china pharmaceutical sector - credit suisse

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

30 June 2011 Asia Pacific/Hong Kong

Equity Research Major Pharmaceuticals

China Pharmaceutical Sector INDUSTRY PRIMER

Price-cut concerns overdone; pick safe harbour under headwinds Figure 1: China hospital drug sales will continue 20%+ growth momentum

33 37 40 49 63 76 86 108 145182

269325

391468

5562 71

3 2 8

3 9 7

4 77

571

6 78

222

0

100

200

300

400

500

600

700

800

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Rmb bn

Hospital drug sales Total pharma market sales

Hospital drug sales 2000-2010 CAGR: 20.9%%

Hospital drug sales 2010-2015E CAGR: 20.1%

Source: IMS

■ Price-cut concerns overdone: The current market is concerned that the ‘lowest-price-win’ Anhui EDL tender model will spread to the entire market. We believe this concern is overdone as: 1) price-control is a normal theme for years, but the actual impact is minimal with only 3% annual price erosion, 2) non-EDL market, which accounts over 90% market, is more important and less vulnerable to price-control, and 3) investors can always find leaders who can take advantage of favourable policies to charge premium.

■ Find safe harbour under price-control headwinds?: Under the current price-cut headwinds, we would recommend investing in leaders in the non-EDL market with the following attributes:1) differentiated and diversified drug portfolio, 2) comprehensive commercialisation networks, 3) solid R&D with promising pipeline, and 4) a visionary team with effective execution capabilities.

■ Stock calls: The current market correction due to the price-cut fear is overdone, in our view. Our stock calls are – 1177.HK (Sino Biopharm) due to its limited exposure to price cut and robust pipeline, 2607.HK (Shanghai Pharma) due to its integrated business model and 1099.HK (Sinopharm) the No.1 national drug distributor as good proxy to China healthcare market.

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Duo Chen 852 2101 7350

[email protected]

30 June 2011

China Pharmaceutical Sector 2

Focus charts Figure 2: China hospital drug sales only recorded 3% annual average price erosion from 2000 to 2010

14 01 2 9

1 23 12 21 1 5

1 09 10 5 1 0 1 1 01 10 1 9 9 9 4 9 0 8 8 8 6 8 5

0

2 0

4 0

6 0

8 0

10 0

12 0

14 0

16 0

18 0

20 0

20 0 0 2 0 01 2 00 2 20 0 3 2 0 04 2 00 5 20 0 6 2 0 07 2 00 8 20 0 9 2 0 1 0 2 0 11 E 2 01 2 E 2 0 1 3E 2 0 14 E 2 01 5 E

P ric e in d ex

C AG R 2 00 0 - 20 1 0 : - 3 .4 %

C AG R 2 01 0 -2 0 15 E : - 3 .2 %

Source: IMS

Figure 3: Robust demand: Patient visits soaring Figure 4: Robust demand: Inpatient visits soaring

