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Morningstar | Sinopharm Posts In-Line Quarterly Result, but Seasonal Trends Will Keep Investors Cautious

Narrow-moat Sinopharm first-quarter earnings reported revenue growth and margins in line with our estimates after adjusting for seasonality. Operating cash flow was deeply negative because of lengthening accounts receivable days; while this is typical of the company’s first quarter, it will likely be a focus for investors. We believe the company's cash flow remains manageable, supported by its large cash position and ability to borrow. We retain our fair value estimate of HKD 38 per share. While the company is trading at a 20% discount to our fair value, we think that investor sentiment toward the stock could remain choppy until the seasonal trends exhibited the past few years are once again validated by stronger quarterly results later this year.

Revenue was CNY 95 billion, which is on track for our full-year forecast of CNY 374 billion. Gross profit margins were 8.1%, which is 85 basis points lower than our full-year estimate, but in line with our quarterly expectations. Sinopharm exhibits strong seasonality, and its first quarter typically has gross margins that are 100 to 150 basis points lower than full-year results.

Sinopharm reported a significant negative operating cash flow of CNY 22 billion, compared with core operating profit of CNY 3 billion and cash balances of CNY 34 billion. Since the start of the two-invoice policy, Sinopharm has been posting operating cash outflow in the first quarter, which turns positive for the full year. This is mostly due to Sinopharm’s cash conversion cycle, as it extends credit to hospitals in the beginning of the year and then collects or factors its receivables later on. However, this quarter’s outflow is worse than recent years; 2017’s first-quarter outflow was CNY 15 billion, and 2016’s was CNY 10 billion. Ultimately, we don’t think this is a serious concern because public hospitals are highly unlikely to default, and Sinopharm still has room to borrow to fund longer receivable days.

Finally, finance costs remain elevated at 1.0% of total revenue, compared with operating profit margins of just 3.5%. Despite Sinopharm’s issuance of a modest amount of debt last year to fund its acquisition of CSIMC, interest rates have fallen, so finance costs as a percentage of revenue are 25 basis points lower than 2018. While we believe finance costs are manageable, the company’s net profits remain sensitive to interest-rate fluctuations.