A Go-getter in the Pharmaceutical Distribution Market of Guangdong Province, China, Initiate with Accumulate

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1 Health Care Sector Equity Research Report Company Report Equity Research 股票研究 Company Report: Kay Mai 麦梓琪 公司报告 : 创美药业 (2289 HK) maiziqi@gtjas.com 公司报告 A Go-getter in the Pharmaceutical Distribution Market of Guangdong Province, China, Initiate with Accumulate 中国广东医药分销市场的进取者, 首次覆盖并给予 收集 的投资评级 Charmacy Pharmaceutical ( Charmacy Pharma or the Company ), a pharmaceutical distributor operating in southern China, mainly serves downstream customers related to the pharmaceutical retail market. According to the MOFCOM of the PRC, Charmacy Pharma ranked 37th in the PRC in terms of the scale of revenue derived from principal business; market share stood at around.2%/2.3% in China/Guangdong Province in 216. Rating: Accumulate Initial 评级 : 收集 ( 首次研究 ) 6-18m TP 目标价 : HK$8.8 证券研究报告医药行业 Investment highlights include: 1) Focusing on business related to the pharmaceutical retail market, the Company is expected to be barely affected by the implementation of the two-invoice system and to benefit from the outflow of prescriptions to retail pharmacies from public hospitals, which is expected to boost the sales of the pharmaceutical retail market; 2) high revenue CAGR of 12.6% in FY16-FY19F is expected thanks to the proactive expansion of distribution network, customer base and product portfolio; 3) improvement in gross margin is expected thanks to increasing contribution from business with high gross margin, such as sales to retail pharmacies and consultancy services, the expansion of business scale and the increase in number of drug types sold by the Company as the primary distributor; and 4) high dividend payout ratio is expected in FY17F-FY19F. EPS is expected to grow YoY by -.2%/18.7%/17.8% to RMB.549/ RMB.651/RMB.767, in FY17F-FY19F, respectively. Initiate coverage with Accumulate investment rating and a target price of HK$8.8, representing 14.x FY17F PER and 11.8x FY18F PER. 创美药业 ( 公司 ) 是于华南地区经营的医药分销商, 主要服务于与医药零售市场相关 的下游客户 根据中国商务部,216 年创美药业按主营业务收入规模排行全国 37, 公司在 全国 / 广东省的市占率约为.2%/2.3% 投资亮点包括 :1) 着重于与医药零售市场相关的业务, 公司预计不受两票制的实行影响同 时将受益于处方外流 ( 处方外流将促进医药零售市场销售额提高 );2)216 财年 -219 财年高收入年复合增长率 (12.6%) 可期, 主要得益于对分销网络 产品组合以及客户群体 的积极拓展 ;3) 毛利率预计将有所提升, 主要是由于拥有较高毛利率的业务如对零售药房 销售以及咨询服务对收入贡献度有所提高 业务规模扩大以及公司作为一级分销商的产品 数目有所增加 ; 以及 4)217 财年 -219 财年股利分配率预期较高 每股盈利预计将于 财年分别同比增长 -.2%/18.7%/17.8% 至人民币.549/ 人民 币.651/ 人民币.767 首次覆盖给予 收集 投资评级, 目标价为 8.8 港元, 对应 14. 倍 217 财年的市盈率以及 11.8 倍 218 财年的市盈率 Share price 股价 : Stock performance 股价表现 (5.) (1.) (15.) % of return HK$8.11 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Change in Share Price 股价变动 HSI Charmacy Pharma 1 M 1 个月 3 M 3 个月 1 Y 1 年 Abs. % 绝对变动 % (4.8) 2. (3.8) Rel. % to HS index 相对恒指变动 % (6.8) (6.8) (26.2) Avg. share price(hk$) 平均股价 ( 港元 ) Source: Bloomberg, Guotai Junan International. 创美药业 Year End Turnover Net Profit EPS EPS PER BPS PBR DPS Yield ROE 年结 收入 股东净利 每股净利 每股净利变动 市盈率 每股净资产 市净率 每股股息 股息率 净资产收益率 12/31 (RMB m) (RMB m) (RMB) ( %) (x) (RMB) (x) (RMB) (%) (%) 215A 3, (29.1) A 3, F 4, (.2) F 4, F 5, Shares in issue (m) 总股数 (m) 18. Major shareholder 大股东 Mr. Yao Chuanglong 54.63% Market cap. (HK$ m) 市值 (HK$ m) Free float (%) 自由流通比率 (%) 13.2% 3 month average vol. 3 个月平均成交股数 ( ) 9.7 FY17 Net gearing (%) FY17 净负债 / 股东资金 (%) Weeks high/low (HK$) 52 周高 / 低 9.2 / 6.6 FY17 Est. NAV (HK$) FY17 每股估值 ( 港元 ) See the last page for disclaimer Page 1 of 14

2 INDUSTRY OVERVIEW Industry Drivers The PRC health care industry is one of the largest and one of the most rapidly growing components of the national economy with promising growth opportunities. It is believed that the growth of the PRC health care industry will continue to outpace the national GDP growth rate in the long run, primarily favored by sustainable growth in medical demand, triggered by an aging population and a raise in the payment level from individuals, government and insurance. The expected raise in payment level is mainly driven by 1) increasing per capita disposable income with rising healthcare awareness; 2) growing healthcare expenditure from the Chinese government, which still has ample room to be improved; and 3) increasing payment from insurance, supported by relative sufficient surplus of basic medical insurance funds as well as the commercial health insurance market, which is expected to boom under encouragement by the Chinese government. Figure-1: Total Population in the PRC and the Proportion of Population Aged over 65 1,39 1,38 1,37 1,36 1,35 1,34 1,33 1,32 Million % Total Population (LHS) Proportion of Population Aged over 65 (RHS) Source: National Bureau of Statistics of China, Guotai Junan International Figure-2: 1Q13-1H17 China s YTD Per Capita Disposal Income 3, RMB % 25, 2, 15, 1, 5, Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 China's Per Capita Disposable Income (LHS) YTD YoY Growth of China's Per Capita Disposable Income (RHS) Source: National Bureau of Statistics of China, Guotai Junan International Figure-3: Jan. 213-June 217 YTD Government Health Figure-4: Jan. 213-May 217 YTD Collection/Payment of Expenditure Basic Medical Insurance Fund 1,4 RMB in Billion % 4. 1,4 Billion % 6. 1,2 1, Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Government Health Expenditure (LHS) YTD YoY Growth of Government Health Expenditure (RHS) Government Health Expenditure as % of Government Spending (RHS) Source: Ministry of Finance of China, Guotai Junan International. Note: Government health expenditure includes spending on family planning ,2 1, Jan-13 Jan-14 Jan-15 Jan-16 Jan YTD Payment of Bacis Medical Insurance Fund YTD Collection of Bacis Medical Insurance Fund YTD YoY Growth of Payment of Bacis Medical Insurance Fund YTD YoY Growth of Collection of Bacis Medical Insurance Fund YTD YoY Growth of Number of Participants of the Basic Medical Insurance Source: Ministry of Human Resources and Social Security of China, Guotai Junan International.. The Pharmaceutical Distribution Industry The growth rate of the pharmaceutical distribution industry showed a rebound for the first time in 216 after suffering a couple of years of slowdown. According to the Ministry of Commerce of the People's Republic of China (MOFCOM), sales growth of the pharmaceutical distribution industry dropped by 8.3 ppts in from 18.5% to 1.2% as a result of national economy slowdown, price control brought about through the medical insurance system and drug price cuts brought by provincial tenders. With the weakening impact from such factors, the growth rate of the pharmaceutical distribution industry rebounded slightly by.2 ppts to 1.4% in 216. See the last page for disclaimer Page 2 of 14

