1. Investing in China Healthcare
Golden Decade
Alex Ng
Research Analyst, HK/China Healthcare
China Merchants Securities (HK)
Sept, 2012
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2. Investment Thesis
 12th FYP healthcare reform continues to drive healthy long-term growth under a more balanced and
sustainable development model
• China healthcare sector significantly boosted by RMB 1 trillion government investment during 2009-2011
healthcare reform, while demographic changes and government spending remain the LT key drivers
• Ongoing 12th FYP healthcare reform to accelerate reshaping market structure and competitive landscape
• Market leaders have better financial and industry position by leveraging strengths in R&D capability,
distribution network and capital flexibility
 Near-term policy headwinds to abate; margins set to recover in 2H12
• 2011 policy overhang slowing down 1H12 earnings growth: 1) antibiotics restrictions, 2) medical
insurance cost control, 3) maximum drug retail price-cuts, and 4) EDL tender pricing pressure
• Positive policy trend to improve industry sentiment: 1) Guangdong EDL tender shifting away from Anhui
model, 2) strong patient volume growth in 1H12, 3) Jan-Aug industry data suggested earnings rebound
 Investment Strategy
• Focus on industry leaders with strong M&A capability, resources and experience amid intensified
competition and policy-led consolidation during 12th FYP
• Prefer quality companies with 1) limited negative policy exposure (e.g. price-cut, antibiotics), 2) strong
product portfolios (branding and exclusive pricing), 3) high earnings visibility
 Near-term Catalysts
• Further easing policy uncertainties, 2H11 low base effects, EDL list expansion and improving tendering
policies, non-EDL tender results
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3. Key facts about China healthcare market
 Most drugs are dispensed through hospital pharmacies
– Hospitals market accounts for over 75% of drug sales.
 Revenues from drugs contributes to over 40% of hospitals' income
– Chinese hospitals are allowed to sell drugs with a 15% markup.
 Chinese prescription market is dominated by MNC
– >60% of top 20 pharma companies in China are global MNC, accounting for
~20% of total sales.
 Traditional Chinese Medicine market is large, growing faster than chemical
drugs
– TCM market size is 1/4 of overall drug market.
– # of TCM hospitals accounted for around 15% of all hospitals in China.
 Most domestic companies are generic drug manufacturers
3 3

4. China healthcare industry: Small but delivering robust growth
 In 2011, China’s drug market exceeded RMB900bn (USD142.5bn), growing at
21% CAGR during 2006-2011, equivalent to 1/3 of the US market.
 We expect China’s aging population, strong economic growth, and committed
government expenditure to drive continued growth.
Figure: China’s drug market size and growth Figure: Annual healthcare expenditure in China
(RMB bn) Market Size Growth yoy (RMB bn) Annual healthcare expenditure % of GDP
1000 30% 2,000 5.2
900 1,800
25% 5.0
800 1,600
700 1,400
20% 4.8
600 1,200
500 15% 1,000 4.6
400 800
10% 4.4
300 600
200 400
5% 4.2
100 200
0 0% 0 4.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: SFDA, SMERI, CMS(HK) Source: MOH, CMS(HK)
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5. China will become 2nd largest healthcare market by 2020
Figure: China’s healthcare industry position in the world
2001 2005 2009 2011 2013E 2020E
Country Rank Country Rank Country Rank Country Rank Country Rank Country Rank
USA 1 USA 1 USA 1 USA 1 USA 1 USA 1
Japan 2 Japan 2 Japan 2 Japan 2 Japan 2 China 2
Germany 3 Germany 3 Germany 3 China 3 China 3
France 4 France 4 France 4
Italy 5 Italy 5 China 5
UK 6 UK 6
Spain 7 Spain 7
Canada 8 Canada 8
Mexico 9 China 9
China 10
Source: IMS, CMS(HK)
Figure: Top 20 healthcare market in the world (2009)
USD CAGR USD CAGR
Rank Country Rank Country
bn 05’-09’ bn 05’-09’
1 USA 2,275 5.3% 11 Netherlands 85 7.9%
2 Japan 424 3.3% 12 Australia 85 7.1%
3 Germany 379 6.0% 13 Russian 67 14.1%
4 France 300 6.7% 14 Mexico 55 3.3%
5 China 236 22.4% 15 Switzerland 55 7.4%
6 UK 203 2.0% 16 Belgium 55 9.2%
7 Italy 200 7.0% 17 Korea 54 2.8%
8 Canada 148 8.5% 18 India 52 12.1%
9 Brazil 142 18.5% 19 Turkey 43 11.9%
10 Spain 141 10.9% 20 Austria 42 7.5%
Source: World Bank, CMS(HK)
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6. Low spending provides ample room for growth
 We expect healthcare expenditure as % of GDP to increase to 7%+ by 2020.
