Healthcare Sector:1H15 preview,Divergence among sub-sectors amid sector-wide weakening

The healthcare companies listed in HK will release their 1H15 results in Aug. We expectgrowth to slip across the sector due to the slowdown of GDP, ongoing tender process indifferent provinces, diminishing benefits of medicare expansion, anti-corruption and otherheadwinds. Performance will be divergent among sub-sectors. We prefer the serviceproviders and Chinese medicine companies which we believe have more potential toachieve robust growth in 2H15. In terms of core business, we expect 1H15 earnings ofPhoenix Healthcare (1515 HK), China Pioneer Pharm (1345 HK), Shanghai Pharm (2607 HK)and Shineway Pharm (2877 HK) to be basically in line with consensus. However, we thinkthe performance of United Lab (3933 HK) would likely be affected by the impairment loss ofits land in Pengzhou. In addition, the increasing competition in the intravenous infusionindustry and the tender process may cause the performance of SSY Group (2005 HK) tomiss consensus, in our view.

    Pharmaceutical Distribution: While we think this segment will be directly impactedby the industry slowdown and face downside pressure, it is less affected by theprovincial drug tenders, meaning the risk of drug price decrease could be largelymitigated. Considering the expected 2Q slowdown and relatively high valuation(Bloomberg consensus: PE of 18.5x/15.3x for 2015/2016) of Sinopharm (1099 HK),we prefer Shanghai Pharm (2607 HK) (Buy, TP: HKD24.04). The key reasons forrecommending the stock include: (1) As the industry leader, Shanghai Pharmbenefits directly from the continuing industry growth; (2) Management is keen toreform and the DTP business has shown initial success; and (3) Its valuation isrelatively low at 13.6x/12.2x 2015/2016E PE.

    We are also positive on CMS (867 HK) and China Pioneer Pharm (1345 HK) (Buy, TP:HKD6.6) in the distribution segment. Both companies have clear business strategiesand are penetrating into upstream to secure stronger control of drugs. Compared withCMS (18.0x/14.4x 2015/ 2016E PE), China Pioneer Pharm’s valuation is more attractive(13.9x/10.5x 2015/ 2016E PE). Regarding China Pioneer Pharm’s 1H15 performance,we expect rapid growth for its core drugs with approximately 20% increase in revenueand operating profit. However, the potential loss of its associate companies and weaksales of its medical devices would weigh on its 1H15 performance.

    Drug makers: We prefer the Chinese medicine manufacturers, andcancer/cardiovascular drug and other high-end drug manufacturers. Chinesemedicines are largely shielded from the tender impact, thanks to their low-priceadvantage. In addition, it is worth noting that companies like China TraditionalChinese Medicine (570 HK) and PuraPharm are involved in the ConcentratedChinese Medicine Granule (CCMG) business, where high growth is expected.Moreover, we think Shineway Pharm (2877 HK) (Neutral, TP: HKD14.41) may alsobenefit once the CCMG market is opened in the coming years. Incancer/cardiovascular drugs and other high-end drugs, the logic of “expanding salesvolume to compensate for price cut by deepening sales channel” still works, in ourview. Investors may watch out for stocks like Luye Pharm (2186 HK) and CSPC (1093HK). However, their relatively high valuations could weigh on the stock priceperformance. Meanwhile, we are concerned about the performance of United Lab(3933 HK). We believe its traditional “medical intermediates, APLs andpharmaceutical preparations” business will only record 10%-15% growth. The profitcontribution from its new insulin business will be quite limited, and will probablynot be able to support its overall expansion. What’s more, investors should payattention to the impairment risk of its land in Pengzhou, which may bring downsiderisk to its performance. We are also concerned about SSY Group (2005 HK).Increasing competition in the intravenous infusion industry will gradually heightenthe overcapacity problem. We estimate the unit price of its intravenous infusionproducts to decrease, dragged by price cuts in the tender process. With excesscapacity, it is difficult for the company to expand sales volume to compensate forprice cut, in our view.

    Companies with hospital management concept. Currently, the number of hospitalmanagement companies listed in HK is quite limited, and for some of them this isnot their principal business. Among the limited options, including PhoenixHealthcare (PHG) (1515 HK), Hua Han Bio-Pharm (587 HK), Harmonicare (1509 HK),Shanghai Fosun Pharm (2196 HK) and Sihuan Pharm (460 HK), we prefer PHG (LTBuy, TP: HKD16.19). The key reason for recommending PHG is its highly replicableIOT business model, which could facilitate its long-term expansion and give it acorresponding first-mover advantage. We believe the public hospital reform inChina is still in its infancy. Hospitals with growth potential but having operatingdifficulties, low efficiency and capital shortage are keen to seek help from privatecapital. Other reforms in the healthcare industry will also be related to the hospitalreform. Accordingly, a well-managed company with experience in operating largehospitals and a solid track record is needed. As a first-mover, PHG possesses suchattributes and stands to benefit from the reforms, in our view.