Tonghua Dongbao Pharmaceutical:Sustained development helped by online platform and new product

H1results in line with expectations

    H1revenue/net profit excluding one-offs jumped 14.1%/36%, matching expectations.We think the insulin market has significant potential and that Dongbao has a clearadvantage in the primary market. We see a five-year revenue CAGR of 20%+ forDongbao, as the online platform could further increase doctor/patient engagement and3rd-gen insulin could get approved. We think profit growth will outpace revenuegrowth on economies of scale. With dilution from a private placement factored in,Dongbao is trading at 43x 2017E PE, in line with its historical average. We thinkvaluation still has room to rise as 3rd-gen insulin registration progresses steadily.

    Insulin bucked the trend and maintained rapid growth

    Revenue from insulin preparations increased 19% YoY in H1. Revenue in the insulinsegment rose only 15.2%, hit by a c50% decline in exports. Since Q2, the governmenthas strengthened its supervision over distribution, causing some small distributors todestock. The destocking has not yet ended, so we slightly cut our insulin revenueforecast for full-year 2016. Insulin gross margin expanded 3.5% YoY to 87.4% butDongbao said it sees little room for further growth. The selling expense ratio decreased4.2% YoY to 23.2%. Even considering that big events are largely concentrated in H2,the full-year selling expense ratio could still be much lower YoY.

    Blood glucose monitoring/online platform/3rd-gen insulin progress smoothly

    Having taken over Bionime's distributors, Dongbao is expanding equipment sales tomore hospitals. Dongbao's plan to add 1k hospitals this year (completed 400+ in H1)and 3k within three years could drive rapid equipment revenue growth. The rising shareof self-operated outlets could boost equipment sales gross margin. Dongbao's onlineplatform, which is under beta testing with c100,000/1,000+ patient-/doctor-users, maygo online in September. The platform mainly helps doctors manage their patients, witha low cost of bringing in users. Dongbao plans to apply for insulin glargine productionin H2. Insulin aspart completed a clinical trial in July and is undergoing data cleansing,with plans to apply for production in 2017. Further, Dongbao has begun to developantidiabetic drugs other than insulin.

    Valuation: Raising DCF-based PT to Rmb26.30, implying 49x 2017E PE

    Our new DCF-based PT is Rmb26.30(WACC 6.2%). Major changes: 1) slightly cut2017/18E earnings; 2) raise 3rd-gen insulin's chance of approval to 90% from 75%; 3)roll over valuation to end-2017; and 4) slight EPS dilution post private placement.