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Equity Research | Healthcare Oct 31, 2016

Traditional Chinese Medicine Industry


Modernization creating opportunities and driving growth

Natalie Chiu Traditional Chinese medicine market to expand rapidly Traditional Chinese Medicine
SFC CE No. AVH029 (TCM) in China enjoyed more rapid growth than other segments of the pharmaceutical
nataliechiu@gfgroup.com.hk industry in 2011-14. Driven by an increasingly aging population, rising GDP per capita,
+852 3760 2030 expanding medical insurance programs and urbanization, we believe it will continue to
expand rapidly, delivering a 15%+ CAGR in sales during 2015-19. The industry will also
GF Securities (Hong Kong) Brokerage Limited benefit from favorable government policies for the Chinese medicine industry, and we
29-30/F, Li Po Chun Chambers
expect it to be globally competitive over the long term. For Chinese patent/finished
189 Des Voeux Road Central
medicines, companies face a tougher operating environment due to slower organic growth
Hong Kong
amid tough competition. For modern Chinese medicines, favorable policies are leading to
the emergence of new companies.

Sector trading at an unjustified discount The Chinese medicine segment is now


trading at 15x 2017E P/E, vs 17x for chemical drugs players. We believe this discount is
due to a lack of understanding among investors of individual companies’ business models.
Solid earnings and industry consolidation could trigger a re-rating. Overall, we believe the
near-term risk-reward profile is attractive.

Initiating coverage of China TCM, Kingworld Medicines, and Beijing Tong Ren Tang
We initiate coverage of China TCM (570 HK, Buy), Kingworld Medicines (1110 HK, Buy),
and Beijing Tong Ren Tang CM (8138 HK, Accumulate) with one-year target prices of
HK$5.20, HK$1.80 and HK$12.30, respectively, implying 30%, 22% and 9% upside from
their latest closing prices.

China TCM is the TCM arm of China National Pharmaceutical Group Corporation,
Sinopharm’s (1099 HK, NR) parent company The company produces traditional patent
medicines (finished TCM) and modern Chinese medicine (concentrated TCM granules,
or CCMG). The company has a diversified finished TCM portfolio with more than 500
prescription and OTC products. In concentrated TCM granules, it is among the top-five
CCMG players that together account for 50% of the market.

Kingworld Medicines to grow through M&A and organic development Kingworld has
a sound growth strategy, aiming to: 1) expand its high-GM product offerings; 2) increase
online sales, and; 3) penetrate lower-tier city markets. With a proven ability for product
integration, we expect the company to continue to grow faster than the industry average
during 2016-18, with further penetration into lower-tier provinces and cities, and improved
profitability through a better product mix and greater operating efficiency.

Beijing Tong Ren Tang Medicine is the largest proprietary Chinese medicine
exporter in China With 62 self-operated stores outside China, Tong Ren Tang CM now
has one of the largest TCM retail networks in Asia. The company operates a TCM clinics-
centric model and relies on product revenue generated from providing TCM consultation
services. It currently offers two self-manufactured products: Angong Niuhuang Pills and
ganoderma lucidum spores powder.

Stock valuations
Mkt Cap P/E (x) Net profit growth (%) EPS growth (%) PEG (x) Revenue growth (%) ROE (%)
Ticker Rating (HK$ m) Price TP FY15 FY16E FY17E FY18E FY15 FY16E FY17E FY18E FY15 FY16E FY17E FY18E FY17E FY15 FY16E FY17E FY18E FY15 FY16E FY17E FY18E
Guangzhou BYS 874 HK NR 44,629 19.08 NR 15.4 15.9 14.7 13.5 9 9 13 6 7 (4) 9 8 1.7 2 6 6 1 16.1 14 13 14
CTCM 570 HK Buy 17,682 3.99 5.20 20.4 13.5 11.3 9.8 51 85 21 17 3 51 20 16 0.6 40 83 17 16 9.1 10 11 12
TRT Tech 1666 HK NR 19,929 15.56 NR 30.0 26.9 23.6 21.7 17 32 14 13 14 12 14 9 1.7 19 14 14 6 14.4 13 14 15
TRT CM 8138 HK Accumulate 9,309 11.12 12.30 26.7 21.0 18.3 15.8 23 28 16 17 20 27 15 16 1.0 28 13 15 16 20.9 22 22 19
Kingworld Med 1110 HK Buy 915 1.47 1.80 26.7 15.4 10.4 8.2 (18) 79 50 28 (22) 73 48 27 0.2 8 41 20 17 5.0 9 12 14
Shineway 2877 HK NR 6,674 8.07 NR 8.2 10.1 10.1 12.6 (7) (22) (6) (5) (8) (19) 0 (20) NA (8) (13) (3) (1) 12.9 9 9 8
Simple average 21.2 17.1 14.7 13.6 13 35 18 13 2 23 18 9 1 15 24 11 9 13 13 13 14

Sources: Company data, GF Securities (Hong Kong)


Note: As of Oct 18, 2016
Sector report Oct 31, 2016

Traditional Chinese medicine sector to grow faster than chemical drugs in


2016-20
In 2011-14, the traditional Chinese medicine (TCM) sector grew faster than chemical drugs but
slower than biologics. Frost & Suillivan estimates that the segment will continue to expand rapidly
and deliver an 8.2% CAGR in sales during 2016-20. In 2015, wholesale revenue for TCM products
in China reached approximately Rmb392bn, and accounted for around 32% of the country’s total
pharmaceutical market. In terms of sales volume, TCM currently represents around two-thirds of
drug sales in China. The faster growth in TCM compared to the conventional drug industry is
attributable to: 1) government investment and favorable policies for the healthcare sector; 2)
increasing demand for TCM due to the high incidence of chronic diseases; 3) extended applications
of Chinese medicines, and; 4) changing consumer perceptions of Chinese medicines.

Figure 1: Breakdown of China’s pharmaceutical market (2011-


2020E)
Rmb bn, at wholesale level
2000
CAGR 2011-15 2016-20E
1800
Chemical drug 9.6% 5.1%
1600 333.3
TCM 16.8% 8.2%
298.7
1400 Biologics 25.0% 18.1% 258.7
225.4
1200 Total 13.2% 8.0% 180.1
145.3 580.6
116.7 500.4 542.2
1000 460.4
86.2 423.8
391.8
800 75.2 359
59.4 314
259.3
600 210.3
400 790.1 790.1 878
683.6 720.5 748.8
595.3 646.3
473.3 529.7
200

0
2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E
Chemical Drug TCM Biologics

Sources: Frost & Sullivan, GF Securities (Hong Kong)

Favorable government policy support The Chinese government has set TCM as a strategic
priority and has issued supportive policies. Most recently, the State Council issued a formal notice
as part of the 13th Five-Year Plan on the development of the TCM industry. Specifically, by 2020,
it wants every citizen to be able to enjoy quality TCM services through balanced progress in TCM
medical care, scientific research, education and culture. The government will undertake efforts to
ensure that for every 1,000 people, there will be 0.55 beds in public TCM hospitals and 0.4 licensed
TCM doctors. The State Council encouraged the establishment of a TCM service network that
covers both urban and rural areas. Additionally, it called for the protection and industrialization of
TCM herbs, as well as innovation in the TCM industry.

Figure 2: Key TCM-related initiatives in the 13th Five-Year Plan


Development plan Specific action points Target
Enhance TCM primary servicing capabilities Relax entry barriers to TCM services Increase the share of private TCM medical healthcare
institutions by 5% from 2015 to 20% of overall TCM services

Improve TCM services network to cover urban and rural areas Reach 70% TCM service coverage in all community health
service institutions, township hospitals and village clinics.
Ensure equal rights for private and public Chinese medical healthcare institutions
Promote TCM rehabilitation services Improve the function of TCM as emergency and preventive treatments Set up TCM rehabilitation departments in all Class-2 or above
TCM hospitals, 30% of maternal and child health centers, all
community health service institutions, and township hospitals.
50% of village clinics should provide TCM health intervention
services.
Support the development of TCM nursing homes for the elderly
Establish chains of TCM rehabilitaion institutions
Promote inheritance of TCM and other ancient Chinese Organize personnel training, conduct scientific research, encourage technological Establish 3-5 international research platforms for TCM.
medicine development and protect of intellectual property
Develop 8-10 international scientific exchanges.
Establish 50 TCM innovation teams with a total oft 300 leading
scientists.
Accelerate TCM practitioner training Standardization of Chinese medicine residency training Ensure all Chinese medical practitioners possess postgraduate
medical degree with standardized training.
Strengthen TCM apprentice education Establish a national TCM training center and 50 TCM
apprentice education centers.
Nurture TCM culture and promote healthcare-related Strengthen the cultural awareness and literacy on TCM Construction of 70 TCM education bases and 30 TCM culture
tourism experience centers.
Promote TCM's core values and cultivate a healthy lifestyle

Sources: SATCM, GF Securities (Hong Kong)

2
Sector report Oct 31, 2016

Competitive TCM landscape Traditional Chinese medicine is divided into 1) Chinese patent
medicines, 2) decoction pieces and 3) Chinese herbs. Chinese patent medicines are defined as any
Chinese herbal medicine formulated into a finished dose form, while decoction pieces are mainly
Chinese herbs that have been processed further. Historically, Chinese patent medicines account
for about 50% of all traditional Chinese medicines sold, but decoction pieces now make up an
increased share following their faster growth. Sales growth of Chinese patent medicines slowed
from 40% in 2012 to 9% in 2014, while sales growth in the decoction pieces market rose from 22%
in 2012 to 24% in 2014, based on industry data provided by chyxx. Development of modernized
decoction technology such as ultra-fine pulverization has led to continued strong growth in the
decoction pieces market.