3 Distribution business to retail pharmacies is estimated to have an opportunity to boom in the coming years while distribution business to public hospitals may remain under pressure. During the past several years, the Chinese government has introduced a series of policies to reduce patients' spending on drugs, but most of which are aimed at public hospitals rather than retail pharmacies because public hospital terminals account for the biggest market share of drug sales to end-customers; drug sales in public hospitals can be up to three times higher than in retail pharmacies. Therefore, the growth rate of drug sales in public hospitals has suffered sustained downward pressure and fell below the growth rate of drug sales in retail pharmacies in 216 for the first time. We expect the growth rate of drug sales in retail pharmacies to continue outpacing that of the drug sales in public hospitals in 217, mainly considering that the execution of the 3% cap on proportion of drug sales to total revenue of hospitals and zero-markup policy nationwide by the end of 217 will lead to further downward pressure on drug sales volume growth in public hospitals as well as the outflow of prescriptions to retail pharmacies from public hospitals. In addition, the separation of medical treatment and drug sales is expected to be a long-term trend that cannot be avoided; this trend is expected to keep boosting drug sales growth in retail pharmacies, hence, the distribution business to retail pharmacy customers. The industry has undergone significant consolidation and is expected to experience further consolidation in the coming years. Driven by government encouragement, drug price cuts, the enforcement of the more stringent Good Supply Practices for Pharmaceutical Products policy, which has brought huge challenges to many enterprises, especially small- and medium-sized ones, the pharmaceutical distribution industry in China has been confronted with consolidation in The number of pharmaceutical distributors fell to 12,975 in 216 from 16,295 in 212, while the market share of the top 1 largest pharmaceutical distributors ratcheted up from 64.% to 7.9% in the same period. With the consolidation of the industry, gross margin of the overall pharmaceutical distribution industry increased slightly by.1 ppt to 7.% in 216 from 6.9% in 212, even under the backdrop of drug price cuts. Considering that the two-invoice system, which facilitates the flattening of distribution channels to public hospitals and primary healthcare institutions, will be implemented nationwide by the end of 218, we expect the consolidation process of the whole industry to accelerate over the next couple years. Figure-5: Total Sales and Gross Margin of the Pharmaceutical Distribution Industry in China 2, 1,5 1, 5 RMB in billion % Total Sales of the Pharmaceutical Distribution Industry (LHS) YoY Growth (RHS) Gross Margin (RHS) Source: MOFCOM, Guotai Junan International. Figure-7: YoY Growth of Drug Sales in Terminals in China 35.% 31.4% 3.% 25.% 2.% 15.% 1.% 5.% 18.4% 23.5% 14.8% 13.4% 12.8% 19.% 13.7% 16.3% 1.7% 1.6% 1.% % 8.5% 7.6% Public Hospital Pharmacies Primary Healthcare Institutions Source: Menet, Guotai Junan International. Retail Pharmacies Figure-6: Market Share of the Top 1 Largest Pharmaceutical Distributors in China % Market Share of the Top 1 Largest Pharmaceutical Distributors Source: MOFCOM, Guotai Junan International. Figure-8: Total Sales of the Pharmaceutical Distribution Industry in Guangdong Province RMB in billion % Sales of the Pharmaceutical Distribution Industry in Guangdong Province (LHS) The Proportion of Sales of the Pharmaceutical Distribution Industry in Guangdong Province (RHS) Source: MOFCOM, Guotai Junan International. See the last page for disclaimer Page 3 of 14

4 Market Landscape of Guangdong Province Guangdong owns the biggest pharmaceutical distribution market among other provinces in China with a market share of 8.7% in 216, according to MOFCOM. Total sales of the pharmaceutical distribution market in Guangdong was about RMB16 billion in 216, with a CAGR of around 17% from 21 to 216, outperforming the overall industry. We expect that the pharmaceutical distribution market in Guangdong Province will continue to outgrow those of most other areas, primarily in view of the above-average estimation of GDP growth rate of Guangdong Province, which is expected to lead to a higher payment level of Guangdong residents than those of other areas in the country. BUSINESS OVERVIEW Company Profile Charmacy Pharmaceutical Co., Ltd. ( Charmacy Pharma or the Company") is a pharmaceutical distributor operating in southern China. Established in 2, the Company mainly engages in the distribution of pharmaceutical products in Guangdong Province and other surrounding provinces. As of FY16, the Company recorded revenue of RMB3,669 million with a YoY growth rate of 8.