1 5 6

1 7 8

1 4 0

1 4 5

1 5 0

1 5 5

1 6 0

1 6 5

1 7 0

1 7 5

1 8 0

1 Q 1 0 1 Q 1 1

M illio n

N o . o f p a tie n t v is its in c la s s 3 h o s p ita ls

Y o Y g r o w t h : 1 4 .3 %

6 . 4

7 . 4

5 . 8

6 . 0

6 . 2

6 . 4

6 . 6

6 . 8

7 . 0

7 . 2

7 . 4

7 . 6

2 0 1 0 2 0 1 1

M illio n

N u m b e r o f p a tie n t d is c h a rg e in c la s s 3 h o s p ita ls

Y o Y g r o w t h : 1 5 .6 %

Source: MOH Source: MOH

Figure 5: Average drug costs per inpatient keeps

increasing

Figure 6: Average drug costs per outpatient keeps

increasing

2,0692,349

2,5732,784

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010

R MB

Av erage drug costs per inpatient in MOH hospitals

CAGR: 10.4%

64.272.3

80.087.4

0

20

40

60

80

100

120

2007 2008 2009 2010

R M B

Av erage drug c os ts per outpatient in M O H hospitals

CAGR: 10.8%

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

30 June 2011


Price-cut concerns overdone; pick safe harbour under headwinds China’s pharma market is one of the most attractive markets worldwide. According to IMS, the market will become the third largest pharmaceutical market globally in 2011, with over US$50 billion size and is projected to grow more than 20% in the next five years driven by significant unmet needs, huge untapped patient pool, increasing disease incidence rates, favourable macro demographics together with increased government funding, improved healthcare access and affordability. China’s market is too lucrative to miss for investors. After the recent sizable correction of the pharma stocks, we would suggest investors to pick defensive leaders at an attractive entry point to capture China’s lucrative pharma market.

Price-cut concerns overdone Recently, the market consensus seems to be increasingly concerned about the potential national wide application of the so-called ‘lowest-price-win’ Anhui EDL (essential drug list) drug-tendering model for all provinces. People are further worried this could be a direction to go for non-EDL drugs and eventually adversely affect the industry. We believe that the market concerns about the potential impact could be overdone because: 1) Price-control is a normal theme in the pharma industry for the past 10 years, but the actual impact is minimal with only 3% average annual price erosion. 2) Price-control is not the only theme; innovation is an emerging theme in the non-EDL market. The value-driven non-EDL market accounting more than 90% share is strategically more important to focus and less vulnerable to price-control compared to the volume-driven commodity EDL market. 3) Investors can always find safe harbour leaders who can take advantage of government’s favourable policies to encourage innovation and drug R&D; new differentiated pricing policies have been proposed and piloted to allow ‘proprietary’ and ‘government-encouraged’ drugs to set independent pricing with premium. Leading companies with such qualified drugs would benefit the most and could be the safe harbour for investors to invest under the current price-control headwinds.

Find safe harbour under price-control headwinds Conquering China’s pharma market is not an easy task, as one has to tackle multiple challenging commercialisation barriers. Differentiation to avoid fierce competition would be the key to succeed. Since China has broadly two segments, we would recommend different investment criteria to find leaders in each one with the following characteristics. (1) Invest in differentiated leaders with sustainability in ’value’ driven non-EDL market: Differentiated and diversified drug portfolio qualify for differentiated pricing such as focusing on SFDA category 1 and category 3 drugs; comprehensive and effective commercialisation capabilities; solid R&D with promising pipeline; a visionary management team with an efficient execution team. (2) Invest in cost-effective leaders with scale in the volume-driven EDL market.

Stock calls: Sino Biopharm, Shanghai Pharma and Sinopharm The current market correction due to the price-cut fear is overdone, in our view. However, it will be a good entry point to pick attractive winners. Our stock calls are: 1177.HK (Sino Biopharm) due to its limited exposure to price cut, market leadership and robust pipeline, 2607.HK (Shanghai Pharma) due to its scale leadership and integrated business model and 1099.HK (Sinopharm) as the No.1 national drug distributor, it has less direct exposure to price-control but may gain more from volume growth.

China will be the third largest pharma market with 20% plus growth in next five years

Price-cut concern is overdone; investors can find safe harbour leaders with ‘proprietary’ and ‘government-encouraged’ drugs to enjoy independent pricing and favourable support from the government

Differentiation to avoid fierce competition would be the key to succeed in China

We recommend investing in Sino Biopharm, Shanghai Pharma and Sinopharm under current price-cut headwinds

30 Ju

ne 2011

Ch

ina P

harm

aceutical S

ector

4

Sector valuation comps Figure 7: China pharmaceuticals sector valuation comps Mkt cap Price TP P/E (x) EV/EBITDA (x) P/S (x) 3-yr ROE (%)

Company Ticker (US$ mn) (local) (local) Rating 2,011 2,012 2,011 2,012 2,011 2,012 CAGR PEG 2,011 2,012

Hong Kong-listed

Sino Biopharmaceutical 1177-HK 1,693 2.66 3.6 O 21.2 16.3 9.3 7.1 2.4 1.9 23.0 0.9 16.4 19.8