Figure 3: TCM industry overview

modern
decoction pieces
(including CCMG),
1%

Chinese patent
medicines, 46%
Decoction pieces, traditional
42% decoction pieces,
41%

Chinese herbs ,
12%

Sources: IMS, GF Securities (Hong Kong)

Low market concentration Currently, the industry remains fragmented with different market
players of various sizes. According the China Association of TCM, there are more than 1,500
Chinese patent medicine manufacturers and 800 decoction pieces manufacturers in China. In terms
of market revenue, the top 5 manufacturers of Chinese patent medicines and decoction pieces
accounted for approximately 29% and 70% of the respective total revenue in 2013, including many
state-owned enterprises.

Figure 4: Annual revenue at TCM companies Figure 5: Market share of top-10 TCM companies

Rmb10m or below, 91.27%

Rmb10-30m, 3.79% 69%

Rmb30-50m, 1.48%

Rmb50-100m, 1.43%

Rmb100-300m, 1.3%
29%

Rmb300-500m. 0.3%

Rmb500-1bn, 0.23%

Rmb1-5bn, 0.16%
Chinese patent medicines Decoction pieces
Rmb5bn or above, 0.04%

Sources: chyxx, GF Securities (Hong Kong)

The rise of modern TCM Facing tough competition from local manufacturers and potential drug
quality issues, sales growth of Chinese patent medicines and traditional decoction pieces has
continued to decline. Amid rising costs, the margins of these TCM players have remained under
pressure and profitability has deteriorated. Industry players are expanding into new segments to
seek higher growth. The introduction of concentrated Chinese medicine granules (CCMG) in China
has created new opportunities for industry players. Over the long term, the market will be
consolidated and we expect to see the emergence of several dominant national players.

3
Sector report Oct 31, 2016

Figure 6: Historical and projected sales in the Chinese Figure 7: Historical and projected sales of decoction
patent medicine market (2010-19) pieces market (2010-19)
450 Rmb bn 60% 1800 70%
400 1600
50% 60%
350 1400
50%
300 40% 1200

250 1000 40%


30%
200 800 30%
150 20% 600
20%
100 400
10% 10%
50 200

0 0% 0 0%
2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2010 2011 2012 2013 2014 2015 1H16

Revenue YoY % Decoction pieces (Rmb100m) YoY %

Sources: chyxx, GF Securities (Hong Kong)

TCM standardization crucial for its modernization The Chinese government has made
significant efforts to promote standardization of TCM in recent years. The aim is to align with
practices in western medicine, meaning we could see the implementation of international
standards, while TCMs will remain a drug class with unique features.

Figure 8: The national standards on TCM in China


Years A seies of standards
1953 Chinese Pharmacopoeia
1989 Drug Standards of the Ministry of Health (Finished Herbal Products Volume)
1992 Drug Standards of the Ministry of Health (Herbs Volume)
1999 Regulations for New Drug Approval
1999 Good Clinical Practices
1999 Good Laboratory Practices
2000 Good Supply Practices
2001 Good Manufacturing Practices
2002 Good Agriculture Practices
2005 Clinical Medicine Guidelines (Traditional Chinese Medicines Volume)
2010 Clinical Medicine Guidelines (Herbal Material Volume)
Sources: Ministry of Health, CFDA, GF Securities (Hong Kong)

Evidence-based clinical trials In contrast to chemical drugs whose properties can be elucidated
via precise comparisons with current standards of care, proving the therapeutic value of TCMs is
more difficult given its compound nature. The problem is more obvious in decoction TCMs with
varying dosages. Despite this challenge, double-blind randomized controlled trials (RCTs) have
been performed on various compound TCMs to study their safety and efficacy. Based on expert
evaluations, it was found that the proportion of published RCTs in relation to all types of published
clinical trials increased from 19% in 1999 to 36% in 2004. Academics generally believe Chinese
medicine now has a better PK/PD profile compared with its previous status, but more effort is
needed to ensure quality of the trials.

4
Sector report Oct 31, 2016

China TCM (570 HK)


Buy (initiation) Emerging TCM leader
Target price: HK$5.20
TCM arm of CNPGC China TCM (CTCM) is the TCM arm of China National
Pharmaceutical Group Corporation, Sinopharm’s (1099 HK, NR) parent company. The
Natalie Chiu company produces traditional patent medicine (finished TCMs) and modern Chinese
SFC CE No. AVH029 medicine (concentrated TCM granules, or CCMG). It has a diversified finished TCM
nataliechiu@gfgroup.com.hk portfolio with more than 500 prescription and OTC products. In concentrated TCM
+852 3760 2030 granules, it is among the top-five CCMG players that together account for 50% of the
market.
GF Securities (Hong Kong) Brokerage Limited
29-30/F, Li Po Chun Chambers
189 Des Voeux Road Central Becoming vertically integrated Five large acquisitions since 2006 have transformed
Hong Kong CTCM into an integrated TCM conglomerate covering decoction pieces, granules, patent
medicines and supplement products. Total revenue and net profit rose at CAGRs of 30.1%
and 62.2% respectively during 2007-15.

Reform to lead to long-term shareholder value CTCM’s finished drug sales volume
growth and drug prices have come under pressure amid the currently severe market
environment. To address pricing pressure, the company aims to: 1) actively adjust its
product strategies to alleviate pressure on its finished drug business; 2) accelerate
expansion of its concentrated TCM granules business, and; 3) overhaul its sales team.

Strategic planning in its CCMG business The concentrated TCM granules market in
China has experienced rapid growth due to its regulated nature. With deregulation
expected in the near future, the company has brought forward the integration of Tianjiang
Pharma and promoted resource sharing to achieve synergy and improve core
competitiveness.

Attractive valuation The stock is currently trading at 11.4x 2017E P/E, compared to the
current average of 15x for other TCM manufacturers listed in Hong Kong. As an emerging
leader in the TCM space with a faster-than-peers growth outlook, we believe CTCM’s
discount to its HK-listed peers should narrow. Our one-year target price of HK$5.20 is
based on a target P/E of 15x our 2017 EPS forecast of Rmb0.30 and represents 0.5x
PEG.

Risks 1) More aggressive price cuts for its key Essential Drug List drugs; 2) Weaker-than-
expected volume growth following tender withdrawals; 3) More intense competition after
the CCMG market is liberalized.
Stock performance

570 HK Equity Hang Seng Index


100%

80%

60%

40%

20%

0%
Nov-14

Jun-15

Nov-15

Jun-16
Oct-14

Dec-14

Feb-15

Oct-15

Dec-15
Apr-15

Jul-15

Sep-15

Feb-16

Apr-16

Jul-16
May-16

Sep-16
Mar-15

May-15

Aug-15

Aug-16
Jan-15

Jan-16

Mar-16

-20%

-40%

Source: Bloomberg

Stock valuation
Key data
Turnover Net profit EPS EPS YoY P/E BPS P/B ROE
Oct 27 close (HK$) 4.01 (Rmb m) (Rmb m) (Rmb) (%) (Rmb) (%)
Shares in issue (m) 4.43 2014 2,650 412 0.16 68% 21.2 1.3 2.7 13%
Major shareholder Sinopharm HK (36%) 2015 3,709 622 0.17 3% 20.5 3.0 1.1 8%
Market cap (HK$ bn) 17.903 2016E 6,805 1,150 0.25 51% 13.6 2.7 1.3 9%
3M avg. vol. (m) 12.67 2017E 7,930 1,388 0.30 20% 11.4 2.9 1.2 11%
52W high/low (HK$) 6.42/2.89 2018E 9,218 1,623 0.35 16% 9.8 3.1 1.1 12%
Source: Bloomberg Sources: Company data, GF Securities (Hong Kong)

5
Sector report Oct 31, 2016

Weak finished drug growth amid stringent drug pricing


Reimbursement control hurting finished drug sales growth Since 2015, the Chinese
government has deepened healthcare reform with reform of the drug approval process,
implementation of the “two-invoice system”, and secondary drug tender policies. While these
initiatives have spurred development in the industry, sales growth has slowed from 23% (for finished
TCMs) and 24% (for decoction pieces) in 2013 to 8% and 13% respectively in 1H16.

Figure 9: Finished drugs market revenue (2010-1H16) Figure 10: Decoction pieces market revenue (2010-1H16)

7000 25% 1800 70%


6000 1600
20% 60%
1400
5000
50%
15%
1200
4000
1000 40%
3000
10% 800 30%
2000 600
20%
5%
1000
400
10%
200
0 0%
2010 2011 2012 2013 2014 2015 1H16 0 0%
2010 2011 2012 2013 2014 2015 1H16
Finished TCM (Rmb100m) YoY %
Decoction pieces (Rmb100m) YoY %

Sources: MIIT, GF Securities (Hong Kong)

Finished TCMs under more pricing pressure than overall pharma sector Sales growth of
finished TCMs was only half that of the overall pharma sector during 2015-1H16, due to: 1) the
zero-mark up policy aimed at bringing the contribution from drug sales to hospital revenues to 30%
by 2017, and; 2) TCM drugs being a common form of complementary medicine leading to more
pricing control. Only companies with flexible growth strategies can survive in this dynamic industry
environment.

CTCM to adjust product strategy in 2016 CTCM has over 500 products (70 of which are national
exclusive products), used for musculoskeletal, respiratory, dermatology and central nervous system
problems, as well as infectious and cardiovascular diseases. The Tongjitang acquisition in May
2013 led to rapid growth in finished products in 2014. However, sales growth momentum weakened
to 3.8% in 2015 and -20% in 1H16 due to an inventory build-up following the elimination of the
second and third layers of distributors under the “two-invoice system”. Inventory rose to four months
by the end of 2015 (two months under normal conditions).

