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Morningstar | CSPC Falls on News of New Drug Tendering Process

On Sept. 11, China’s National Health Insurance Bureau held a symposium on the requirements and operation of a new joint tendering pilot program, which may have the long-term effect of increasing price competition for domestic generics manufacturers. On Sept. 12, narrow-moat CSPC Pharmaceutical Group Limited, or CSPC, fell 10.2% to a price of HKD 16.2. While this represents a 23% discount to our fair value estimate, there is still considerable uncertainty on how government policy will develop. We believe it makes sense to take a cautious approach and wait for a lower price or more policy clarity before increasing exposure.

The pilot program for joint tendering will include 33 drugs, of which six are injectables. Eleven Chinese cities have confirmed their participation, representing approximately 20%-30% of China’s national drug market. The first pilot program will run in October, with results announced in November. A key aspect of this program is the size, which is much larger than the provincial drug tenders that until now have been the main vehicle for selling drugs to public hospitals. With provincial tenders, the smaller size and certain procedural differences mean that drugmakers can selectively participate to protect their margins. However, the large scale of the pilot program means that drugmakers will have more pressure to participate or else risk losing an unacceptable level of market share. Therefore, price competition for joint tenders in the future will likely be more intense than the provincial tenders of the past. We believe the assumptions backing our FVE already incorporate a reasonable degree of price competition in CSPC’s generics portfolio. However, given the considerable uncertainty in policy direction, we believe it makes sense to wait for either a more attractive entry point, or more clarity on the pilot program in November.

Given current information, we expect the near-term impact on CSPC to be limited for the next two years. The company’s portfolio has minimal exposure to the 33 drugs on this list. Additionally, even if the list expands for future tenders, many of the company’s drugs will face limited competition because it is taking longer than expected for companies to complete their necessary GCE’s. (As detailed in our Company Report, GCE’s are China’s newly required bioequivalence tests for generic drugs.)

However, over time as more domestic drugs pass their GCEs, this style of large-scale tendering may put significant downward pressure on generic drug prices. Ultimately, the long-term impact will depend on a number of factors that are currently not yet known. For example, it is possible that logistics hurdles will require the government to scale down the program's size. It is not clear which drugs will be included in future tenders, or whether more cities will join the process. Additionally, the timeline for drugmakers to complete the necessary GCEs is uncertain, especially in light of the reduced financial incentive implied by this pilot program.