% and a gross margin of 4.9%. According to MOFCOM, Charmacy Pharma ranked 37th in the PRC in terms of scale of revenue derived from principal business, and it possessed a market share of around.2% in 216. The Company was listed on the stock exchange of Hong Kong on 14 December 215. Mr. Yao Chuanglong, Charmacy Pharma s Chairman, Executive Director and CEO, together with his spouse Ms. You Zeyan currently possesses the largest stake in the Company (54.63% interest as at 13 April 217). Figure-9: Charmacy Pharma s Shareholding Structure as at 13 April 217 Domestic Share H Share Mr. Yao Chuanglong Ms. You Zeyan Other shareholders of domestic shares 54.63% 19.44% Guangzhou Pharmaceutical Baiyunshan Hong Kong Company Limited Xiangxue Group (Hong Kong) Company Limited Kingworld Medicines Health Management Limited. Other public shareholders of H shares 7.32% 3.23% 2.13% 13.24% Charmacy Pharma Source: the Company. Notes: 1. Other shareholders of domestic shares include Shantou Zhichuang Investment Management Limited Partnership, Shantou Meizhi Investment Management Limited Partnership, Shantou Youran Investment Management Limited Partnership, Binhua Wu, Jigui Liu and others. 2. Mr. Lin Zhixiong, Executive Director, joint company secretary and CFO of Charmacy Pharma, owns 2.96% interest of the Company through Shantou Meizhi Investment Management Limited Partnership as of 6 January Ms. Zheng Yuyan,Vice president, Executive Director and CMO of Charmacy Pharma, possesses 1.57% interest of the Company through Shantou Youran Investment Management Limited Partnership as of 6 January Guangzhou Pharmaceutical Baiyunshan Hong Kong Company Limited is a wholly-owned subsidiary of Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (6332 CH), which in turn is held by Guangzhou Pharmaceutical Holdings Limited as to 45.23%. 5. Xiangxue Group (Hong Kong) Company Limited is a wholly-owned subsidiary of Xiangxue Pharmaceutical Factory Co., Ltd. (3147 CH). 6. Kingworld Medicines Health Management Limited is a wholly-owned subsidiary of Kingworld Medicines Group Limited (111 HK). Business Model The distribution of pharmaceutical products is Charmacy Pharma s principal business. The Company primarily procures pharmaceutical products from pharmaceutical manufacturers and distributor suppliers and then resells such products to distributors, retail pharmacies, hospitals, clinics, health centers and others. The Company also provides consultancy services to its suppliers on marketing strategy and provides information services on customer preferences, affordability and other related information. As of FY16, sales of goods, of which most were pharmaceutical products, accounted for 99.2% of Charmacy Pharma s total revenue and the rest was derived from services income. See the last page for disclaimer Page 4 of 14

5 Figure-1: Distribution Business Model of Charmacy Pharma Distributor suppliers Distributor customers Pharmaceutical manufacturers The Company Retail pharmacies, hospitals, clinics and health centers End-customers Source: the Company. Figure-11: Revenue Structure of Charmacy Pharma as of FY16 To distributors 69.44% Services income.76% Sales of Goods 99.24% To hospitals, clinics, health centres and others 1.83% To retail pharmacies 27.97% The Company serves downstream customers that are mainly related to the pharmaceutical retail market. As of FY16, the Company had 5,674 customers (vs. 5,245 in FY15), including 3,496 retail pharmacies, 783 distributors which primarily serve retail pharmacies, and 1,395 hospitals, clinics, health centers and others (non-public healthcare institutions). Sales to distributor customers and retail pharmacies contributed more than 95% of Charmacy Pharma's total revenue in recent years. The distribution network of the Company primarily covers Guangdong Province with revenue derived from Guangdong Province making up more than 8% of the Company's total revenue in recent years. Currently, the Company possesses two logistics centers under operation located in Shantou and Foshan of Guangdong Province and two under establishment located in Zhuhai and Guangzhou of Guangdong Province, which have enabled the Company to deliver distribution operations in the eastern region and Pearl River Delta region of Guangdong Province. The Company has further extended its distribution range to cover surrounding provinces such as Fujian, Guangxi, Hainan and Hunan through third party logistics service providers. Figure-12: Distribution Range of Charmacy Pharma as of 3 June 215 Figure-13: Distribution Network of Charmacy Pharma in Guangdong Province as of 19 July 217 See the last page for disclaimer Page 5 of 14

6 The Company offered 6,69 products as of FY16 (vs. 5,561 in FY15), most of which were western medicines and Chinese patent medicines. Other products include healthcare products, Chinese medicine material and decoction pieces, medical devices and cosmetic products. As of FY16, the Company is the primary distributor of 4,59 products (74.3% of total products), compared to 3,794 (68.2% of total products) in FY15. Sales of western medicines and Chinese patent medicines contributed to over 9.% of the Company's total revenue in recent years. Strategy and Outlook Primary Strategy: to gain additional market share so as to grow into one of the pharmaceutical distribution industry s leaders through M&As and/or establishment of new logistics centers over the next couple years. So far, with regard to this goal, the Company entered into a capital contribution agreement with Zhuhai Hengxiang Pharmaceutical Limited ("Zhuhai Hengxiang") and also entered into a Sale and Purchase Agreement in relation to the acquisition of a property located in Guangzhou, Guangdong Province. In addition, Charmacy Pharma intends to establish a new subsidiary in Shenzhen, Guangdong Province, in order to extend its distribution network to Shenzhen and surrounding cities. It also plans to issue no more than 2 million A-Shares of the Company on the Shenzhen Stock Exchange in mainland China (representing approximately 18.52%/15.63% of total existing issued share capital of the Company before/after the issuance) to support possible M&As or other investments in the future as well as to further optimize the corporate governance structure. Table-1: Recent M&As and Investments Announcement Date Event Consideration Comment 217/3/13 Acquisition of the control right of Zhuhai Hengxiang Pharmaceutical Limited through a raise of the Company s contribution to the registered capital of Zhuhai Hengxiang to 7% RMB 18,, Zhuhai Hengxiang Pharmaceutical Limited is an established pharmaceutical distribution company based in Zhuhai, Guangdong Province. We believe the Investment will extend the Company's network to cover the entire end market of Zhuhai and part of the Zhongshan market. Furthermore, the Company is estimated to gain 1,1 new downstream customers and 1,4 new products upon the completion of the Investment. 