Figure 11: CTCM’s top-ten finished products in 2015


2015
Drug Name Drug Type Therapeutic Area Indication Sales (Rmb m) YoY %
Xianling Gubao TCM Musculoskeletal Osteoporosis 862.19 1.4%
Yupingfeng Granule TCM Infectious diseases Cold 271.14 8.4%
Jingshu Granule TCM Musculoskeletal Cervical spondylosis 224.91 12.2%
Moisturising & anti-itching Capsule TCM Dermatology 202.50 27.8%
Biyankang Granule TCM Respiratory Rhinitis 168.71 -34.1%
Sheng Tong Ping Chemical Cardiovascular Hypertension 99.51 3.60%
Fengshi Gutong Capsule TCM Musculoskeletal Rheumatoid arthritis 73.67 39.6%
Zaoren Anshen Capsule TCM CNS Insomnia 71.18 22.9%
Feng Liao Xing Medicinal Wine TCM Musculoskeletal Rheumatism 65.94 -19.2%
Gao De Chemical Infectious diseases Bacterial infection 59.33 -31.9%

Sources: Company data, GF Securities (Hong Kong)

Sales restructuring began at end-2015 Rather than focusing on ex-factory sales, CTCM has
adopted a partner/responsible person system whereby sales are now focused on in-market sales.
The company’s conventional marketing line has changed from geography-based to product-based,
which includes three business units responsible for selling the seven exclusive Essential Drug List
(EDL) products, OTC products and about 60 non-EDL national exclusive products respectively. This
provides better financial flexibility allowing them to monitor stock across channels, manage sales
planning and performance, and control inventory. The sales revamp should help to unlock product
potential and digest inventory at hospitals or OTC channels more quickly, in our view.

6
Sector report Oct 31, 2016

TCM granules sales remain strong, profitability improving


Healthy growth for its concentrated TCM granules business In China, concentrated TCM
granules (CCMG) are still classified as trial products, with six production licenses held by five
companies. Due to tight regulation, only registered Class-2 or above TCM hospitals can prescribe
these modernized medicines.

CCMG market to be worth Rmb19bn by 2018 The market posted strong sales growth of 24.2%
in 2010-14 to about Rmb6bn and is expected to reach Rmb15bn during 2015-19, representing a
CAGR of 21%. In Dec 2015, the China Food and Drug Administration (CFDA) issued a draft
commentary on CCMG manufacturing guidelines, including entry requirements, reporting of the
manufacturing process, traceability of the source of medicinal herbs, standardization of quality
checks, product manufacturing and usage regulations. The official guidelines are expected to be
released in 1H17.

Figure 12: Historical and projected CCMG sales (2010-19) Figure 13: Revenue comparison of CCMG players
16 Rmb bn 45% Rmb m

14 40% 3500
35% 3000
12
30%
10 2500
25%
8 2000
20%
6 1500
15%
4 1000
10%
2 5% 500

0 0% 0
2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2008 2009 2010 2011 2012 2013 2014

Revenue YoY % CTCM Chase Sun CR Sanjiu PuraPharm

Sources: Company data, GF Securities (Hong Kong)

Competitive advantage in CCMGs after Tianjiang acquisition Tianjiang Pharma was one of the
first companies to manufacture and research CCMG products. It produces about 700 types of
single-formula granule and sells directly to TCM hospitals. These products differ from those of other
CCMG players in terms of the manufacturing process and product standards. The segment has
been relatively unaffected by the zero mark-up policy as it can mark prices up by 25% as they are
regulated as decoction pieces. CCMG sales grew 21.9% YoY for the company in 1H16, in-line with
industry growth.

Centralized herb procurement CTCM’s annual herb procurement reached Rmb1.5bn in 2015,
with responsibility for procurement split between its finished drugs and CCMG businesses. Given
its large procurement needs, it set up a TCM procurement center in May 2016 for centralized
procurement of 105 common medicinal herbs. Suppliers now bid on tenders and the company
assesses their supply of raw materials based on price and quality. This will effectively reduce
procurement cost next year and improve profit margin.

7
Sector report Oct 31, 2016

Growth outlook
We expect CTCM to deliver an 28% EPS CAGR during FY16-18, driven by a 36% rise in revenue
during the period and improving margins from its integration of resources and improved utilization
efficiency of labor, capital and production facilities.

Finished drugs to see negative revenue growth in FY16 In line with the company’s guidance,
we expect sales growth of CTCM’s finished drugs (both TCM finished drugs and chemical medicine)
to slow from 3.8% YoY in FY15 to -20% YoY in FY16, due to: 1) The impact of medical insurance
payments and the “two-invoice system”, which forced distributors to reduce inventory; 2) Price cuts
from tenders of 3-4% for key EDL products; 3) Secondary price negotiations leading to tender
withdrawals in several provinces, and; 4) Adjustments of the sales model and selling prices for some
products sold through agencies. The restructuring of the sales team and increased focus on in-
market sales (instead of ex-factory sales) should mean sales growth gradually returns to 5/7% in
FY17/18.

Evidence-based trials for eight exclusive EDL drugs To validate the clinical benefits of its TCM
finished product portfolio, the company has conducted evidence-based clinical research of all of its
EDL products. Xianling Gubao has completed the relevant trials and was included in national clinical
guideline for osteoporosis in early 2016. The company will conduct research into the other seven
exclusive EDL products (Biyankang tablets, Yu Ping Feng Granules, Jingshu Granules, Moisturising
& Anti-Itching Capsules, Zaoren Anshen Capsules and Fengshi Gutong Capsules) on their
respective indications. We believe this will unlock product potential, reduce pricing pressure and
support sales volume growth.

Chinese medicine granules driving revenue growth Over the next three years, CTCM will focus
on the CCMG industry, where competition is limited. The company has guided for 15-20% revenue
growth and higher earnings growth due to centralized procurement and integration of other
resources. We believe CTCM could also enhance Tianjiang’s product portfolio through cross-selling,
after they have been allowed to sell to comprehensive hospitals and Class-1 or below TCM hospitals
as well as grassroots health centers.

Higher inventory and receivables days following Tianjiang consolidation CTCM’s inventory
days increased from 125 in 1H15 to 173 in 1H16 due to the consolidation of Tianjiang, which sells
CCMG products directly to hospitals. Receivable days also increased from 80 to 129 days due to
the longer collection period from hospitals. Cash conversion cycle increased to 218 days from 160
days a year ago.

Rmb300m capex in FY16 for Tianjiang and Tongjitang expansion This includes construction of
two CCMG production lines in Shandong and Liaoning for Rmb100 each, and another Rmb100m
for Guizhou Tongjitang expansion.

Figure 14: Revenue mix Figure 15: Revenue and gross margin forecasts
10,000 63%
9,000
2015 1H16 62.0% 62%
8,000
7,000
61%
6,000
5,000 59.9% 60%
26.4% 35.8% 4,000 59.5%
59.2% 59.1% 59%
3,000 58.7%
64.2%
73.6% 2,000
58%
1,000
- 57%
2013 2014 2015 2016E 2017E 2018E
Finished drugs CCMG Finished drugs CCMG
Revenue (Rmb m) GPM

Sources: Company data, GF Securities (Hong Kong)

8
Sector report Oct 31, 2016

Figure 16: Operating profit and OPM forecasts Figure 17: Net profit and net margin forecasts
2,500 Rmb m 22% 2,000 Rmb m 20%

1,800 18%
22%
2,000 1,600 16%
21% 1,400 14%

1,500 1,200 12%


21%
1,000 10%
20%
1,000 800 8%

20% 600 6%

500 400 4%
19%
200 2%

- 19% - 0%
2013 2014 2015 2016E 2017E 2018E 2013 2014 2015 2016E 2017E 2018E

Operating profit OPM Net profit NPM

Sources: Company data, GF Securities (Hong Kong

Valuation
Our one-year target price of HK$5.20 implies 30% upside, represents 0.5x PEG, and is based on a
target P/E of 15x our 2017 EPS forecast of Rmb0.30, compared to the current average of 15x for
other Chinese medicines manufacturers listed in Hong Kong. As the leading TCM manufacturer, we
believe CTCM’s discount to its HK-listed peers should narrow. Concerns about slowing growth in
the finished TCM industry have led to de-rating since mid-2015.

Figure 18: P/E band

Share Price 11x 18x 21x 24x 27x

Sources: Bloomberg

9
Sector report Oct 31, 2016

Figure 19: Financial summary


Income Statement Balance Sheet
Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E

