Tonghua Dongbao:Growth momentum expected to continue

Guiding 30% core profit growth in 2016; Buy .

    Solid growth for insulin products Tonghua Dongbao (THDB) reported sales/core profit of RMB431m/113m for 4Q15, representing YoY growth of 2%/34%, respectively. The deceleration in revenue growth in 4Q15 was due to a high base in 4Q14 from a change in the VAT rate as well as delayed revenue recognition for 4Q15. The robust profit growth was driven by COGS savings from procurement of insulin pens as well as a loss-making subsidiary. Management guided to 20% and 30% for insulin sales and core profit growth in 2016, respectively.

    Solid growth for insulin products

    Sales growth of insulin products reached 22% in 2H15, vs. 22% in 1H15. We remind investors that the company had a high revenue base in 4Q14 due to the VAT rate cut and a change of booking method. On an apple-to-apple basis, sales growth, based on the amount of shipped products, was approximately 20% in 2015, according to the company. Going forward, the company is confident its human insulin business can achieve 20% growth. We expect the launch of insulin Glargine in 1H17 to add another leg of growth.

    Multiple drivers to support margin expansion

    GM/OPM reached 79.1%/31.6% in 4Q15 vs. 68.3%/24.5% in 4Q14. In 2015, GM/OPM was 75.3%/34.3%, vs. 68.9%/25.1% in 2014. The margin expansion in 2015 was due to COGS savings from procurement of insulin pens and a loss-making subsidiary, and a rising utilization rate as well as operating leverage improvement. We believe margin expansion will continue due to: 1) continued GM expansion from improved product mix, limited price cuts with the ramp-up of 40R/50R as well as new product launches in 2017; and 2) R&D cost savings. For selling expense, we believe the operating leverage improvement on this side could still be maintained in 2016.

    Maintaining price target of RMB29; risks

    We base our RMB29 price target on 55x 2016E EPS of RMB0.53. We believe 55x is justified as its A-share biotech peers are trading at 51x on 2016E EPS with 24% growth in 2017E (vs. the 27% we model for THDB). In our view, the premium is justified by its higher growth sustainability and visibility of insulin franchise vs. most other therapeutics, and a compelling risk profile. Key risks include larger price cuts and pipeline failure.