Hengrui Medicine:Expecting growth momentum to continue

Strong organic growth delivered in 4Q16

    Hengrui reported sales/core profit of RMB2.8bn/653m in 4Q16, representingYoY growth of 16% and 10%, respectively. If we were to exclude the milestonepayment from Incyte in 4Q15, the organic sales growth would have been 24%vs. 20% in 9m16, in line with our previous expectation. For 2017, managementexpects growth to be largely similar to 2016. We believe apatinib and contrastagents could continue be the major drivers for the domestic business, whilethe ramp up of sevoflurane would add a leg of growth to exports. We model21%/24% growth for China/exports in 2017, respectively.

    Apatinib remains the bright spot; growth for exports likely to accelerate

    Growth momentum for oncology, contrast agents and anesthetics remainedstrong, with 42%, 30%, 18% growth in 2H16vs. 30%, 30%, 20% in 1H16,respectively. We attribute the strong performance of oncology to the ramp upof apatinib. We estimate the sales for this drug to be RMB950m in 2016vs.RMB280m in 2015. Management indicated that price negotiation for apatinibis ongoing for NRDL inclusion and the outcome is expected in 4Q17. Forexports, the growth for 2016was 21%, primarily driven by cyclophosphamide.Management continues to expect 5-8ANDA approvals this year. We expectgrowth for exports will likely accelerate to 24% in 2017and 33% in 2018.

    On margin and pipeline progress

    Gross margin increased to 87.7% in 4Q16vs. 86.0% in 4Q15due to productmix. Operating margin decreased slightly to 23.8% in 4Q16from 24.8% in4Q15. We attribute this to higher selling expenses from optimization of thestructure of sales force, as well as higher R&D spending. On pipeline,management indicated that the P2study for PD-1is progressing well and a P3study on liver cancer should start in 2H17. Additionally, the company plans tore-file 19K in 1H17and it is likely that the drug could be approved by YE17. Forretagliptin, the company will likely resubmit the application in 1H17after 19K.

    Increasing target price to RMB60.0from RMB55.0; risks

    We roll over to use 2018E EPS for valuation. Our target price is based on 36x2018EPS, vs. 39.5x 2017EPS previously. We believe 36x is justified, as its Asharepeers are trading at 25x 2018EPS with 18% growth (vs. 25% forHengrui). The premium is justified by the superior value of its products and itsstrong pipeline. With expected growth acceleration, we expect stock to re-rateas it delivers. Key risks include product launch delays and price cuts.