Revenue 2,650 3,709 6,805 7,930 9,218 Non-current assets


Cost of sales (1,007) (1,515) (2,812) (3,213) (3,695) PPE 751 1,669 1,941 2,179 2,456
Gross profit 1,643 2,194 3,993 4,717 5,523 Investment properties 3 3 0 0 0
Prepaid lease payments 283 308 375 412 453
Other income 32 142 123 149 216 Goodwill 1,191 3,341 3,665 3,677 3,705
Selling and distribution expenses (903) (1,196) (1,871) (2,173) (2,507) Intangible assets 948 6,680 6,547 6,416 6,288
Administration expenses (222) (385) (612) (714) (830) Other receivables 13 136 142 150 157
Operating profit 552 756 1,386 1,682 1,970 Interest in JV and associate 0 88 97 107 117
Net finance income (cost) (63) 15 28 25 25 Deferred tax assets 48 111 114 134 189
Other non-recurring items 0 (2) 0 0 0 3,236 12,336 12,881 13,075 13,366
Profit before tax 489 769 1,414 1,707 1,995
Income tax expense (70) (118) (254) (307) (359) Current assets
Net profit 413 640 1,159 1,399 1,636 Inventories 418 1,236 1,434 1,506 1,536
Minority interests (2) (18) (9) (11) (13) Trade and other receivables 1,236 3,398 3,449 3,518 3,588
Net profit attributable to shareholders 412 622 1,150 1,388 1,623 Other current assets 1 101 611 646 489
EPS (Rmb) 0.16 0.17 0.25 0.30 0.35 Restricted bank deposits 0 36 0 0 0
Bank balance and cash 440 2,102 1,446 2,271 3,328
Growth rates (%) 2,095 6,873 6,940 7,941 8,941
Revenue 90.0% 40.0% 83.4% 16.5% 16.2%
Adjusted net profit 107.2% 50.5% 85.0% 20.7% 16.9% Total assets 5,331 19,209 19,821 21,016 22,306
Adjusted EPS 68.4% 3.4% 50.6% 19.5% 15.8%
Current liabilities
Margin & ratios (%) Trade and other payables 540 2,660 2,008 2,295 2,639
Gross margin 62.0% 59.1% 58.7% 59.5% 59.9% Current portion of deferred government grants 44 76 0 0 0
OP margin 20.8% 20.4% 20.4% 21.2% 21.4% Tax liabilitites 48 149 153 163 25
Net margin 15.5% 16.8% 16.9% 17.5% 17.6% Bank borrowings 502 1,600 2,800 2,800 2,800
Effective tax rate 14.4% 15.4% 18.0% 18.0% 18.0% 1,134 4,485 4,961 5,259 5,464
Payout ratio 0.0% 0.0% 30.0% 30.0% 30.0%
Non-current liabilities
Cash Flow Statement Deferred tax liabilities 245 1,669 1,502 1,352 1,217
Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E Borrowings 671 850 0 0 0
Government grants 25 64 58 52 52
Profit before tax 489 769 1,414 1,707 1,995 941 2,583 1,560 1,404 1,269
Depreciation and amortization 119 168 - - -
Net finance income (cost) 63 (25) (30) 35 35 Equity
Others 7 (39) (32) (49) (49) Shareholders' equity 3,257 12,140 13,300 13,300 14,354
Change of working capital (260) (207) (901) 146 244
Tax paid (93) (149) (254) (307) (359) Total liabilities & equity 5,332 19,209 19,821 19,962 21,087
Operating cash flow 325.0 518.7 196.7 1,531.8 1,865.9

Capex (80) (225) (612) (634) (737)


Change of AFS investments 5 301 - - -
Acquisitions (12) (7,353) (500) 0 0
Others 6 119 (36) 0 0
Investing cash flow (81) (7,158) (1,148) (634) (737) Financial Ratios
Year-end Dec 31 FY14 FY15 FY16E FY17E FY18E
Change of borrowings (27) 1,202 350 0 0
Repayment to related companies (5) 0 0 0 0 Current ratio 1.8 1.5 1.4 1.5 1.6
Net proceeds from shares issued 0 7,200 0 0 0 Quick ratio 1.5 1.2 1.0 1.1 1.3
Others (117) (72) (54) (72) (72)
Financing cash flow (150) 8,330 296 (72) (72) Asset turnover 0.5 0.3 0.3 0.4 0.4
Total assets/total equity 1.6 1.6 1.5 1.6 1.6
Net change of cash flow 94 1,690 (656) 825 1,056 Net cash/(debt) (Rmb m) (732) (312) (1,354) (529) 528
Forex changes (0) (28) 0 0 0
Cash and cash equivalents at beginning 345 439 2,102 1,446 2,271 ROE (%) 14% 9% 10% 11% 12%
Cash and cash equivalents at end 439 2,102 1,446 2,271 3,328 ROA (%) 8% 5% 6% 7% 7%

Sources: Company data, GF Securities (Hong Kong)

10
Sector report Oct 31, 2016

Kingworld Medicines (1110 HK)


Buy (initiation) Beneficiary of rising demand for health supplements in China
Target price: HK$1.80
Kingworld is a Chinese proprietary medicine and health supplement distributor in
southern China The company distributes Hong Kong and overseas’ OTC and other
Natalie Chiu healhcare products and sells via distributors in south and southeastern China. It has a
SFC CE No. AVH029 network of about 200,000 drug retailers and benefits from close relationships with
nataliechiu@gfgroup.com.hk distributors.
+852 3760 2030
Strong market capabilities and product selectivity offers above-peer profitability
GF Securities (Hong Kong) Brokerage Limited
and revenue growth Kingworld posted revenue and gross profit CAGRs of 13% and 31%
29-30/F, Li Po Chun Chambers
189 Des Voeux Road Central
respectively in 2013-15 and had a gross margin of 31.8% in 2015. This was attributable
Hong Kong to its focus on selling high-margin products (e.g. distribution of foreign healthcare
supplements in eastern and southern China, which carry a gross margin of about 60% vs
the industry average of 30%).

Sound growth strategy, active marketing and close distributor partnerships


Kingworld aims to: 1) expand its high-GM product offerings; 2) increase online sales, and;
3) penetrate into lower-tier cities. With a successful track record of product marketability,
we expect Kingworld to continue to grow faster than the industry average in 2016-18 with
improved profitability through a better product mix and superior operating efficiency. We
project a CAGR of 23% and 42% for revenue and earnings respectively in 2016-18.

Compelling valuation offers near-term upside Our target price of HK$1.80 represents
13x our 2017 diluted EPS estimate. The stock is trading at 11x our 2017 EPS estimate, a
27% discount to its peer group average of 15x. We believe early signs of growth
acceleration will narrow this valuation discount.

Risks: 1) Failure to renew distribution rights and registration certificates; 2) early


termination of distribution agreements with Nin Jiom Pei Pa Koa if guaranteed sales
volume is not achieved; 3) damage to products’ brand image due to quality issues or
aggressive discounts.

Stock performance

1110 HK Equity Hang Seng Index


40%

30%

20%

10%

0%
Nov-14
Dec-14

Jun-15

Jun-16
Oct-14

Jul-15

Nov-15
Dec-15
Feb-15

Oct-15

Feb-16

Jul-16
Apr-15

Apr-16
Mar-15

Aug-15
Sep-15

Aug-16
Sep-16
Jan-15

May-15

Jan-16

Mar-16

May-16

-10%

-20%

-30%

-40%

-50%

Source: Bloomberg

Stock valuation
Key data Turnover Net profit EPS EPS YoY P/E BPS P/B ROE
(Rmb m) (Rmb m) (Rmb) (%) (Rmb) (%)
Oct 27 close (HK$) 1.38
2014 660 38 0.06 -20% 19.6 1.6 0.7 4%
Shares in issue (m) 623
2015 714 31 0.05 -18% 25.1 1.7 0.7 3%
Major shareholder Zhao Li Sheng (47.84%)
Market cap (HK$ bn) 0.87 2016E 1,004 56 0.08 79% 14.5 1.8 0.7 5%
3M avg. vol. (m) 0.12 2017E 1,200 84 0.12 50% 9.8 2.0 0.6 6%
52W high/low (HK$) 1.945/1.13 2018E 1,398 107 0.15 28% 7.7 2.2 0.5 7%
Source: Bloomberg Sources: Company data, GF Securities (Hong Kong)

11
Sector report Oct 31, 2016

Retail pharmacies offer stronger growth outlook than hospitals


China’s over-the-counter market reached Rmb1.8bn in 2015 Revenue growth in the over-the-
counter (OTC) market (+8.9% YoY) overtook the prescription market (+7.4% YoY) in 2015 due to
government healthcare budget controls and more restrained use of medicines by doctors, and will
be supported by 1) a demand shift from prescription to OTC drugs as the government tries to reduce
healthcare spending and free up hospital capacity by encouraging self-diagnosis for non-serious
conditions, and 2) overall pharmaceutical industry growth due to an increasingly aging population,
rising GDP per capita and urbanization.

Figure 20: Revenue in China’s OTC and prescription drug


markets (2012-15)
1400 Rmb bn 20%
18%
1200
16%
1000 14%
12%
800
10%
600
8%

400 6%
4%
200
2%
0 0%
2012 2013 2014 2015

OTC Rx OTC YoY Rx YoY

Sources: IMS, GF Securities (Hong Kong)

Retail pharmacies and community health centers driving growth in the OTC market China’s
OTC drugs are sold via three main channels (hospitals, retail pharmacies and community health
centers). Retail pharmacies and community health centers posted faster growth than hospitals in
2015 with sales growth of 11.6% and 11.1% YoY respectively.

Figure 21: Drug sales by channel in Beijing (2014-15) Figure 22: Revenue growth at major drug channels in
China (2013-15)
18%

16% 15.60%
13.80%
14%
14% 13.10%
12% 13.40%
11.70%
10%
16% 9.50%
8% 8.30%
6.90%
70% 6%
5.00%
4%

2%

0%
2013% 2014 2015
Hospitals Retail pharmacies Community health centers Hospitals Retail pharmacies Community health centers

Sources: IMS, GF Securities (Hong Kong)

Finished Chinese medicine represents over 60% of all retail pharmacies sales Although
overall finished Chinese medicine wholesale revenue growth slowed significantly from 13.1% YoY
in 2014 to 5.7% YoY in 2015, we believe much of the slowdown is from sales to hospitals. This is
evident in Beijing’s drug market, where sales growth of finished Chinese medicines and OTC drugs
was 12.9% YoY and 8.5% YoY respectively in 2015.

12
Sector report Oct 31, 2016

Figure 23: Channel mix and revenue growth in Beijing’s Figure 24: Channel mix and revenue growth in Beijing’s
pharma market (2014-15) finished TCM market (2014-15)
120% 16.00% 120% 14%
14.00% 12%
100% 100%
12.00%
80% 10%
10.00% 80%
8%
60% 8.00%
60%
6.00% 6%
40%
4.00% 40%
4%
20%
2.00%
20% 2%
0% 0.00%
2014 2015 0% 0%
2014 2015
Hospitals Retail pharmacies
Community health centers Hospitals YoY Hospitals Retail pharmacies
Retail pharmacies YoY Community health centers YoY Community health centers Retail pharmacies YoY

Sources: IMS, GF Securities (Hong Kong)

Figure 25: Channel mix and revenue growth in Beijing’s


OTC drug market (2014-15)
120% 9%
8%
100%
7%
80% 6%
5%
60%
4%
40% 3%
2%
20%
1%
0% 0%
2014 2015

Hospitals Retail pharmacies


Community health centers Retail pharmacies YoY

Sources: IMS, GF Securities (Hong Kong)

Proprietary Chinese medicine distribution market grew at a CAGR of 16.8% to Rmb392bn in


2011-15 Finished Chinese medicine can be classified into: 1) proprietary Chinese medicines, which
are exclusive formulas protected by the government, and 2) common TCM. Based on Euromonitor
estimates, the proprietary Chinese medicine market in China is expected to grow at a CAGR of 17%
during 2016-20.

