EUR 850.00 For Business Accounts Only

Morningstar | Fudan Zhangjiang Applies for Listing in China; Chinese Healthcare Stocks Rally

On March 11, Shanghai Fudan Zhangjiang Bio-Pharmaceutical, or FD-ZJ, announced plans to issue A shares on the Sci-Tech Innovation Board at the Shanghai Stock Exchange. This announcement caused FD-ZJ’s share price to rally 26% and galvanized the entire Chinese healthcare sector. Narrow-moat Shanghai Pharmaceuticals Holding owns 23% of FD-ZJ; SPH’s A shares rallied 10%, although its H shares experienced a modest increase of 4%. While we believe SPH’s H shares are undervalued, this listing announcement does not affect our core earnings outlook or views on the Chinese healthcare sector.

The primary reason behind the rally in SPH and other healthcare stocks is that market participants are expecting them to list more subsidiaries, joint ventures, and associates responsible for innovative research and development on the new Sci-Tech Board at relatively high valuations. However, we do not think this rally has much substance. First, capital raises are unlikely to increase research productivity, since funding is not one of the key constraints on Chinese R&D innovation. Second, even if the Sci-Tech Board offers sky-high valuations upon listing, the trading floats will be small, and it is unlikely the parent companies can sell their entire stakes at such inflated prices. Therefore, we do not think this news offers much potential to improve the parent companies’ core R&D capabilities or realize unreasonably high capital gains.

We think many names in Chinese healthcare are attractive long-term investments, but drugmakers will be subject to heavy price volatility for at least the first half of this year as policy details on the group purchasing organization and other cost-control measures are clarified. Distributors are a sensible option for investors who want exposure to Chinese healthcare but reduced exposure to policy uncertainty. SPH’s H shares and CR Pharma are our top picks among distributors and trade at 19% discounts to our fair value estimates.

The new Sci-Tech Innovation Board was announced in January and provides a way for high-tech companies to raise capital in China’s capital markets by removing key barriers present on the main boards. For example, it will scrap the prevailing 23 times price/earnings cap on initial public offering pricing, it will allow preprofit and prerevenue companies to list, and it accepts companies with dual-class voting structures.

FD-ZJ is a microcap innovative drugmaker that generates approximately $63 million of revenue and $7 million of consolidated profit. It has two launched drugs, with no phase 3 drugs and most of its pipeline in discovery. While it is working on oncology and autoimmune antibodies, its most developed platform is photodynamic drugs. Both of its commercialized products are photodynamic treatments, one for genital warts and the other for port wine stain birthmarks.

SPH owns 22.77% of FD-ZJ. Before the listing announcement, FD-ZJ’s market capitalization was approximately $700 million, whereas SPH’s market capitalization was $6.4 billion. We do not believe FD-ZJ is a core part of SPH, whose main strengths are drug distribution in eastern and northern China and manufacturing noninnovative drugs.

While several stocks in the sector experienced large swings after the listing announcement, the Chinese healthcare stocks we cover experienced only mild gains. CSPC rallied 1% but still trades at a 34% discount to our fair value estimate, CR Pharma rallied 0.6% and trades at 19% discount, and Sinopharm rallied 3% and trades at a 1% premium. All these companies possess a narrow moat rating.