(USD) Figure: Healthcare expenditure per capita and as % of GDP (2010)
9,000 8,362 20%
8,000 18%
7,000 16%
14%
6,000
5,222
12%
5,000 4,668 4,668
4,365
4,065 10%
4,000 3,503 3,368
3,248 8%
2,883
3,000
6%
2,000 4%
990 950
1,000 500 2%
221
0 0%
Source: World Bank, CMS(HK)
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7. What makes the growth so strong?
 Favorable demographic changes:
– Urbanization and aging population
– Rising disposable income and healthcare awareness
– Shift of disease pattern from infectious to chronic disease
 Government policy support:
– Increase public funding for healthcare expenditure
– New healthcare reform to improve accessibility and affordability
• Expand nationwide medical insurance coverage
• Strengthen and upgrade grassroots medical infrastructure
– Promote investment in private hospitals with favorable policies
– Policy-driven industry consolidation: upgraded pharmacopoeia, new GMP,
pricing controls
– Increasing R&D investment to ensure safety, quality and innovation
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8. Favorable demographic changes: Aging population
 According to SFDA’s SMERI, it will only take 25 years (1999-2014) for the proportion of population aged
60+ to increase from 9% to 18% in China; vs. 66 years for US, 45 for UK, 140 for France.
 In China, 5.96mn incremental population will be aged over 60+ each year from 2000-2020; while 6.2mn
incremental population from 2020-2050.
Figure: China's ageing population (60+) will double by 2030
Aged 60+ % of total population
(mn)
500 35%
450
30%
400
350 25%
300 20%
250
200 15%
150 10%
100
5%
50
0 0%
2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Source: UN, CMS(HK)
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9. Favorable demographic changes: Urbanization and disease
pattern shift to chronic disease
 Lifestyle changes driven by urbanization is shifting the disease pattern from infectious to
chronic disease, which now accounts for over 80% of deaths in China.
 The top 4 chronic diseases in China are cardiovascular, diabetes, oncology, and lung diseases.
Figure: China's accelerating urbanization Figure: Number of patients with chronic diseases in China (2010)
Urban population Rural population
>200mn
100%
80%
60% CAGR: -1.80% >90mn
40% 20mn
1.6mn 1.5mn
750k
20%
0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 High Blood Diabetes Cancer (new Stroke (new Lung disease Heart Disease
Pressure case) case) (new case)
Source: NBS, MOH, CMS(HK) Source: SFDA, SMERI, CMS(HK)
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10. Government support: Increasing government spending
 Due to a decade of robust economic growth and healthy GDP, the government has increased
the public funding for healthcare but individuals still pay 35% now.
 Healthcare spending as % of GDP is still half that of the developed markets (around 5%).
 MOH aims to increase total healthcare budget to 6.5-7% of GDP by 2020.
Figure: China’s healthcare spending by source Figure: China’s public healthcare spending
Government Social Individual Government healthcare spending % of fiscal budget
(RMB bn)
100%
7,000 6%
90%
80% 6,000 5%
70% 5,000
4%
60%
4,000
50% 3%
40% 3,000
30% 2%
2,000
20%
1,000 1%
10%
0% 0 0%
2007
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2008
2009
2010
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: MOF, MOH, CMS(HK)
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11. Healthcare reform is the catalyst for growth
 Two core objectives: To improve affordability and accessibility of medical services
 Five major goals in the RMB850 billion plan for 2009-2011
– Expanding medical insurance coverage
– Establishing a national essential drug list (EDL) system
– Strengthening grassroots medical infrastructure
– Providing equal public healthcare services to both rural and urban areas
– Implement public hospital pilot reforms
Source: CMS(HK), Shanghai Pharma Prospectus}
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12. Rising health insurance coverage rate - full coverage by 2020
Launch Covered Coverage
Scheme Name Qualified individuals Premium payer
Date Population (2010)
Urban Employee Urban workers, retirees Employer +
1999 237mn
Basic Medical Insurance 97% Employee
Urban Residents Urban non-workers Government +
2007 194mn
Basic Medical Insurance (Students, elderly, immigrant workers) Individual
New Rural Cooperative Rural residents Government +
2003 836mn 96%
Health Care System Individual
Others - 26mn 100% Military, government, etc
Figure: Nationwide insurance coverage reached 97% in 2011 Figure: Government per-capita subsidy (NRCMI and URBMI)
NRCMS URBMI UEBMI Insurance coverage (%) (RMB)
1400 100%
90% 400 360
1200
80% 350
1000 70% 300
240
800 60% 250
200
50% 200
600 40%
150 120
400 30% 80 80
100
20% 40
200 50 20
10%
0 0% 0
2005 2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011 2012 2015E
Source: MOH, MHRSS, CMS(HK)
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13. … also some short-term pain
 Insurance cost control in hospitals
– “Double Capping” in Shanghai (cap at 7% yoy, drug exp<40% per patient visit)
– “DRGs” in Beijing (reducing over-prescribing and overuse)
 Antibiotics restriction guideline
– reduction in overuse of antibiotics
 EDL (Essential Drug List) system
– Lowering tender prices (favor pricing over quality), average cut of ~30%
– Drug quality problem
 NRDL (National Reimbursement Drug List) price cuts
– Max drug retail price reduction by NDRC
– 29 times since 1997, average cut of ~20%
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14. Looking ahead… in 12th FYP
 Healthcare is a strategic industry for China to support its sustainable growth
– Provide cost-effective alternatives of domestic drugs to MNC products
– Ensure reasonable profitability to encourage investments for industry competitiveness
 Healthcare reform poised to accelerate, but in a more balanced and cautious way
– Greater focus on rural healthcare: EDL list expansion, infrastructure upgrade.