Figure 26: Proprietary Chinese medicine market


1,800,000 40%
33.8%
1,600,000 35%
33.8%
1,400,000
30%
1,200,000
25%
21.6%
1,000,000 20.3%
19.2% 18.3% 17.4% 20%
16.2%
800,000 15.1%
15%
600,000
10%
400,000

200,000 5%

0 0%
2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Retail sales value (Rmb m) YoY %

Sources: Euromonitor, GF Securities (Hong Kong)

Local companies represent 86% of the OTC market in China, and finished TCM companies
account for 50% The top-ten manufacturers/importers of OTC and healthcare supplement products
in China account for 26% of the market. By-Health (300146 CH) is the biggest OTC and health
supplement player and Dong-E E-Jiao’s (000423 CH) E-Jiao is the best-selling product.

13
Sector report Oct 31, 2016

Figure 27: Top-10 OTC and healthcare Figure 28: Top-10 OTC and healthcare supplement
supplement product companies in China products in China
Rank OTC and health supplement company Rank Product Manufacturer Drug type
1 BY-Health 1 E-Jiao Dong-E E-Jiao TCM
2 Dong-E E-Jiao 2 Caltrate Wyeth Chemical
3 Wyeth 3 Kidney treasure tablets Jiangsxi Huiren TCM
4 Bayer Healthcare 4 E-Jiao Fupai E-jiao TCM
5 Yunnan Baiyao 5 Hong Mao Medicinal Wine Hong Mao pharma TCM
6 Xi'an Janssen Pharm 6 Nin Jiom Pei Pa Koa Nin Jiom Medicine TCM
7 Jiangsxi Huiren 7 Compound E Jiao Jiang Dong-E E-Jiao TCM
8 Xiuzheng Pharm 8 Shujin Jinyao Wan Guangzhou Chenliji TCM
9 Fupai E-jiao 9 BY-Health protein powder BY-Health Chemical
10 Nin Jiom Medicine 10 Centrum Wyeth Chemical

Sources: IMS, GF Securities (Hong Kong)

Greater growth potential in lower-tier cities Sales growth at retail pharmacies in first and second-
tier cities has slowed since 2014, while third and fourth-tier cities have seen faster growth both in
terms of sales value and volume. Sales growth in top tier cities is driven by price hikes from product
upgrade, while in lower tier cities sales are driven by urbanization and the upgrading of infrastructure
in these less-accessed markets.

Selective product sourcing to drive growth


Quality portfolio of 60 products Kingworld was set up in 1996 and began by signing three major
distribution agreements with Tai San Enterprise, Nin Jiom Medicine and Great Pleasure, and Etta
Trading, which supplies the best-selling proprietary Chinese medicines and health supplements in
Hong Kong. Since then it has expanded its product portfolio and currently manages 60 products
used for cough and phlegm relief, vitamins, and gastrointestinal, orthopedic, cardiovascular and
influenza issues. These include 12 pharmaceutical products, seven healthcare products, 28 general
foodstuffs and two medical products, and are manufactured in Japan, Canada, Hong Kong, Taiwan,
Thailand and mainland China and sourced from 13 different suppliers.

Figure 29: Kingworld’s revenue mix

2014 2015
Imada Red Flower Mentholatum
Mentholatum Menthol Menthol Cream,
Others, 2.26% Oil, 1.87%
Cream, 3.78% 4.35%

Taiko
Seirogan,
Culturelle probiotic
9.63%
series, 3.94%

Others, 22.26% Nin Jiom Chuan Bei


Pei Pa series,
45.69%
Nin Jiom Chuan Bei
Pei Pa series,
80.39%
Taiko Seirogan,
6.96% Culturelle
probiotic
Flying Eagle Wood series, 13%
Lok Medicated Oil,
5.87%

Sources: Company data, GF Securities (Hong Kong)

Stable relationship with suppliers Kingworld has maintained stable relationships with its five
largest suppliers for periods of between 10-20 years. Nin Jiom Pei Pa Koa was introduced to the
company by Kingworld’s chairman, Zhao Li Sheng, as he believed there was a potential market for
the product in mainland China. Mr Zhao secured the distribution rights of Nin Jiom Pei Pa Koa for
Kingworld in 1997. In Apr 2010, before listing, Kingworld entered into a written three-year
distribution agreement with the manufacturer and supplier of Nin Jiom Pei Pa Koa to sell the product
in 14 regions in China. The agreement has been renewed twice, most recently in 1H16.

14
Sector report Oct 31, 2016

Figure 30: Market share of cough relief products in China Figure 31: China’s cough relief market

18 12%
10.6%
Nin Jiom Chuan 16 9.7%
Bei Pei Pa Koa, 10%
14 8.4% 8.6%
21.20% 8.6%

Acute bronchitis 12 8%
6.7%
syrup (急支糖浆), 10
6%
5.30% 8

Felike Heji (肺力咳 6 4%


Others, 61.60%
合剂), 4.60% 4
2%
2
Corbrin capsule (百
令胶囊), 3.80% 0 0%
2011 2012 2013 2014 2015 2016 2017

Kesutingtangjiang (咳 Revenue (Rmb bn) YoY%


速停糖浆), 3.50%

Sources: Company data, GF Securities (Hong Kong)

Prudent sourcing criteria Kingworld’s product portfolio is made up of products purchased from
overseas and local suppliers. Its international sourcing department is responsible for researching,
identifying and introducing new products from international markets to diversify the portfolio.
Kingworld typically enters into distribution agreements for products which the company believes
have market potential or products which the company has been selling for three or more years. The
sourcing criteria for new products are based on proven sales records and profitability, reputation,
safety and reliability of the new products. For example, Kingworld introduced the Culturelle
probiotics series from the US in 2014 as their first major healthcare product. Based on Euromonitor
data, Amerifit’s Culturelle is the third-biggest probiotic supplement brand in the US market after
P&G’s Align brand and Italy’s Enterogermina (Sanofi-Aventis). The global probiotics supplement
market was estimated to be worth US$35bn in 2015 and should see sales grow at an annual rate
of over 8% until 2018, with China seeing the fastest growth of about 20% due to the increasing
prevalence of gut-related disorders and the relaxation of one-child policy.

Figure 32: Global sales of leading dietary supplement categories


9000 12%

8000 10%

7000
8%

6000
6%
5000
4%
4000
2%
3000

0%
2000

1000 -2%

0 -4%
Glucosamine Ginseng Mineral Calcium Combination Fish Probiotic Omega-3-6-9 Other Fish Protein
Supplements Supplements Dietary Oils/Omega Supplements (Fish and Oils Supplements
Supplements Fatty Acids Non-Fish)

Global sales (US$ m) % CAGR 2013-18

Sources: Euromonitor, GF Securities (Hong Kong)

More high-margin product offerings Kingworld’s growth strategy is to add more high gross
margin pharmaceutical and healthcare products by 1) developing exclusive distribution agreements
with overseas and local manufacturers, 2) introducing quality pharmaceutical and healthcare
products with high growth potential, and 3) increasing average selling price of its existing products.

Expansion of distribution network Kingworld’s distribution network consists of ~300 distributor


customers, who have a network of over 300 sub-distributor customers which are not Kingworld’s
direct customers, and ~4,400 product display booths at retail outlets. Their current distribution
network covers more than 220,000 retail outlets throughout the country. For ease of management
and implementation of marketing policies, Kingworld has divided the market into 34 regions, which
are either managed by one of its 12 subsidiaries or local representative offices. Each region
formulates its own marketing strategies such as the organization of sampling events. This market
segmentation allows the company to keep track each region’s performance.

15
Sector report Oct 31, 2016

Figure 33: Flying Eagle Wood Lok Medicated Oil Figure 34: Taiko Seirogan product display booth
product display booth

Sources: Company data, GF Securities (Hong Kong)

Figure 35: Kingworld’s segmentation of distribution network

Sources: Company data, GF Securities (Hong Kong)

16
Sector report Oct 31, 2016

Growth outlook
We expect Kingworld Medicines to deliver CAGRs of 48% in EPS and 25% in revenue during FY16-
18, driven by its expanding retail and distribution network and greater number of high-margin
product offerings.

Sustainable gross margin improvement supported by launch of higher-margin products The


company has actively adjusted its product mix by distributing high margin OTC and healthcare
products. Overall GM improved from 23.7% in 2014 to 33% in 1H16, driven by improved sales of
high-margin products such as the Culturelle probiotics series and Flying Eagle Wood Lok Medicated
Oil. We expect margin expansion to continue driven by a better product mix.

Figure 36: Sales of Kingworld’s high-margin products increasing

2014 1H16
90% 70%
80%
60%
70%
50%
60%

50% 40%

40% 30% Kingworld GM: 33%


30%
20%
20% Kingworld GM: 23.7%

10% 10%

0% 0%
>50% 30-50% 20-30% 10-20% >50% 30-50% 20-30% 10-20%

Sources: Company data, GF Securities (Hong Kong)

License renewal of Nim Jiom Pei Pa Koa in April 2016 The Imported Drug Registration Certificate
and the Pharmaceutical Product Registration Certificate were issued and approved by the CFDA,
with a validity period of five years. For Nim Joim Pei Pa Koa, the expiry date of the Pharmaceutical
Product Registration Certificate was March 2015 and product sales were affected during the
renewal process. In 2015, revenue from Nim Jiom reached Rmb290m, down 40% from 2014. It
booked Rmb230m in 1H16 and is on track to post Rmb575m in revenue in 2016, based on its
40/60% conventional yearly split.