Shanghai Pharmaceuticals 2607-HK 2,036 20.70 24.3 O 25.7 17.0 2.3 1.6 1.1 0.8 38.0 0.7 12.0 12.2

Sinopharm Group 1099-HK 2,771 26.05 40.0 O 33.7 26.6 12.2 9.7 0.7 0.5 23.9 1.4 12.3 14.5

China Shineway Pharmaceutical 2877-HK 1,538 14.48 NR 10.3 8.7 6.6 5.5 4.0 3.2 12.3 0.8 26.2 26.7

Lijun International Pharmaceutical 2005-HK 478 1.52 NR 12.6 10.1 7.6 6.2 1.7 1.4 10.7 1.2 11.9 13.6

Sihuan Pharmaceutical. 460-HK 2,325 3.49 NR 17.3 12.9 8.8 6.2 8.3 6.1 22.3 0.8 12.5 15.3

United Laboratories 3933-HK 1,906 11.40 NR 12.1 9.9 8.5 7.0 1.9 1.6 13.9 0.9 21.8 23.2

Average 19.0 14.5 7.9 6.2 2.9 2.2 20.6 1.0 16.2 17.9

US-listed

3SBio SSRX 365 17.00 NR 22.8 17.3 11.9 9.5 4.6 3.8 21.5 1.1 9.3 10.7

Simcere Pharmaceutical Group SCR 503 9.34 NR 17.0 13.9 10.6 8.8 1.4 1.2 13.9 1.2 12.0 10.6

Average 19.9 15.6 11.3 9.2 3.0 2.5 17.7 1.1 10.7 10.6

China-listed

Shanghai Pharmaceuticals 601607-CN 4,993 16.80 NR 18.3 14.9 11.9 9.0 0.6 0.5 19.8 0.9 18.4 19.2

Yunnan Baiyao Group 000538-CN 6,105 56.90 NR 32.3 24.9 26.2 20.3 3.1 2.5 22.0 1.5 22.9 23.5

Kangmei Pharmaceutical 600518-CN 4,462 13.13 NR 25.5 19.6 19.5 13.8 6.2 4.5 25.1 1.0 16.5 17.7

Harbin Pharmaceutical Group 600664-CN 2,975 15.50 NR 14.3 11.6 9.3 8.4 1.3 1.1 12.4 1.2 16.9 17.1

Shanghai Fosun Pharmaceutical 600196-CN 3,058 10.39 NR 17.6 15.6 9.5 9.9 3.4 3.0 16.3 1.1 12.6 12.8

Tianjin Tasly Pharmaceutical 600535-CN 3,228 40.45 NR 33.5 26.9 25.4 21.2 3.7 3.1 19.3 1.7 17.9 18.9

Zhejiang Hisun Pharmaceutical 600267-CN 2,968 36.59 NR 37.4 27.2 25.6 19.5 3.5 2.9 21.9 1.7 11.5 13.2

Jiangsu Hengrui Medicine 600276-CN 5,146 29.62 NR 34.9 27.6 27.2 21.7 7.0 5.8 18.9 1.8 22.4 22.8

Guangxi Wuzhou Zhongheng 600252-CN 3,121 18.50 NR 29.7 30.5 12.7 13.7 8.8 6.6 32.0 0.9 43.0 39.0

Beijing Tongrentang 600085-CN 2,852 35.43 NR 45.4 36.9 25.6 22.8 4.1 3.5 17.0 2.7 11.6 13.2

Shenzhen Salubris Pharmaceuticals 002294-CN 1,880 33.50 NR 26.0 19.8 20.3 15.6 7.2 5.7 22.9 1.1 20.9 22.4

Beijing SL Pharmaceutical 002038-CN 2,199 37.37 NR 34.6 25.0 28.4 20.2 20.8 14.9 27.9 1.2 27.3 27.4

Wuhan Humanwell Healthcare 600079-CN 1,657 21.73 NR 32.0 24.8 19.2 14.7 3.2 2.4 24.4 1.3 13.5 14.8