217/7/13 Entrance into a Sale and Purchase Agreement in relation to the acquisition of a property located at Guangzhou, Guangdong Province RMB 131,, (tax included) A new logistics center is expected to be established in the target property, through which Charmacy Pharma will develop new businesses in Guangzhou (referred to as "Guangzhou business"). We believe such investment will enhance Charmacy Pharma's distribution network to Guangzhou and assists the Company to develop new end market in Guangzhou and other surrounding cities. With the expansion of its distribution channels, the revenue growth of the Company is expected to speed up and its profitability is expected to be improved. As of 216, Charmacy Pharma accounted for approximately 2.3% of the pharmaceutical distribution market in Guangdong Province, according to MOFCOM. As the pharmaceutical distribution market in Guangdong Province remains somewhat fragmented, we believe the room for Charmacy Pharma to gain additional market share in Guangdong Province is large and hence, such network expansion will be one of the major growth drivers for the Company over the next few years. We also believe Charmacy Pharma will achieve better profitability thanks to economies of scale and the increasing bargaining power of the Company (which means bigger purchase discounts from manufacturer suppliers can be achieved) induced by sales boost. Through channel expansion, the Company is expected to reach around 8, downstream customers (+41.% YoY), especially retail pharmacies by the end of FY17 and 1, (+25.% YoY) by the end of FY18. Along with the distribution network expansion, enlargement of the product portfolio is another strategy in plan, which we expect to be advantageous to gross margin and revenue growth of the Company. Charmacy Pharma intends to continuously introduce new pharmaceutical and healthcare products, especially prescription drugs, to enrich its product diversity. We believe, with its ever-expanding product portfolio, Charmacy Pharma will 1) be capable of meeting diversified demand from downstream customers and enjoy greater customer reliance and loyalty, and thus further strengthen its competitive position and boost sales volume; 2) be able to better catch opportunities induced by the outflow of prescriptions from hospitals and eventually realize sales boost; and 3) obtain a higher degree of flexibility to adjust its products to diminish or even eliminate the impact of different industry policies and/or to achieve better margins and credit terms. In addition, the Company's plan to increase the proportion of products sold by the Company as the primary distributor is favorable to the overall gross margin of the Company as the primary distributors commonly enjoy higher gross margin than sub-distributors. See the last page for disclaimer Page 6 of 14

7 In addition, the Company plans to further upgrade/utilize the B2B e-commerce platform Charmacy e-medicine and information systems to increase operating efficiency. Based on the B2B e-commerce platform, Charmacy Pharma intends to replace offline orders with online ones through gradually introducing existing customers to the online platform from 2H17 and to proactively embrace new retail pharmacy customers. We regard such a plan as a strategy that fits the demand of modern logistics and will improve the operational efficiency of the Company through saving staff expenses and shortening order processing time. Through the improvement in operational efficiency, we think that the Company will be able to reduce their reliance on sub-distributors and will be able to serve more retail pharmacies directly and efficiently. Since sales to retail pharmacies commonly enjoy a higher gross margin than sales to distributors, we expect an improvement in the gross margin of the Company with the better use of the B2B e-commerce platform. As at FY16, the B2B e-commerce platform had 4,759 registered customers (83.9% of total customers), which were mainly retail pharmacies. The revenue generated through the B2B e-commerce platform in FY16 was approximately RMB million, representing 4.8% of the Company s total revenue. FINANCIAL ANALYSIS Revenue CAGR of total revenue is estimated to be 12.6% in FY16-FY19F. We forecast that total revenue will grow by 1.3% YoY, 17.7% YoY and 1.% YoY to RMB4,46 million, RMB4,762 million and RMB5,237 million in FY17F, FY18F and FY19F, respectively, with consideration to 1) market share gains triggered by the proactive expansion of distribution network, customer base and product portfolio, and 2) organic sales growth of existing customers which benefit from the outflow of prescriptions to retail pharmacies from public hospitals and barely suffer from the implementation of the two-invoice system. Strong top-line growth of 17.7% YoY is expected in FY18F, mainly due to the full year contributions from Zhuhai Hengxiang and Guangzhou business for the first time. On 13 March 217, the acquisition of Zhuhai Hengxiang was completed, yet, we don t expect it to significantly contribute to revenue growth of the Company until FY18F as the Company intends to upgrade the logistics center in Zhuhai and the related business will be therefore negatively impacted in FY17F. However, with the new logistics center put into operation, we expect that Zhuhai Hengxiang will provide Charmacy Pharma with more than RMB3 million in revenue in FY18F. In addition, we expect the new logistics center under construction in Guangzhou will be put into use in 4Q17 and will help contributing around RMB1 million in revenue to the Company in FY18F. We believe the contribution from the newly added business in Zhuhai and Guangzhou, as well as the existing business, will together lead to robust revenue growth of 17.7% YoY in FY18F. Figure-14: Charmacy Pharma's Revenue Breakdown in FY15-FY19F (Amount) 6, 5, 4, 3, 2, 1, RMB in million 12.7% 8.