Lower costs in online pharmacy Kingworld gained access to an e-commerce platform in 2015
and built an online sales network to distribute its pharmaceutical and healthcare products. It opens
online stores that 1) are commercially attractive, 2) have a good reputation, and are 3) within their
target group and industry, such as professional retail channels related to maternity and babies. In
1H16, online sales reached Rmb39m and contributed 9% of revenue. We believe the surge in online
pharmacy sales will help to improve margins and increase sales by diverting customer traffic away
from traditional brick-and-mortar drugstores, especially in second and third-tier cities.

Strategic cooperation with Sinopharm Capital Sinopharm Capital, a sister company of


Sinopharm Holdings (1099 HK, NR), became a strategic investor in Kingworld Medicines in Sept
2014 with the purchase of a 9.99% stake and HK$134m worth of convertible bonds which can be
converted into shares at HK$2.15/share. Both parties extended the conversion period from 18
months to 36 months, ending in Dec 2017, and the annual interest rate was reduced from 7.4% to
5.0%. We believe Sinopharm Capital’s involvement is positive for Kingworld, as it could leverage
Sinopharm’s resource network to distribute its products and pursue a more aggressive M&A
strategy.

17
Sector report Oct 31, 2016

Figure 37: Kingworld’s pharmaceutical business Figure 38: Kingworld’s healthcare business
500 180%
450 160%
800 50%
400 140%
700 40%
350
30% 120%
600 300
20% 100%
500 250
10% 80%
400 200
0%
300 60%
-10% 150
200 100 40%
-20%
100 -30% 50 20%
0 -40% 0 0%
2013 2014 2015 2016E 2017E 2018E 2013 2014 2015 2016E 2017E 2018E

Pharmaceutical products revenue (Rmb m) YoY growth Healthcare products revenue (Rmb m) YoY growth

Sources: Company data, GF Securities (Hong Kong)

Figure 39: Kingworld’s margins Figure 40: Revenue mix by business segment (1H16)
40.0%

35.0% 35.3% 36.1%


34.5%
33.3%
31.8%
30.0%

25.0% Medical devices


20%
20.0%

15.0% Healthcare
Pharmaceutical
13.2% products
11.2% 12.0% products
10.0% 9.6% 19%
8.6% 61%
6.9% 7.0% 7.7%
5.0% 5.6%
4.4%
0.0%
2014 2015 2016E 2017E 2018E

Gross margin Operating margin Net margin

Sources: Company data, GF Securities (Hong Kong)

Valuation
Our one-year target price of HK$1.80 implies 22% upside and is based on a target P/E of 13x our
2017 EPS forecast of Rmb0.12, compared to the current average of 15x for its HK-listed peers. The
stock is currently trading at 10.5x our 2017 EPS forecast. Concerns about the company’s slowing
product sales growth have led to de-rating since mid-2015. We believe early signs of growth
acceleration in 2016 will narrow the valuation discount to its peers.

Figure 41: P/E band

2.9
2.7
2.5
2.3
2.1
1.9
1.7
1.5
1.3
1.1
0.9
0.7
0.5
10/2014

11/2014
12/2014

01/2015

02/2015
03/2015

04/2015
05/2015

06/2015
07/2015

08/2015

09/2015
10/2015

11/2015
12/2015

01/2016

02/2016
03/2016

04/2016
05/2016

06/2016
07/2016

08/2016

09/2016

10x 13x 16x 19x 22x Share Price

Sources: Bloomberg

18
Sector report Oct 31, 2016

Figure 42: Financial summary


Income Statement Balance Sheet
Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E

Revenue 660 714 1,004 1,200 1,398 Non-current assets


Cost of sales (504) (487) (670) (786) (904) PPE 5 16 21 27 34
Gross profit 156 227 334 414 493 Investment properties 92 108 129 155 186
Interest in a joint venture 45 63 68 74 81
Other income 27 10 30 36 42 Goodwill 0 91 91 91 91
Selling and distribution expenses (88) (119) (178) (208) (242) Intangible assets 0 116 215 187 155
Administration expenses (46) (69) (90) (108) (126) Other receivables 75 75 99 104 109
Operating profit 49 49 96 134 168 Available for sales investments 0 10 17 19 21
Net finance income (cost) (7) (16) (5) (7) (7) 218 478 640 657 676
Other non-recurring items 6 18 5 6 7
Profit before tax 49 51 97 133 167 Current assets
Income tax expense (11) (12) (21) (29) (37) Inventories 70 79 96 112 129
Net profit 38 39 76 104 130 Trade and other receivables 418 287 335 400 466
Minority interests 0 (8) (20) (20) (23) Other current assets 0 105 87 92 93
Net profit attributable to shareholders 38 31 56 84 107 Restricted bank deposits 84 0 0 0 0
EPS (Rmb) 0.06 0.05 0.08 0.12 0.15 Bank balance and cash 230 132 132 190 279
802 604 649 794 967
Growth rates (%)
Revenue 19.0% 8.1% 40.7% 19.5% 16.5% Total assets 1,019 1,082 1,289 1,451 1,643
Adjusted net profit -19.7% -17.6% 78.9% 49.8% 28.0%
Adjusted EPS -19.9% -21.9% 73.3% 48.3% 26.7% Current liabilities
Trade and other payables 186 159 167 197 226
Margin & ratios (%) Other financial liability 7 21 20 20 0
Gross margin 23.7% 31.8% 33.3% 34.5% 35.3% Tax liabilitites 13 17 19 47 61
OP margin 7.5% 6.9% 9.6% 11.2% 12.0% Bank borrowings 229 168 190 200 200
Net margin 5.7% 4.4% 5.6% 7.0% 7.7% 435 364 396 463 487
Effective tax rate 22.2% 23.3% 22.0% 22.0% 22.0%
Payout ratio 24.9% 27.0% 25.0% 25.0% 25.0% Non-current liabilities
Deferred tax liabilities 10 30 32 165 335
Cash Flow Statement Other liabilities 3 0 98 93 0
Year-end Dec 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E 14 30 130 258 335

Profit before tax 49 51 97 133 167 Equity


Depreciation and amortization 2 4 28 34 39 Shareholders' equity 571 687 763 728 818
Net finance income (cost) 5 11 (0) 1 1
Others (9) (9) (13) (10) 9 Total liabilities & equity 1,019 1,082 1,289 1,449 1,639
Change of working capital (44) 61 (56) (53) (53)
Tax paid (8) (16) (21) (29) (37)
Operating cash flow (5.2) 103.2 34.8 76.1 126.7

Capex (2) (6) (34) (18) (21)


Change of AFS investments - (31) (15) 5 5
Acquisitions 0 (148) 0 0 0
Others (28) 17 5 6 6
Investing cash flow (30) (168) (44) (8) (10) Financial Ratios
Year-end Dec 31 FY14 FY15 FY16E FY17E FY18E
Change of borrowings 130 (61) 22 10 0
Decrease /(increase) in pledged bank deposits (66) 84 0 0 0 Current ratio 1.8 1.7 1.6 1.7 2.0
Proceeds from issuance of mandatorily convertible bonds 105 0 0 0 0 Quick ratio 1.7 1.2 1.0 1.2 1.3
Others (26) (24) (14) (21) (28)
Financing cash flow 144 (1) 9 (11) (28) Asset turnover 0.8 0.7 0.8 0.9 0.9
Total assets/total equity 1.8 1.6 1.7 2.0 2.0
Net change of cash flow 109 (66) (1) 58 89 Net cash/(debt) (Rmb m) 85 (35) (58) (10) 79
Forex changes (0) (1) 0 0 0
Cash and cash equivalents at beginning 91 200 132 132 190 ROE (%) 7% 5% 9% 12% 14%
Cash and cash equivalents at end 200 133 132 190 279 ROA (%) 4% 3% 5% 6% 7%

Sources: Company data, GF Securities (Hong Kong)

19
Sector report Oct 31, 2016

Beijing Tong Ren Tang Chinese Medicine (8138 HK)


Accumulate (initiation) Expanding global footprint
Target price: HK$12.30
Largest proprietary Chinese medicine exporter in China Tong Ren Tang Group
restructured its overseas business in 2010 and listed Beijing Tong Ren Tang Chinese
Natalie Chiu Medicine (Tong Ren Tang CM) in 2013. With 62 self-operated stores outside China, Tong
SFC CE No. AVH029 Ren Tang CM now has one of the largest TCM retail networks in Asia. The company
nataliechiu@gfgroup.com.hk operates a TCM clinics-centric model and relies on product revenue generated from
+852 3760 2030 providing TCM consultation services. It currently offers two self-manufactured products:
GF Securities (Hong Kong) Brokerage Limited Angong Niuhuang Pills (安宮牛黃丸) and ganoderma lucidum spores powder (靈芝孢子
29-30/F, Li Po Chun Chambers 粉). It developed ten new healthcare products under four series in 2015, including omega-
189 Des Voeux Road Central
Hong Kong 3 extracted from plants, probiotics, etc.

3Q16 revenue grew 15.2%yoy to HK$266.3mn reversing the slowdown in 1H16.


Product sales, service income and royalty fee income rose 15.2%/13.1%/10.8% yoy
respectively. During the period, Hong Kong sales decline has narrowed. Net profit grew
25.2%yoy to HK$105.3mn, vs 32%yoy growth in 1H16. The company opened its first 2
US stores in Sept leading to higher SG&A expenses.