Zhejiang Xianju Pharmaceutical 002332-CN 680 12.89 NR 30.2 24.4 19.0 15.3 2.6 2.2 18.5 1.6 13.1 14.5

Shanghai Modern Pharmaceutical 600420-CN 592 13.31 NR 25.7 19.4 15.1 12.5 2.2 1.8 24.0 1.1 17.0 18.8

Harbin Gloria Pharmaceuticals 002437-CN 1,005 23.23 NR 24.5 19.1 14.3 11.1 7.1 5.5 23.2 1.1 12.5 14.2

Average 28.9 23.0 19.3 15.6 5.3 4.1 21.6 1.4 18.6 19.3

Source: FactSet, Bloomberg, Credit Suisse estimates

30 June 2011


Price-cut concerns overdone China’s pharmaceutical market correction due to price-cut fear overdone Recently, the performance of China’s healthcare stocks particularly pharmaceutical stocks dropped significantly. If we compare the year-to-date performance data for MSCI China’s healthcare index versus MSCI China index, it is underperforming. Particularly, if we compare some leading Chinese pharmaceutical companies like Sino Biopharm (1177.HK), Sihuan Pharmaceuticals (0460.HK), China Shineway Pharmaceuticals versus MSCI China healthcare and MSCI China index, we could see significant underperformance for those stocks.

The major reason behind is that the market consensus is increasingly concerned about the potential national wide application of the so called ‘lowest-price-win’ Anhui model for all provincial EDL drug tendering process. People are further worried this could be a direction to go for non-EDL drugs and eventually adversely affect the industry. We believe the market over-corrected due to this price-cut fear. We believe that market’s concern about the potential impact of the price-cut is overdone. Leading companies with ’proprietary’ and ’government-encouraged’ drugs qualified for differentiated pricing would benefit the most and would be the safe harbour for investors to invest under price-control headwinds.

Figure 8: China pharma stocks are over corrected by price-cut fear

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

6/24/2010 8/24/2010 10/24/2010 12/24/2010 2/24/2011 4/24/2011 6/24/2011

Sino Biopharmaceutical MSCI China MSCI Ch ina Healthcare

Source: Company data, Credit Suisse estimates

Price control is a normal theme in pharma industry, the actual industry impact is minimal ■ Price control happening for years, but overall pricing erosion is limited

From 2000, the government has imposed more than 27 rounds of price-control initiatives. However, each control will be limited to selective drug portfolio so that only a small percentage of drugs in the entire market gets impacted. More importantly, the market always could find other balancing means to avoid price-control effects. Although each time the average drug price-cut percentage is about 20%, the final impact usually turns out to be minimal to the whole industry. Without a drastic change of the current healthcare system, the price control will not truly affect the whole market fundamentals and stop its solid growth momentum. The unmet medical demands, aging population, changing disease profile, improving affordability and better access to healthcare are all strong underlying drivers for the market growth.

Market’s concerns about the ‘lowest-price-win’ Anhui model’s impact is overdone; leading companies with ‘proprietary’ and ‘encouraged’ drugs would benefit the most from differentiated pricing even under price-control headwinds

China has imposed more than 27 rounds of price-control initiatives; however, the final impact to the whole market is minimal

30 June 2011


IMS does annual systematic analysis on China’s hospital drug sales each year and projects the future trends as well. According to IMS, the overall hospital drug sales price index merely eroded from 140.1 in 2000 to 99 in 2010 implying a -3% CAGR in the past 10 years under more than 27 rounds of price-control actions. On the contrary, sales at constant prices (assuming at the same price index so an indicator for volume growth) have grown at an impressive 24.7% CAGR in the past 10 years and sales value has grown at a 20.9% CAGR after adjusting the price-control impact. According to IMS’s forecast, from 2010 to 2015, the overall price index will reduce at a -3% CAGR but will maintain more than 24% volume CAGR and more than 20% value CAGR. The volume growth will likely far outpace potential price erosion.