% 1.3% 17.7% 1.% FY15 FY16 FY17F FY18F FY19F 2.% 15.% 1.% 5.%.% Services income (LHS) Sales of goods - to distributors (LHS) Sales of goods - to retail pharmacies (LHS) Sales of goods - to hospitals, clinics, health centres and others (LHS) YoY growth of total revenue (RHS) Figure-15 Charmacy Pharma's Revenue Breakdown in FY15-FY19F (%) 1% 5% % 1.8% 1.8% 1.8% 1.7% 1.6% 27.% 28.% 29.8% 3.7% 31.9% 7.7% 69.4% 67.3% 66.2% 64.6%.5%.8% 1.1% 1.4% 1.9% FY15 FY16 FY17F FY18F FY19F Services income Sales of goods - to distributors Sales of goods - to retail pharmacies Sales of goods - to hospitals, clinics, health centres and others Revenue growth is expected to be mostly reflected in sales to retail pharmacies in FY17F-FY19F even though sales to distributor customers will remain as the largest portion of the Company's total sales. We expect growth in sales to retail pharmacies will be faster than growth in sales to distributor customers or to hospitals, clinics, health centers and others, considering that the Company will be able to reduce the dependency on distributor customers to serve end-customers and will be able to serve more retail pharmacies directly in the future by taking advantage of the ever-expanding distribution network and the increasingly widely used B2B e-commerce platform. We expect sales to distributor customers/retail See the last page for disclaimer Page 7 of 14

8 pharmacies/hospitals, clinics, health centers and others to grow at a CAGR of 9.9%/17.7%/8.6% in FY16-FY19F, respectively. In 216, sales to distributor customers/retail pharmacies/hospitals, clinics, health centers and others, accounted for 69.4%, 28.%, and 1.8% of sales of goods revenue, respectively. In FY19F, we expect sales to distributor customers, retail pharmacies, and hospitals, clinics, health centers and others to account for 64.6%, 31.9%, and 1.6% of total revenue, respectively. In addition, we expect service income from consultancy services to upstream pharmaceutical manufacturers to grow faster than sales of goods. As of FY19F, sales of goods is projected to account for about 98.1% of Charmacy Pharma s total revenue (vs. 99.2% in FY16) and the rest will derive from services income. Gross Profit Gross margin is expected to improve gradually from 4.9% in FY16 to 5.2% in FY19F, given 1) business with higher gross margin, such as sales to retail pharmacies and consultancy services, will account for a higher proportion of total sales; 2) the expansion of business scale will lead to bigger purchase discounts from manufacturer suppliers and the number of drug types sold by the Company as the primary distributor, which enjoys relatively high gross margin, is expected to increase; and 3) the Company will periodically adjust product structure to prevent a significant decrease in the gross margin of the product mix. We expect gross profit to be RMB22 million, RMB242 million and RMB272 million, up 11.9% YoY, 2.2% YoY and 12.3% YoY in FY17F, FY18F and FY19F, respectively. Figure-16: Charmacy Pharma's Gross Profit and Operating Profit RMB in million 4.8% 2.7% -5.3% 9.5% 17.7% 11.9% 21.3% 2.2% 16.2% 12.3% FY15 FY16 FY17F FY18F FY19F Gross Profit (LHS) Operating Profit (LHS) YoY Growth of Gross Profit (RHS) YoY Growth of Operating Profit (RHS) 5.% 4.% 3.% 2.% 1.%.% -1.% Figure-17: Charmacy Pharma's Margins and Expenses Ratios 6.% 5.% 4.% 3.% 2.% 1.%.% 4.85% 4.91% 4.98% 5.9% 5.2% 1.89% 1.77% 2.31% 2.46% 2.54% 2.68% 1.29% 1.29% 1.32% 1.29% 1.19% 1.31% 1.23% 1.23% 1.23% FY15 FY16 FY17F FY18F FY19F Gross Margin Operating Margin S&D Expenses Ratio Administrative Expenses Ratio Operating Profit The operating margin is expected to improve from 2.3% in FY16 to 2.7% in FY19F, mainly due to the improvement in gross margin. We define operating profit as the residual value after gross profit minus selling & distribution expenses and administrative expenses. We expect that the S&D expenses ratio will stabilize at the historic average of 1.2% under the combined effect of efficiency improvement brought by the increasingly widely used B2B e-commerce platform and the increase in marketing expenses related to the development of new customers. We also expect that the new logistics center in Guangzhou will depreciate after FY17F, leading to a rise in administrative expenses ratio to 1.32% in FY18F, and that the administrative expenses ratio will start to decrease in FY19F, primarily thanks to economies of scale. We forecast operating profit to grow by 17.7% YoY, 21.3% YoY and 16.2% YoY to RMB1 million, RMB121 million and RMB14 million in FY17F, FY18F and FY19F, respectively. Other Income Other income is projected to grow by -53.7% YoY, 51.5 YoY and 26.3% YoY to RMB5 million, RMB8 million and RMB1 million in FY17F, FY18F and FY19F, respectively. Other income is mainly derived from bank interest income, government grants and exchange gain/loss. With regard to exchange gain/loss, the Company obtained exchange gains of RMB5.4 million in FY16, due to a significant depreciation of the RMB exchange rate to HKD, yet, we assume that the RMB exchange rate to HKD will remain relatively stable in FY17F-FY19F, so that the amount of exchange gain/loss will be relatively small. The increase in other income in FY18F and FY19F is mainly attributable to the rise in bank interest income, supported by a surge See the last page for disclaimer Page 8 of 14