– County-level public hospital reform: reimbursement reform, zero-markup.
– Promote private investment in healthcare service sector
 Healthcare 12th Five-Year Plan
– Achieve 20% yoy growth, with RMB3,000bn in industrial output by 2015
– Provide support for R&D of innovative drugs
– Increase funding for biotechnology industry
– Promote industry consolidation and support growing market leaders
– Emphasize advanced medical equipment and related technologies
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15. Focus on public hospital reform in 2H12
 Public hospital reform as the most complicated part of healthcare reform is
expected to accelerate during 12th FYP
 Key objectives
– Hospital revenue structure shift from drug sales to service fees and government subsidy
– Shift of patient flow from higher-tier hospitals to primary healthcare institutions
– Promote the development of private hospitals with favorable policies
 Policies launched in 2012
1) Elimination of 15% drug mark-ups
2) Reimbursement payment reform (e.g. hospital reimbursement control, DRGs)
3) Raising medical service fees and government financial subsidies
 Implementation timeline of zero mark-ups: 1) 300 county-level hospitals by 2012,
2) all county-level hospitals by 2013 and 3) all public hospitals by 2015
 Potential impact
– Sales pressure of expensive drugs given less incentive for over-prescription
– Drug volume growth to compensate for pricing pressure in long term
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16. Chinese healthcare industry value chain
OTC drug
Manufacturers Distributors Drugstores Patients
Marketing Rx drug
Payer
Hospitals
agencies (Indv/Govt/Social)
• API = 900 • Regional = 100 • Hospitals = ~20,000 • Urban workers = 250mn
• Chemical Drugs = 1600 • Provincial = 1000 (Public = 13,000) • Urban residents = 200mn
• Herbals = 1990 • County/City = 10,000 • Health Centers = 38,000 • Rural = 800mn
• TCM = 780 • CHC Center = 33000
• Drugstores = 380,000
• Biological = 180 • Payment (Indv : Govt : Social)
• Medical Devices (Equipment, = 35% : 28% : 38%
• Revenue (Hospital : Others)
Consumable, Diagnostic) = 10000 = 75% : 25%
Source: MOH, NBS, ,MHRSS CMS(HK)
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17. Market tends to adapt to reform policy
Antibiotics Antibiotics
Anhui Model Restriction Poison drug
Restriction Drug price
nationwide Advice capsule event
Launch markup guidance
EDL Anhui Price-cut
Price-cut Fujian NDRL Price-cut
Model Price-cut Price-cut
tender started
Fujian NDRL Drug
New
12/2009， 2010 tender result Manufacturing Serious disease
GMP
New NRDL launch Pharmacopoeia out 12th FYP insurance
Healthcare
Public hospital guidance
structural reform
Public hospital Healthcare
35% Comment reform Procedure
reform Comment Biotech, Reform 12th
science 12th FYP
Drug distribution
FYP
12th FYP
25%
Guangdong EDL
Drug Safety 12th tendering guidance
FYP
15% Notice on
county-level
hospital reform
5%
-5%
-15%
-25%
-35%
MSCI China MSCI China Healthcare
Source: Bloomberg, CMS(HK), as of 27 Sept 2012