Figure 9: Historical average drug price cut percentage announced by the government

15

10

20

5

15

10

15

10

20 20

15

20

15

10

14

30

35

23

40

15

20

151619

12

19

0

5

10

15

20

25

30

35

40

45

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

(%)

Price cut %

Source: NDRC

Figure 10: China hospital drug sales only recorded 3% annual average price erosion

from 2000 to 2010

140129

123 122115

109 105 101 101 101 99 94 90 88 86 85

0

20

40

60

80

100

120

140

160

180

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Price index

C A GR 2000-2010: -3 .4%

C A GR 2010-2015E: -3 .2%

Source: IMS

According to industry’s well-regarded market intelligence firm IMS; from 2000 to 2010, the overall hospital drug market only has 3% CAGR price erosion; the volume growth would far outpacing the minimal price-cut effects

30 June 2011


Figure 11: China hospital drug sales will continue 20%+ growth momentum

33 37 40 49 63 76 86 108 145182

269325

391468

5562 71

3 2 8

3 9 7

4 77

571

6 78

222

0

100

200

300

400

500

600

700

800

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Rmb bn

Hospital drug sales Total pharma market sales

Hospital drug sales 2000-2010 CAGR: 20.9%%

Hospital drug sales 2010-2015E CAGR: 20.1%

Source: IMS

■ The market keeps growing, so does patient drug expenses

On the other hand, the drug costs per patient, inpatient or outpatient, are still growing although after multiple rounds of price-control. One implication we could observe is that despite the government-imposed price-control, the end-user demand keeps growing and would offset the price control impact. The hospitals and physicians could simply either prescribe more drugs per patient or use more expensive alternative drugs to offset the effects of price control. The slower growth rate in drug cost per patient compared to a hospital’s total drug sales growth would imply that another secular fundamental growth driver is the increasing number of patient visits, which would be a more sustainable corner stone to drive the market.

Interestingly, based on most recent data from MOH, we could identify both the number of patient visits and number of inpatient discharges from the class 3 hospitals registered 14.3% and 15.6% growth in 1Q11 versus 1Q10 implying a solid demand. Given such high momentum of volume growth, we believe volume growth will outpace most potential price-control effects as unmet medical demand rises rapidly.

Figure 12: Average drug costs per inpatient keeps increasing

2,0692,349

2,5732,784

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010

RMB

Av erage drug costs per inpatient in MOH hospitals

CAGR: 10.4%

Source: MOH

Number of patient visits and inpatient discharges in class 3 hospitals registered impressive over 14% volume growth in 1Q11 versus 1Q10, implying unstoppable demands; most price-control effects would be easily offset by volume growth

30 June 2011


Figure 13: Average drug costs per outpatient keeps increasing

64.272.3

80.087.4

0

20

40

60

80

100

120

2007 2008 2009 2010

RMB

Av erage drug costs per outpatient in MOH hospitals

CAGR: 10.8%

Source: MOH

Figure 14: Robust demand: Patient visits

soaring

Figure 15: Robust demand: Inpatient visits

soaring

156

178

140

145

150

155

160

165

170

175

180

1Q10 1Q11

Million

No. of patient v isits in class 3 hospitals

YoY grow th: 14.3%

6.4

7.4

5.5

6.0

6.5

7.0

7.5

8.0

1Q10 1Q11

Million

No. of patient discharge in class 3 hospitals

YoY grow th: 15.6%

Source: MOH Source: MOH

■ OECD countries also conduct price-control routinely

Price-control is not a ‘China only’ phenomenon, many countries globally have implemented various price-control schemes because healthcare demand is always growing faster than what a country can afford. Without appropriately managing the social expenses in healthcare spending, it will be hard to build a sustainable healthcare system. Although China’s government has under-invested in healthcare spending, the appropriate management of healthcare cost is an expected rational trend. Therefore, we will not be surprised if the industry has price-control measures similar to other countries.