9 in restricted cash (used as deposits for bills payables) and interest rate. Financial Costs and Gearing We expect financial costs to grow at a CAGR of 32.% in FY16-FY19F, as a result of the rise in total borrowing as well as effective interest rate. We expect that the Company will borrow additional loans to fund part of the investments related to the business expansion and the increase of the working capital induced by the business expansion and that total borrowing will surge to RMB588 million in FY19F from RMB421 million, with a forecast that effective interest rate will rise to 6.8% from 4.7%. Increasing financial burden of the Company is expected, but is bearable. Net gearing ratio of the Company is estimated to surge from 66.7% to 98.% in FY16-FY19F, however, the financial position of the Company is considered to still be healthy, given that 1) the Company has a big pile of restricted cash amounting to RMB394 million-rmb484 million in FY17F-FY18F, representing 79.8%-82.3% of total debt; and 2) liquidity of the Company is expected not to be poor since the interest coverage ratio will remain at around 4.x in FY17F-FY19F and OCF/financial costs as well as current ratio will stay above 1.x in FY17F-FY19F. Figure-18: Charmacy Pharma's Financial Cost and Effective Interest Rate RMB in million % 4.66% % % 6.8% FY15 FY16 FY17F FY18F FY19F Finance Costs (LHS) 9.% 8.% 7.% 6.% 5.% 4.% 3.% 2.% 1.%.% Effective Interest Rate (RHS) Figure-19: Charmacy Pharma's Net Profit and Net Profit Margin RMB in million.78% % % 1.48% 1.58% 7 83 FY15 FY16 FY17F FY18F FY19F Net Profit (LHS) Net Profit Margin (RHS) 2.% 1.%.% Net Profit We expect that net profit margin will trend up slightly from 1.5% in FY17F to 1.6% in FY19F, mainly because the increasing financial cost will partially offset the improvement in the operating margin. Net profit is expected to grow by -.2% YoY, 18.7% YoY and 17.8% YoY to RMB59 million, RMB7 million and RMB83 million in FY17F, FY18F and FY19F, respectively, representing EPS of RMB.549, RMB.651 and RMB.767, respectively. We expect that growth of net profit will be flat in FY17F as a result of a significant surge in financial costs and a significant decrease in exchange gains. Cash Conversion Cycle The cash conversion cycle of the Company is smaller than other pharmaceutical distributors, mainly because it possesses a longer DPO. We believe that Charmacy Pharma has a similar level of high operational efficiency as Sinopharm, in terms of the management of inventories and trade & bills receivables as both companies have similar DSI and DSO. However, the DPO of Charmacy Pharma is around 3 days longer than that of Sinopharm in FY16, leading to a much smaller CCC of Charmacy Pharma. We do no regard a longer DPO as a signal of better operational efficiency, since there is commonly a tradeoff between gross margin and DPO, which means that a longer DPO (or a longer credit term granted by suppliers) will raise procurement costs and drag down the gross margin of the Company. Yet, we cannot deny that a longer DPO will help the Company ease short-term financial burden. We expect the CCC to increase from.5 day in FY16 to 8.2 days in FY19F, as a result of 1) expectations that DSI will See the last page for disclaimer Page 9 of 14

10 remain at a low level of around 35 days thanks to the application of the Company's effective information system; 2) DSO is expected to decrease in FY17F and FY18F due to the increase in the proportion of retail pharmacy customers, which is commonly granted shorter credit terms than distributor customers, to then rebound in FY19F as we assume that longer business relations with downstream customers will be achieved, leading to a rise in the credit terms; 3) DPO is projected to be on the decline gradually in FY16-FY17F considering that the Company is expected to lack cash to place as restricted cash in order to support part of the increase in bills payables. Figure-2: Charmacy Pharma's Cash Conversion Cycle FY15 FY16 FY17F FY18F FY19F Days Sales Of Inventory - DSI Days Sales Outstanding - DSO Days Payable Outstanding - DPO Cash conversion cycle Figure-21: Sinopharm's Cash Conversion Cycle FY14 FY15 FY16 FY17F FY18F FY19F DSI (LHS) DSO (RHS) DPO (RHS) CCC (LHS) Source: Sinopharm, Guotai Junan International. Table-2: Estimates of Charmacy Pharma RMB million FY17F FY18F FY19F Revenue 4,46 4,762 5,237 - Sales of goods 4,3 4,695 5, To distributors 2,723 3,154 3, To retail pharmacies 1,27 1,461 1, To hospitals, clinics, health centers and others Services income Gross profit Operating profit Financial cost (25) (33) (38) Net profit EPS (RMB) DPS (RMB) VALUATION Investment highlights of Charmacy Pharma include: 1) Focusing on business to the pharmaceutical retail market, the Company is expected to be barely influenced by the implementation of the two-invoice system and to benefit from the outflow of prescriptions to retail pharmacies from public hospitals, which is expected to boost sales within the pharmaceutical retail market; 2) High revenue growth is expected especially in FY18F through the proactive expansion of distribution network, customer base and product portfolio; 3) Improvement in gross margin is expected thanks to increasing contribution from business with higher gross margins such as sales to retail pharmacies and consultancy services, the expansion of business scale, and the increase in the number of drug types sold by the Company as the primary distributor; and 4) High dividend payout ratio is expected in FY17F-FY19F. We initiate coverage with Accumulate investment rating and a TP price of HK$8.8. We benchmark our target PER against the typical pharmaceutical distributors operating in mainland China and listed in Hong Kong, among which we think Sinopharm (199 HK) is the most comparable peer as pharmaceutical distribution business made up most of its revenue and net profit while other peers such as CR Pharma (332 HK), Shanghai Pharma (267 HK) and GZ Baiyunshan Pharma (874 HK) are involved largely in pharmaceutical manufacturing. Comparing with Sinopharm, Charmacy Pharma 1) is less See the last page for disclaimer Page 1 of 14

