Shangdong Realcan Pharmaceutical:Raising our earnings estimates,as results are better than we expected

Q3 earnings beat expectations; we raise our EPS estimates, but valuation is fair

    Realcan's Q1-Q3 revenue rose 54.7% YoY and net profit attributable to the parent rose124% YoY, in line with the company's guidance (110-160%). Q3 revenue rose 56%YoY and net profit (excluding one-offs) attributable to the parent rose 159% YoY,better than we expected. The progress of cross-province acquisitions was the mainfactor driving the rapid earnings growth in Q3. We raise our 2016-18E EPS fromRmb0.7/0.96/1.21 to Rmb0.82/1.07/1.27. We maintain our Neutral rating because webelieve: 1) the current valuation has factored in the rapid growth expectations driven byacquisitions in the past two years; 2) it remains to be seen how effective the company'smanagement and integration will be after rapid expansion.

    Raising our estimates for drug revenue from markets outside Shandong

    Following Realcan's expansion outside Shandong via acquisitions, the markets outsidethe province contributed Rmb840m to the company's revenue in H1, driving drugrevenue growth of 41%. Drug revenue continued to grow rapidly in Q3. Thecompany's private placement raised Rmb3.1bn, which it will use to support crossprovinceacquisitions. For the drug business, considering that its cross-provinceexpansion is progressing well, we raise our 2016-18E revenue from markets outsideShangdong from Rmb0.17/0.5/0.87bn to Rmb1.68/3.02/4.23bn, with drug revenuegrowth lifted from 20.0%/18.2%/18.0% to 37.4%/24.4%/20.6%. We also revise ourfull-year estimates for the device business based on the H1 and Q3 results.

    Lower financial expenses due to funds raised via placement, lower interest, etc.

    We lower our forecast for the short-term borrowing rate from 6.0% to 4.5% based onthe overall decline in interest rates. As the company usually pays for acquisitions ininstalments, we change the payment method for acquisitions of device companies froma lump-sum payment to instalments over three years. We lower our 2016-18E financialexpenses 62.8%/89.5%/70.8% to Rmb31/15/63m, as the company raised Rmb3.1bnvia the additional placement.

    Valuation: Raising PT to Rmb38.65; maintain Neutral rating

    Our DCF-based PT is Rmb38.65, with WACC falling from 6.2% to 5.3% mainly due to:1) revision of the risk-free rate; and 2) lower debt costs. The stock is trading at 43x/33x2016E/17E PE, or 1.78x/1.37x PEG, higher than the peer average PE (40x/30x) and PEG(1.50x/1.16x). We maintain our Neutral rating, as we think the valuation is fair.