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18. Diverged stock performance on uneven outlook
HSI Index HSCEI Index 1099 HK 2607 HK
867 HK 1066 HK 853 HK 325 HK
460 HK 3933 HK 2877 HK 874 HK
YTD
Ticker Company 3M (%)
(%)
1093 HK 1666 HK 1177 HK 2005 HK
200% - HSI Index 13.8 9.1
- HSCEI Index -0.7 3.8
1099.HK Sinopharm 31.2 18.5
2607.HK Shanghai Pharm 13.2 47.1
150%
1066.HK Weigao Group 37.0 12.4
0460.HK Sihuan Pharm 7.9 2.4
3933.HK United Lab -10.9 13.4
100% 2877.HK Shineway -0.2 -1.1
1177.HK Sino Biopharm 23.1 1.8
0874.HK GZ Pharm 144.2 11.3
0853.HK Microport -1.2 20.3
50%
0867.HK China Med. Sys. 19.8 22.3
0325.HK Trauson 112.6 23.3
1666.HK TRT Tech 73.2 19.3
0% 1093.HK China Pharm 22.9 13.2
2005.HK Lijun Intl 167.8 14.1
-50%
1/2012 2/2012 3/2012 4/2012 5/2012 6/2012 7/2012 8/2012 9/2012
Source: Bloomberg, CMS(HK), as of 27 Sept 2012
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19. Prefer high earnings visibility amid policy uncertainties
11-13E EPS CAGR
90%
United Lab
80%
70% PEG = 0.5
60%
50% Sino Biopharm
Lee’s Pharm
China Medical
40%
System Sinopharm PEG = 1
30%
Trauson Weigao
TRT Tech
20% Hua Han Biopharm GZ Pharm
Sihuan Lijun
10%
Microport
Shineway
0%
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0
2012 PE (x)
Source: Bloomberg, CMS(HK), as of 27 Sept 2012
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20. HK-listed healthcare companies valuation comparison
Market Cap Price PE (x) EPS EPS CARG
Company Ticker (HKD mn) (HKD) 11 12E 13E 11 12E 13E 11-13E
Drug Distributors
Sinopharm Group 1099 HK 59,225 24.7 30.3 24.7 19.9 0.66 0.81 1.01 23.5%
Shanghai Pharma 2607 HK 37,925 14.0 13.4 15.0 13.4 0.84 0.75 0.85 0.2%
China Medical Systems 867 HK 9,659 4.0 19.1 13.6 10.3 0.03 0.04 0.05 36.1%
China NT Pharma Group 1011 HK 747 0.7 2.4 - - 0.23 (0.09) (0.04) -
Kingworld Medicines 1110 HK 828 1.3 12.9 10.3 8.5 0.08 0.10 0.13 23.5%
Pharmaceuticals
Sihuan Pharm 460 HK 14,645 2.9 14.8 12.7 10.6 0.16 0.19 0.22 17.9%
Sino BioPharm 1177 HK 13,836 2.9 30.4 18.9 15.1 0.09 0.15 0.19 41.8%
United Lab 3933 HK 5,906 3.6 49.3 23.2 14.0 0.07 0.16 0.26 87.6%
China Pharm 1093 HK 3,289 2.1 13.9 46.9 17.0 0.15 0.05 0.12 -9.7%
Lijun Intl 2005 HK 5,772 2.0 32.3 24.1 19.0 0.06 0.08 0.11 30.1%
Lansen Pharm 503 HK 809 2.0 8.4 7.9 6.5 0.03 0.03 0.04 14.0%
Lee's Pharm 950 HK 2,649 5.1 28.6 19.7 14.8 0.18 0.26 0.35 38.8%
Guangzhou Pharm 874 HK 18,134 14.7 33.5 27.4 21.3 0.36 0.43 0.56 25.4%
China Shineway 2877 HK 9,031 11.0 9.8 10.0 8.9 0.91 0.88 1.00 4.6%
TRT Tech 1666 HK 8,303 14.0 26.3 20.3 15.9 0.43 0.56 0.71 28.7%
Hua Han Bio-Pharm 587 HK 3,784 1.5 7.8 6.0 6.0 0.19 0.25 0.25 14.7%
Real Nutri. 2010 HK 2,639 2.4 3.9 3.5 3.0 0.49 0.55 0.63 13.1%
Medical Device
Shandong Weigao 1066 HK 43,779 10.0 40.3 30.7 24.3 0.20 0.26 0.33 28.9%
Microport 853 HK 5,381 3.75 13.8 13.1 12.1 0.22 0.23 0.25 7.0%
Trauson 325 HK 2,679 3.5 15.5 12.0 10.3 0.18 0.23 0.27 22.9%
Average 20.3 16.7 11.8
Median 15.1 14.3 12.7
Source: Bloomberg, CMS(HK), as of 27 Sept 2012
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