11 negatively impacted by policies related to healthcare reform as Charmacy Pharma is mainly involved in business to the retail pharmacy terminal rather than the public hospital terminal which Sinopharm concentrates on; 2) has similar efficiency and higher growth potential; but 3) has much smaller business scale, lower profitability, as well as a higher financial burden. Summing up, we believe that Charmacy Pharma should be valued at a discount to Sinopharm which is trading at 15.1x, 13.3x and 12.3x FY17F-FY19F PER, respectively. We apply a 14.x FY17F PER or 11.8x FY18F PER (representing a 7%/11% discount to Sinopharm s FY17F/FY18F trading PER), with TP of HK$8.8 and Accumulate investment rating. Current price level is equivalent to 12.9x FY17F PER and 1.9x FY18F PER. Table-3: Comparison between Charmacy Pharma and Sinopharm (as of FY16) Charmacy Pharma Sinopharm Business Scale --Distribution network Mainly in Guangdong Province Nationwide, 31 Provinces --Number of customers ----Retail pharmacy 3,496 79, Distributors 783 n.a. ----Nationally-ranked hospitals 14, Other healthcare institutions 1, ,931 --Number of products 6,69 ~2, --Sales amount from distribution business RMB3,669 million RMB246,459 million Profitability --Gross margin 4.9% 8.% --Operating margin 2.4% 3.8% --PAT margin 1.6% 2.7% --Net margin 1.6% 1.8% --ROE 13.7% 15.% --ROA 2.8% 4.6% Efficiency --DSI 35.3 days 37.1 days --DSO 11.4 days 94.8 days --DPO days 97. days --CCC.5 days 35. days Growth --FY14-FY16 CAGR of total revenue 1.3% 13.6% --FY14-FY16 CAGR of net profit 27.6% 27.1% --FY16-FY19F CAGR of total revenue 12.6% 9.6% --FY16-FY19F CAGR of net profit 11.8% 11.3% Financial Burden --Net debt/shareholder's Equity 66.7% 24.9% --Effective interest rate on bank borrowings 5.% 4.% --Current ratio 1.1x 1.3x --OCF/interest paid -6.1x 4.2x Source: the Company, Sinopharm, Guotai Junan International. Note: 1. Operating profit is defined as the residual value after the gross profit minus selling & distribution expenses and administrative expenses. Operating margin is the defined operating profit divided by total sales. 2. FY16-FY19F CAGR of total revenue and FY16-FY19F CAGR of net profit are estimated by Guotai Junan International. 3. Restricted cash is not deducted from net debt in this case. See the last page for disclaimer Page 11 of 14

12 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Table-4: Peers Group Comparison of Charmacy Pharma Company Stock Code Currency Last price Market Cap PE (fiscal year) PB (fiscal year) ROE(%) ROA(%) EV/EBITDA HKD mil 16A 17F 18F 19F 16A 17F 18F 19F 17F 17F 17F 18F HK - Listed Peers Charmacy Pharma-H 2289 HK HKD n.a. n.a. Sinopharm-H 199 HK HKD , CR Pharma 332 HK HKD , Shanghai Pharma-H 267 HK HKD , GZ Baiyunshan Pharma-H 874 HK HKD , n.a. n.a. Universal Health 2211 HK HKD n.a. n.a. n.a. n.a..1 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Wanjia Group 41 HK HKD n.a. n.a. n.a. n.a n.a. n.a. (12.6) (4.3) n.a. n.a. Simple Average Weighted Average China - Listed Peers Shanghai Pharma-A 6167 CH CNY , Huadong Medicine-A 963 CH CNY , n.a. n.a. Jointown Pharma-A 6998 CH CNY , China National Med-A 6511 CH CNY , n.a. n.a. Realcan Pharma-A 2589 CH CNY , GX Liuzhou Pharma-A CH CNY , n.a. n.a. Nanjing Pharma-A 6713 CH CNY 7.9 7, n.a. n.a. ZJ Huatong Pharma-A 2758 CH CNY , n.a. n.a. ZJ Zhenyuan-A 75 CH CNY , n.a. n.a. n.a. 2.5 n.a. n.a. n.a. n.a. n.a. n.a. n.a. China Meheco-A 656 CH CNY , n.a. n.a. Luyan Pharma-A 2788 CH CNY , n.a. n.a. n.a. 3. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Humanwell Healthcare-A 679 CH CNY , XJ Ready Health-A 69 CH CNY , n.a. n.a. n.a. 2.4 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Simple Average Weighted Average Source: Bloomberg, Guotai Junan International. Figure-22: Forward PE Band of Charmacy Pharma Figure-23: Forward PB Band of Charmacy Pharma Forward PE since Listing Average Forward PE Average Forward PE + 1 x SD Average Forward PE - 1 x SD Source: the Company, Bloomberg, Guotai Junan International. Forward PB since Listing Average Forward PB Average Forward PB + 1 x SD Average Forward PB - 1 x SD Source: the Company, Bloomberg, Guotai Junan International. RISKS Major risks include: 1) Further expansion plans will be limited by the financial position of high gearing if issuance of new shares cannot be executed in time, which may lead to failure to grab more market share and to remain competitive; 2) higher-than-expected financial costs will lead to a delay of strategy plan and raise financial burden; 3) lower- than-expected industry growth may be triggered by multiple policies aiming to reduce patient expenditure on drugs; 4) uncertainty surrounding government policies related to healthcare reform on the pharmaceutical retail market may bring about changes to the outlook of the pharmaceutical retail market; and 5) increasing competition may be caused by the entry of new rivals from the logistics industry. See the last page for disclaimer Page 12 of 14