Sustained growth of self-manufactured products has led to above-peer profitability


and sales growth Tong Ren Tang CM posted total revenue and net income CAGRs of
43% and 32% respectively in 2013-15, and a gross margin of 70.2% and operating margin
of 47.5% in 2015. This rapid growth and strong profitability are attributable to its self-
manufacturing and wholesale-focused distribution model. Angong Niuhuang Pills have
seen the fastest growth among its products.

Overseas expansion to be accelerated in 2016-18 through partnership model Tong


Ren Tang CM aims to 1) penetrate overseas TCM markets with significant growth
potential, and 2) expand the therapeutic focus of Angong Niuhuang Pills from curative to
preventive. The company is targeting the US and Europe as long-term growth drivers and
should see stable growth in Hong Kong and other Asian markets.

Valuation offers limited upside in the near term We initiate Tong Ren Tang CM with
an Accumulate rating and a one-year target price of HK$12.30, which implies 9% upside
and is based on a target P/E of 20x our 2017 EPS forecast of HK$0.61. The target P/E
represents 1.0x PEG against FY16-18 EPS growth of 19.8%. The stock is trading at 18.3x
our 2017 EPS estimate, a 19% premium to its peer group average of 15.3x. We think this
premium is justified given its above-peer profitability and solid execution. However, further
Stock performance share price upside will be capped by slower organic growth in Hong Kong while new
markets are still in ramp-up phase.
8138 HK Equity Hang Seng Index
40%

30%
Risks: 1) Unfavorable regulation for the TCM industry in its overseas markets; 2) over-
20%
reliance on Angong Niuhuang Pills for the company’s revenue; 3) market risk as a GEM
10%
board-listed company.
0%
Oct-14
Nov-14
Dec-14

Jun-15
Feb-15

Oct-15
Nov-15
Dec-15

Jun-16
Apr-15

Jul-15

Sep-15

Feb-16

Apr-16

Jul-16
Aug-16
Sep-16
Oct-16
Mar-15

May-15

Aug-15
Jan-15

Mar-16

May-16
Jan-16

-10%

-20%

-30%

Source: Bloomberg

Key data Stock valuation


Turnover Net profit EPS EPS YoY P/E BPS P/B ROE
Oct 27 close (HK$) 11.10
(HK$ m) (HK$ m) (HK$) (%) (HK$) (%)
Shares in issue (m) 837.1 2014 761 287 0.35 31.7 1.8 5.3 21%
21%
Major shareholder TRT Tech (38.05%) 2015 970 354 0.42 20% 26.4 2.2 4.4 19%
Market cap (HK$ bn) 9.39 2016E 1,097 452 0.54 27% 20.7 2.6 3.7 20%
3M avg. vol. (m) 0.47 2017E 1,266 524 0.61 15% 18.1 3.0 3.2 19%
52W high/low (HK$) 12.2/7.55 2018E 1,473 611 0.71 16% 15.6 3.5 2.7 19%
Source: Bloomberg Sources: Company data, GF Securities (Hong Kong)

20
Sector report Oct 31, 2016

Stable growth for proprietary Chinese medicines in Hong Kong in 2011-15

Stable growth for proprietary Chinese medicine products in Hong Kong Proprietary Chinese
medicine products refers to any proprietary product composed of any Chinese herbal medicines
and formulated in a finished dose form. The segment is expected to sustain stable growth over the
next five years. According to Frost & Sullivan, it grew from HK$1.0bn in 2011 to HK$1.3bn in 2015,
a CAGR of 7.0%, and is expected to grow to HK$1.7bn by 2020, meaning a CAGR of 6.3%.

Figure 43: Breakdown of Hong Kong pharmaceutical market by


western medicine and proprietary Chinese medicine

HK$ bn
2015-20 CAGR:
20 Western medicine: 6.8%
18 Proprietary chinese medicine: 6.3%
2011-15 CAGR:
16 Western medicine: 8.4%
14 Proprietary chinese medicine: 7.0%
12
10
8
6
4
2
0
2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Western medicines Proprietary Chinese medicines

Sources: Tong Ren Tang CM’s prospectus, GF Securities (Hong Kong)

Cardiovascular proprietary Chinese medicines have grown faster than the industry average
The major proprietary Chinese medicines in Hong Kong covers therapeutic categories such as
cardiovascular, respiratory, musculoskeletal, gastrointestinal, gynecological and genitourinary.
Cardiovascular proprietary Chinese medicines can be used for both preventative and curative uses.
Angong Niuhuang Pills account for a dominant share of the Hong Kong cardiovascular proprietary
Chinese medicine market. Tong Ren Tang CM’s Angong Niuhuang Pills accounted for >90% of
Angong Niu Pills in Hong Kong in 2011.

Figure 44: Industry sales of Angong Niuhuang pills in Figure 45: Sales and market share of Angong Niuhuang
Hong Kong pills in Hong Kong (2011)
HK$30m: 6%
HK$ m

1800 1662
CAGR: 18.9%
1600 1445
1400
1221
1200
1018
1000 831
800 HK$486m: 94%

600 516

400 294
172 190 218
200
0
2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E Beijing Tong Ren Tang Others

Sources: Tong Ren Tang CM’s prospectus, GF Securities (Hong Kong)

Rising global demand for high value proprietary Chinese medicines


Export value of Chinese medicine products posted two-year CAGR of 18.8% in 2013-15
According to the China Chamber of Commerce for Import and Export of Medicine and Health
Products, exports of Chinese medicine products have been steadily growing over the years and
totaled US$3.77bn in 2015, representing a two-year CAGR of 18.8% (2013-15). Exports of
proprietary Chinese Medicines accounted for 7% of the total export value of Chinese medicine
products in 2015 and posted growth of 4.7% YoY to US$262m. The slower segment growth in 2015

21
Sector report Oct 31, 2016

was partly due to the loss of TRT Group’s export revenue to its subsidiary Tong Ren Tang CM,
which is a Hong Kong entity.

Tong Ren Tang CM accounts for the majority of proprietary Chinese medicine exports The
TRT Group was the largest Chinese Medicines exporter in 2011 according to the China Chamber
of Commerce for Import & Export of Medicine & Health Products. Tong Ren Tang Ltd. was the top
exporter and Tong Ren Tang Tech was third in terms of export value of Chinese Medicines in China
in 2011. Together they contributed ~19% of total export value of Chinese Medicines. Since 2013,
Tong Ren Tang CM has assumed overseas distribution of “Tong Ren Tang” branded products and
thus its market share largely represents the combined share of TRT Ltd and TRT Tech which
currently holds 33.62% and 38.05% interest in the company.

Figure 46: TRT Group’s export market share and their


respective relevant export value in 2011

US$36.6m:
16% US$7.5m: 3%

US$37.1m: 81%

TRT Ltd TRT Technologies Others

Sources: Tong Ren Tang CM’s prospectus, GF Securities (Hong Kong)

Hong Kong is the top export destination for Chinese medicine products in terms of export
value, but the United States is the fastest growing key export market Asia accounted for 58.8%
of total export value of Chinese medicine products from China in 2015, down from 73.5% four years
ago. The US continued to be the third biggest Chinese medicine product export market, and its
share has increased from 8.0% in 2011 to 14.3% in 2015. During the year, the Chinese regulator
forged a mutual agreement for recognition of herbal extraction standards with the United States
Pharmacopeia (USP), which contributed to the faster growth in Chinese medicine herbs. We believe
improved regulation and supervision of the Chinese medicine industry by foreign counterparts will
promote further growth in these countries.

Above-peer profitability ensures sustainable growth

Competitive advantage for Angong Niuhuang Pills Tong Ren Tang CM’s Angong Niuhuang Pills
is a major TCM proprietary product in Hong Kong’s cardiovascular proprietary Chinese medicines
market. The product differs from other Angong Niuhuang Pills as it contains natural musk, a
regulated Chinese medicinal herb with limited supply. Most other Angong Niuhuang Pills in China
do not contain these Chinese herbs. Together with ganoderma spores powder in Hong Kong, the
two self-manufactured products contributed two-thirds of their product sales in 2015.

Increasing stroke prevalence in Hong Kong and other Asian countries provides long-term
upside Strokes are the fourth leading cause of death in Hong Kong. The prevalence rate for strokes
in people aged above 65 years is around 5%, with 55,000 patients in need of, or under, long-term
treatment. This implies significant growth potential for Angong Niuhuang Pills as a preventive
medicine.

Higher profitability than competitors Tong Ren Tang CM has one of the largest Chinese
medicine retail networks in Hong Kong. Other TCM retail chain operators include Singapore-based
Eu Yan Sang and Hong Kong-based Wai Yuen Tong (897 HK, NR). In contrast to its competitors,
Tong Ren Tang CM’s products are mainly based on therapeutic efficacy while its peers target TCMs
as health supplements. In terms of profitability, Tong Ren Tang CM has the highest gross margin
in sales of key products, which is attributable to its bigger wholesale business and higher retail
segment margins.

22
Sector report Oct 31, 2016

Figure 47: Gross margin comparison (2015) Figure 48: Revenue split comparison (2015)
80%
70.2% Hong Kong and Macau Mainland China SE Asia Others
70%
100%
60%
49.4% 80%
50% 44.9%
60%
40%
40%
30%
20%
20%
0%
10% Tongrentang Chinese *Eu Yan Sang Wai Yuen Tong
Medicine

0%
Tong Ren Tang Eu Yan Sang Wai Yuen Tong

Sources: Company data, GF Securities (Hong Kong); Eu Yan Sang's financial year ends *Mainland China and Macau included in Hong Kong revenue.
in June.

