by the two ticket system).

EARNINGS REVISION/ RISK

Upside adjustment for 2018-19 earnings. 

• We tweak our 2018-19 attributable net profit to Rmb569.4m (+4.4%) and Rmb670.6m (+3.5%) respectively. We factor in:
  1. higher growth of TJZX’s other major products,
  2. a sharper revenue decline for its distribution business and the corresponding improvement in gross margin as lower margin accounts are phased out, and
  3. interest expense as management continues to utilise low interest rate working capital loans to fund their operations despite a substantial cash hoard.
• We introduce our earnings estimates for 2020 with a conservative 6.8% growth from 2019 (which has a high base as the full benefit of Su Xiao’s price hike is seen). 
• Our 2020 estimates assume total revenue growth of 3.5% on the back of increased demand for Su Xiao, Tong Mai and Wei Chang An, and as costs efficiencies are reaped through the streamlining of organisations, thus leading to net income margin stabilising at 11.3% (2018: 9.7%, 2019: 11.0%).

Significant upside risks if management is incentivised to perform. 

• TJZX’s parent is undergoing SOE reform and TJZX’s new management team is aligning its direction with shareholders’ through profit-based incentives. If the new management remuneration scheme is aligned with financial performance or even stock performance, we would see significant upside risks to our current forecasts. 
• Our current profit forecasts are 8.6% and 8.2% below China A-share analysts’ for FY18 and FY19 respectively.

VALUATION/ RECOMMENDATION 

• Maintain BUY with a higher PE-based target price of US$1.66, pegged to peers’ average of 14.1x 2018F PE and based on Rmb6.29/US$. 
• While TJZX is smaller than its peers in terms of market capitalisation, its ROE is similar to the peer average while valuation is much cheaper. We think TJZX is poised for a major turnaround as its blockbuster drug experiences a substantial price appreciation in the Chinese market.

SHARE PRICE CATALYST

• Benefits of price hike coming in stronger than expected.
• Announcement of positive impact from relevant reforms, ie injection of private ownership, and the delisting of Singapore-listed shares.

Edison Chen UOB Kay Hian | Yeo Hai Wei UOB Kay Hian | http://research.uobkayhian.com/ 2018-04-02

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.66 Up 1.520