Zhejiang Huahai Pharmaceutical:Focus on both overseas and domestic businesses to drive growth

Focus on domestic/overseas markets gives preparations high growth visibility

    Changing its past strategy of focusing only on overseas markets, Huahai is beginning tofocus on both domestic and overseas markets and could have growth momentum inthe domestic market. We are upbeat on its long-term development, driven by its focuson both markets and the significant value potential it holds as a platform for exports ofChinese preparations. For the preparation segment, we forecast 2016-18 revenuegrowth of 48%/40%/30%, gross margin of 59.6%/60.4%/60.8% and gross profitcontributions of 63%/68%/69%.

    Anti-neuronal APIs to grow rapidly

    We expect anti-neuronal active pharmaceutical ingredients (APIs) to be the fastestgrowingproducts. The company's extensive anti-neuronal products should drive rapidimprovement in the anti-neuronal API segment. Given the demand growth for antineuronalAPIs, driven by the ramp-up of the company's anti-neuronal preparations andlarge growth potential for anti-psychotic drugs, we forecast the revenue of antineuronalAPIs will have a 40% CAGR in the next three years.

    Advantages of generic drug exports; domestic growth possible

    Relying on its global cost advantages, extensive pipeline support and export-orientedplatform, Huahai's preparation exports are likely to maintain rapid growth. We forecastsales revenue from overseas markets to have a 22% CAGR in the next three years. Dueto its advantages in registration of drugs overseas and increased investment in domesticpreparation sales (which have a low base), the company could have growth momentumin the domestic market. We forecast sales revenue from the domestic market to have a40% CAGR in the next three years.

    Valuation: Raising PT to Rmb36.88, maintain Buy

    Our 2016-18E sales revenue is Rmb4.54bn/5.91bn/7.33bn and EPS are Rmb0.77/0.99/1.38 (including a planned share placement). We believe Huahai's overseas business isunique and could develop rapidly, while its strategy of focusing on overseas/domesticmarkets will further open up its growth potential. Therefore, we are raising ourterminal growth and ROIC assumptions. Our DCF-based PT of Rmb36.88 (fromRmb28.65) assumes 7.1% WACC and implies 37x 2017E PE, lower than its historicalaverage of 41x. We believe the current share price does not fully factor in the growthpotential of the preparation segment and significant value from the construction of anexport-oriented preparation platform. We maintain our Buy rating.