CSPC Earnings: Interim Results Disappoint; Oncology Sales Weak; Valuation Lowered 19.8%

Narrow-moat CSPC’s 01093 interim results fell short of expectations. Revenue for the six months grew 3% year on year whereas operating profit, calculated with cost of sales and expenses for sales, general, and administration, and research and development, had no growth. Gross profit margin fell to 70%, or 2.75 percentage points worse than the same period last year, reflecting lower prices for both finished drugs, especially oncology, and vitamin C. We lower our fair value estimate to HKD 8.90 per share from HKD 11.10 to reflect a more challenging business environment for domestic drug sales, but we still view shares as undervalued.

Finished drug sales for the six months grew 5% year on year thanks to a recovery of hospital traffic and sales in the second quarter. However, much of this is attributable to nervous system disease drugs, of which NBP sales are the most significant component. We do not view this as high-quality growth. Although the company says there is no near-term generic threat, we do not think NBP sales are maintainable given the potential loss of exclusivity as well as limited data on clinical efficacy. Oncology sales were down 26% year on year due to price cuts.

In light of macroeconomic uncertainty, we think there will be continued pricing pressure as China’s policymakers look to keep hospital expenditures under control. Additionally, in July, the government announced a potential antigraft campaign for the healthcare industry, which has caused many drugmakers and medical device makers to significantly reduce promotional and marketing activities to hospitals. We expect this to result in slower revenue growth across the board, especially for innovative drugs and me-too drugs. Although this may lower sales and distribution expenses for highly differentiated drugs, we think it will hurt profit margins for drugs lacking differentiation, which include a significant portion of drugs in CSPC’s portfolio.