Figure 49: Wholesale revenue contribution, Tong Ren Tang and Eu Yan Sang

TRT, 2012 EYS, 2015


Clinics Others
5% 1%
Agency fee
income
3% Wholesale
Others
17% 13%
Retail
Royalty fee 30%
income
0%

Wholesale Retail
50% 81%

Sources: Tong Ren Tang CM’s prospectus and Eu Yan San’s annual report, GF Securities (Hong Kong)

Overseas business to be expanded via partnership model Tong Ren Tang CM self-operates 62
stores outside of China, mainly in Asia. The company plans to penetrate markets with strong
potential including the US and Europe through corporation with local partners to set up Tong Ren
Tang branded TCM clinics and retail stores. Local partners would remain as minority shareholders.
Such a business model could leverage on their partners’ local knowledge, but it requires a longer
ramp-up period. Although more resources are needed, the company believes it will provide long-
term benefits in terms of brand recognition and product promotion.

23
Sector report Oct 31, 2016

Growth outlook
We expect Tong Ren Tang CM to deliver CAGRs of 20% in EPS and 15% in revenue during FY16-
18, driven by product price increases and efficiency improvements.

Hong Kong sales decline to narrow in 2H16 Tong Ren Tang CM has lower retail sales exposure
compared to other TCM companies in Hong Kong and has shown more resilience to fluctuations in
the retail environment. In Feb 2015, the company acquired a 51% stake in Honour Essence Trading
Limited, a local Chinese medicine distributor, to further increase its wholesale presence. Together
with improved consumer sentiment, we believe the decline in HK sales will narrow in 2H16.

Figure 50: Tong Ren Tang CM's Hong Kong sales Figure 51: Tong Ren Tang CM's revenue mix (1H16)
450 60%

400 50% Service income


3% Royalty fee
350 40% income
0%
300 30%

250 20%

200 10%

150 0%

100 -10%
Product sales
50 -20% 97%

0 -30%
1H14 2H14 1H15 2H15 1H16

Revenue HK$ m YoY growth

Sources: Company data, GF Securities (Hong Kong)

Price hike for Angong Niuhuang Pills Tong Ren Tang CM’s Angong Niuhuang Pill have
undergone two price hikes in the past three years, with the retail price of each pill increasing from
HK$670 to HK$690 in 2014 and from HK$690 to HK$720 in 2015. The company has no plans to
increase the price in the near term but would have room to do so. Given the short supply, we expect
one price increase in 2017, which would contribute to a margin improvement.

Acquisition of TCM chain clinics to create cross-selling opportunities Tong Ren Tang CM
acquired a 50% stake in Fook Ming Tong Chinese Medical Center in June 2014. Fook Ming Tong
currently operates six TCM clinics in Hong Kong. The acquisition is in line with the company’s
strategy of marketing their proprietary Chinese medicine products while offering consultations.

Expansion into US and Europe Both markets currently contribute less than 5% of Tong Ren Tang
CM’s revenue. Working with local partners, Tong Ren Tang CM plans to introduce Tong Ren Tang
brands to these markets by offering Chinese medical consultations and treatments in retail outlets.
We believe this will take longer to ramp-up than in Hong Kong stores, where it normally takes two
years to achieve operational breakeven, thus the profit contribution will be immaterial in the next 2-
3 years.

Figure 52: Tong Ren Tang CM’s margins


80%
75%
73.0% 73.5% 73.6%
70% 71.4% 70.2%
68.4%
65%
60%
55%
50% 50.5% 50.6% 50.7%
46.6%
45% 45.1%
43.7%
41.2% 41.4% 41.5%
40%
37.7% 36.5%
35% 35.8%

30%
2013 2014 2015 2016E 2017E 2018E

Gross margin Operating margin Net margin

Sources: Company data, GF Securities (Hong Kong)

24
Sector report Oct 31, 2016

Valuation
Our one-year target price of HK$12.30 implies 9% upside and is based on a target P/E of 20x our
2017 EPS forecast of HK$0.61, and represents 1.0x PEG. Other HK-listed Chinese medicine
companies are trading at 15.3x 2017E P/E. The stock is currently trading at 18.3x our 2017 EPS
forecast. We think this premium is justified given its above-peer profitability and solid execution.
However, further share price upside will be capped by slower organic growth in Hong Kong, and as
new markets are still in ramp-up phase.

Figure 53: P/E band

15

13

11

1
10/2014
11/2014
12/2014
01/2015
02/2015
03/2015
04/2015
05/2015
06/2015
07/2015
08/2015
09/2015
10/2015
11/2015
12/2015
01/2016
02/2016
03/2016
04/2016
05/2016
06/2016
07/2016
08/2016
09/2016
10/2016
10x 13x 16x 19x 22x Share Price

Sources: Bloomberg

25
Sector report Oct 31, 2016

Figure 55: Financial summary


Income Statement Balance Sheet
Year-end Dec 31 (HK$ m) FY14 FY15 FY16E FY17E FY18E Year-end Dec 31 (HK$ m) FY14 FY15 FY16E FY17E FY18E

Revenue 761 970 1,097 1,266 1,473 Non-current assets


Cost of sales (218) (290) (296) (335) (389) PPE 260 262 339 428 531
Gross profit 543 681 801 931 1,084 Leasehold land 18 17 17 16 15
Intangible assets 0 61 60 61 61
Investments accounted for using the
Other income 1 4 4 5 6 26 23 24 24 23
equity method
Selling and distribution expenses (123) (142) (157) (181) (211) Deposits paid for purchase of PP&E 2 0 0 0 0
Administration expenses (78) (90) (94) (114) (133) Deferred income tax assets 7 9 10 11 13
Operating profit 344 452 554 641 747 313 373 451 540 645
Net finance cost 11 9 11 13 15
Other non-recurring items 0 (4) (3) (2) (1) Current assets
Profit before tax 355 457 562 651 761 Inventories 121 160 169 167 222
Income tax expense (61) (82) (101) (117) (137) Trade and other receivables 165 214 364 320 455
Net profit 295 375 461 534 624 Restricted bank deposits 471 520 531 541 552
Minority interests (8) (20) (9) (11) (12) Bank balance and cash 563 760 917 1,380 1,495
Net profit attributable to shareholders 287 354 452 524 611 1,320 1,654 1,981 2,408 2,725
EPS (HK$) 0.35 0.42 0.54 0.61 0.71
Total assets 1,633 2,027 2,432 2,949 3,370
Growth rates (%)
Revenue 24.0% 27.5% 13.1% 15.4% 16.4% Current liabilities
Adjusted net profit 30.5% 23.4% 27.5% 15.9% 16.7% Trade and other payables 71 77 114 221 168
Adjusted EPS 20.7% 20.0% 27.4% 14.7% 15.6% Current income tax liabilities 20 36 153 175 195
91 113 267 396 363
Margin & ratios (%)
Gross margin 71.4% 70.2% 73.0% 73.5% 73.6% Non-current liabilities
OP margin 45.1% 46.6% 50.5% 50.6% 50.7% Deferred tax liabilities 5 5 5 5 6
Net margin 37.7% 36.5% 41.2% 41.4% 41.5% Borrowings 0 1 1 1 1
Effective tax rate 17.0% 18.0% 18.0% 18.0% 18.0% 5 5 6 6 6
Payout ratio 28.6% 31.0% 30.0% 30.0% 30.0%
Equity
Cash Flow Statement Shareholders' equity 1,537 1,909 2,159 2,547 3,001
Year-end Dec 31 (HK$ m) FY14 FY15 FY16E FY17E FY18E
Total liabilities & equity 1,633 2,027 2,432 2,949 3,370
Profit before tax 355 457 562 651 761
Depreciation and amortization 18 23 24 28 -
Net finance income (11) (9) (11) (13) (15)
Others 0 6 4 3 2
Change of working capital (50) (50) (122) 153 (244)
Tax paid (67) (74) (101) (117) (137)
Interest paid 0 0 0 0 0
Operating cash flow 245 354 357 705 367

Capex (83) (31) (91) (106) (125) Financial Ratios


Increase in short-term bank deposits (mat. >3 months) (1) (50) (10) (11) (11) Year-end Dec 31 FY14 FY15 FY16E FY17E FY18E
Acquisitions 0 3 0 0 0
Others 12 9 11 13 15 Current ratio 14.5 14.7 7.4 6.1 7.5
Investing cash flow (73) (69) (90) (104) (121) Quick ratio 13.2 13.3 6.8 5.7 6.9

Change of borrowings 0 1 0 0 0 Asset turnover 0.3 0.5 0.5 0.5 0.5


Dividends paid to the Company’s shareholders (66) (84) (109) (136) (157) Total assets/total equity 1.1 1.1 1.1 1.2 1.1
Dividends paid to non-controlling interests (3) (6) (7) (9) (11) Net cash/(debt) (Rmb m) 1,034 1,280 1,448 1,921 2,047
Others 13 8 7 5 4
Financing cash flow (56) (81) (109) (139) (163) ROE (%) 21% 21.5% 22.7% 22.3% 19.3%
ROA (%) 19% 19% 20% 19% 19%
Net change of cash flow 116 204 157 463 83
Forex changes (7) (8) 0 0 0
Cash and cash equivalents at beginning 454 563 760 917 1,380
Cash and cash equivalents at end 563 760 917 1,380 1,463

Sources: Company data, GF Securities (Hong Kong)

26
Sector report Oct 31, 2016

Rating definitions

Benchmark: Hong Kong Hang Seng Index


Time horizon: 12 months

Company ratings
Buy Stock expected to outperform benchmark by more than 15%
Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%
Hold Expected stock relative performance ranges between -5% and 5%
Underperform Stock expected to underperform benchmark by more than 5%
Sector ratings
Positive Sector expected to outperform benchmark by more than 10%
Neutral Expected sector relative performance ranges between -10% and 10%
Cautious Sector expected to underperform benchmark by more than 10%

Analyst Certification
The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant
securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant
securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific
recommendations or views expressed in this research report.

Disclosure of Interests
(1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated
companies do not hold any shares of the securities mentioned in this research report.
(2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned
in this research report in the past 12 months.
(3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial
interests or hold any shares of the securities mentioned in this report.

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27