EUR 850.00 For Business Accounts Only

Morningstar | Initiating Coverage of CR Pharma With Narrow Moat Rating and HKD 13.20 FVE

We initiate coverage on China Resources Pharmaceutical Group with a narrow moat rating and a fair value estimate of HKD 13.20 per share. This implies a 2018 adjusted P/E of 20.5 times and enterprise value/EBITDA of 7.2 times. The market is currently pricing CR Pharma at a 9% discount to our fair value estimate.

CR Pharma is a top-three drug distributor in China and vertically integrated with a diversified drugmaking segment and a retail distribution franchise. The large scale of its distribution segment affords it a cost advantage in providing logistics and high-value-added services. Additionally, it is geographically distributed across China and actively expanding into rural and inland provinces, which are generally higher-growth and higher-margin areas.

Its drugmaking segment has three key consolidated subsidiaries, which are listed on Chinese stock exchanges. These subsidiaries are only partially owned and are the main reason almost 50% of CR Pharma’s net income belongs to noncontrolling interests. The companies are CR Sanjiu, which makes over-the-counter and traditional Chinese medicine drugs; CR Double Crane, which is CR Pharma’s sole prescription drug platform; and Dong E E Jiao, which makes donkey hide gelatin, a nutritional supplement based on traditional Chinese medicine. Sanjiu's and DEEJ’s products are similar to consumer goods, and the companies spend large amounts on marketing and advertising to maintain market leader positions. We view these OTC products as the strength of CR Pharma’s drugmaking segment, and the strong brands that Sanjiu and DEEJ have cultivated should allow them to generate reasonably high returns.

We view CR Pharma as a defensive stock in a market that has been bearish toward Chinese healthcare over the past few months. Right now, the main policy concern is centralized procurement and the threat it poses to margins and revenues across the supply chain. Despite objections from drugmakers and hospitals, we expect the government to expand centralized procurement nationwide. However, the timing and scope are clouded with uncertainty. Compared with generics manufacturers, distributor earnings should be less affected by centralized procurement. Additionally, much of CR Pharma’s drugmaking segment consists of OTC drugs, which will be less affected by price-cutting measures compared with prescription drugs.