13 Financial Statements and Ratios Income Statement Cash Flow Statement Year end Dec (RMB mn) 215A 216A 217F 218F 219F Year end Dec (RMB mn) 215A 216A 217F 218F 219F Revenue 3,397 3,669 4,46 4,762 5,237 PBT Cost of sales (3,232) (3,489) (3,844) (4,52) (4,965) D&A Gross Profit Other adjustments Changes in WC 14 (185) (3) (25) (77) Selling & distribution expenses (4) (48) (5) (59) (64) Income tax paid (18) (19) (2) (24) (28) Administrative expenses (64) (47) (52) (63) (67) Operating Cash Flow 194 (11) Opt. Profit Capex (2) (22) (13) (9) (8) Other income Others (166) (9) (32) (55) (2) Finance costs (24) (17) (25) (33) (38) Investing Cash Flow (168) (31) (162) (64) (29) Share of profit of associates&jv Profit before tax Issues of shares 188 Debt paid/raised (11) Taxation (15) (21) (2) (24) (28) Dividends paid (46) (21) (36) (32) (38) Profit After Tax Others (24) (14) (23) (31) (36) Financing Cash Flow (22) (22) Minority Interest 1 2 Net Profit Net Increase in Cash 133 (36) (87) 6 4 Cash at bgn of Yr EPS (RMB) FX adjustments DPS (RMB) Cash at end of Yr Balance Sheet Margins and Efficiency Year end Dec (RMB mn) 215A 216A 217F 218F 219F 215A 216A 217F 218F 219F PP&E Gross margin (%) 4.8% 4.9% 5.% 5.1% 5.2% Other non-current assets EBITDA margin (%) 2.3% 3.% 2.9% 3.1% 3.2% Non-current Assets Operating margin (%) 1.8% 2.3% 2.5% 2.5% 2.7% Net Profit margin (%).8% 1.6% 1.5% 1.5% 1.6% Bank balances and cash Dividend Payout Ratio (%) 178.% 72.8% 5.% 5.% 5.% Pledged bank deposits Inventory days Inventories Receivable days Trade & other receivables 1,26 1,17 1,298 1,497 1,662 Payable days Other current assets Current Assets 1,848 2,7 2,123 2,457 2,697 Growth and Profitability Total Assets 2,63 2,231 2,464 2,787 3,16 215A 216A 217F 218F 219F Revenue 12.7% 8.% 1.3% 17.7% 1.% Non-current Liabilities EBITDA -4.4% 4.9% 8.3% 25.6% 14.7% Operating profit -5.3% 4.8% 17.7% 21.3% 16.2% Short-term debts Net Profit -27.7% 125.2% -.2% 18.7% 17.8% Trade & other payables 1,356 1,353 1,491 1,732 1,863 ROE 8.% 13.7% 12.8% 14.2% 15.5% Other current liabilities ROA 1.5% 2.8% 2.5% 2.7% 2.9% Current liabilities 1,649 1,778 1,988 2,272 2,455 ROIC 1.3% 8.9% 8.5% 9.6% 1.2% Total liabilities 1,649 1,778 1,988 2,272 2,455 Financial Ratios Equity to Shareholders A 216A 217F 218F 219F Minority Interest 2 3 Net Debt / Shareholder's Equity 32.6% 66.7% 97.% 96.9% 98.% Total Equity Liabilities/Assets 79.9% 79.7% 8.7% 81.5% 81.4% Total Liability and Equity 2,63 2,231 2,464 2,787 3,16 Current ratio 1.1x 1.1x 1.1x 1.1x 1.1x BVPS (RMB) OCF/Financial costs 8.x -6.1x 2.5x 2.7x 1.4x See the last page for disclaimer Page 13 of 14

14 Company Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months Rating Definition Buy Relative Performance >15%; or the fundamental outlook of the company or sector is favorable. Accumulate Relative Performance is 5% to 15%; or the fundamental outlook of the company or sector is favorable. Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the company or sector is neutral. Reduce Relative Performance is -5% to -15%; or the fundamental outlook of the company or sector is unfavorable. Sell Relative Performance <-15%; or the fundamental outlook of the company or sector is unfavorable. Sector Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months Rating Definition Outperform Relative Performance >5%; or the fundamental outlook of the sector is favorable. Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the sector is neutral. Underperform Relative Performance <-5%; or the fundamental outlook of the sector is unfavorable. DISCLOSURE OF INTERESTS (1) The Analysts and their associates do not serve as an officer of the issuer mentioned in this Research Report. (2) The Analysts and their associates do not have any financial interests in relation to the issuer mentioned in this Research Report. (3) Except for SMI Holdings Group Limited (198 HK), Guotai Junan International Holdings Limited (1788 HK), Binhai Investment Company Limited (2886 HK), Link Holdings Limited (8237 HK), GFI MSCI A I-R (CNY) (83156 HK), GFI MSCI A I (3156 HK) and CAM SCSMALLCAP (3157 HK), Guotai Junan and its group companies do not hold equal to or more than 1% of the market capitalization of the issuer mentioned in this Research Report. (4) Guotai Junan and its group companies have had investment banking relationships with the issuer mentioned in this Research Report within the preceding 12 months. (5) Guotai Junan and its group companies are not making a market in the securities in respect of the issuer mentioned in this Research Report. (6) Guotai Junan and its group companies have not employed an individual serving as an officer of the issuer mentioned in this Research Report. There is no an officer of the issuer mentioned in this Research Report associated with Guotai Junan and its group companies. DISCLAIMER This Research Report does not constitute an invitation or offer to acquire, purchase or subscribe for securities by Guotai Junan Securities (Hong Kong) Limited ("Guotai Junan"). Guotai Junan and its group companies may do business that relates to companies covered in research reports, including investment banking, investment services, etc. (for example, the placing agent, lead manager, sponsor, underwriter or invest proprietarily). Any opinions expressed in this report may differ or be contrary to opinions or investment strategies expressed orally or in written form by sales persons, dealers and other professional executives of Guotai Junan group of companies. Any opinions expressed in this report may differ or be contrary to opinions or investment decisions made by the asset management and investment banking groups of Guotai Junan. Though best effort has been made to ensure the accuracy of the information and data contained in this Research Report, Guotai Junan does not guarantee the accuracy and completeness of the information and data herein. This Research Report may contain some forward-looking estimates and forecasts derived from the assumptions of the future political and economic conditions with inherently unpredictable and mutable situation, so uncertainty may contain. Investors should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. This Research Report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guotai Junan and its group companies to any registration or licensing requirement within such jurisdiction. 217 Guotai Junan Securities (Hong Kong) Limited. All Rights Reserved. 27/F., Low Block, Grand Millennium Plaza, 181 Queen s Road Central, Hong Kong. Tel.: (852) Fax: (852) Website: See the last page for disclaimer Page 14 of 14