In a study on ‘Pharmaceutical Price Controls in OECD Countries’ done by U.S. Department of Commerce, International Trade Administration (ITA), ITA examined the drug price regulatory systems of 11 OECD countries and found that all rely on some form of price controls to limit spending on pharmaceuticals. The principal methods these governments employ are reference pricing, approval delays and procedural barriers, restrictions on dispensing and prescribing, and reimbursement. The most direct method the OECD governments use to control prices is to set the sales price and make sales at any other price illegal. In addition, some OECD governments regularly cut the prices of drugs already in the market. All these approaches are quite similar to what China did. Since it is a rational and common approach widely used, we will not exaggerate the price-control impact in either way in China.

Price-control is not a ‘China only’ phenomenon, OECD countries did for years as well, so not necessary to over-exaggerate the effects

30 June 2011


Non-EDL drug market is strategically more important and less vulnerable to price-control In April 2009, China’s state council released a milestone healthcare system reform proposal and its implementation plan with five priorities from 2009 to 2011 together with Rmb850 bn government investment budget, which was well acknowledged by the market as a strong positive catalyst for the industry. Let us re-examine the government’s reform priorities to understand where the industry is heading for. Our understanding is that the China healthcare reform proposal’s top priority is to establish and improve the basic healthcare system covering all urban and rural residents. To reach this goal, it will need a range of systematic approach. It is a system upgrade not a simple price-cut initiative. Recent price-control events are only a small portion of the reform targeted to relieve the current burning complaints of the public. What matters to the pharma industry would be the government’s commitment to improve ‘basic’ healthcare, which will potentially further differentiate the whole market into two segments. These will be the volume/commodity EDL market from essential medicines to fulfil government’s goal to cover most basic needs and value/proprietary non-EDL market from non-essential medicines (mainly drugs on national and provincial reimbursement list and non-reimbursable drugs) to cover non-basic needs. The government has designed different priorities for the two segments.

■ EDL market, volume/commodity market: It is a basic market and only accounts for less than 10% of the total market. It mainly covers primary healthcare institutions and city healthcare centres, the newly emerging dispensing channel. We believe the establishment of the EDL system will be one of the near-term priorities for the government. As the government would enforce zero mark-ups, reduce the price and fully sponsor the market, we believe the EDL market will face more pricing pressure but gain significant volume. Furthermore, it is a commodity market covering mainly the basic needs of the rural/poor population. Market leaders will be the ones with scale and cost control. Currently, domestic generic pharma companies lead this market.

■ Non-EDL market, value/proprietary market: It is a strategically important market and accounts for more than 90% of the total market. It mainly covers hospitals, the major dispensing channel. We believe the non-EDL market will not simply follow the EDL path, instead will focus more on 1) optimising the rational medicine usage, 2) upgrading the industry and 3) encouraging innovation by mechanism of differentiated pricing and multiple-layer tendering systems based on drug quality and innovation level. Furthermore, it is a premium market catering mainly to middle/high-end of the urban population. Market leaders will be the ones with ‘proprietary drugs’ and ‘differentiated brand’. Currently, multinationals dominate this market.

Current healthcare reform will further differentiate the market into two segments: ‘volume/commodity EDL market’ to cover basic needs and ‘value/proprietary non-EDL market’ to cover non-basic needs

EDL market focuses on basic drugs with commodity nature, a basic market

Non-EDL market encourages innovation and drug R&D, a strategically important market

30 Ju

ne 2011

Ch

ina P

harm

aceutical S

ector

10

Figure 16: Comparison of EDL and Non-EDL market EDL market Non-EDL market

Rough estimate on percentage of total market <10% >90%

Market feature Volume segment with clinically widely used commodity drugs (High volume) Value segment with innovative and new drugs with premium (High value)

Main target population Rural and urban poor Urban

Drug supply Drugs from EDL Drugs from RDL

Non-reimbursable drugs

No. of drugs 307 National RDL A: 451

National RDL B: 1400

Provincial RDL and non-reimbursable drugs: many

Major Medical Insurance Medical Assistance Program Basic medical insurance for urban employee

Rural Cooperative Medical Scheme Basic medical insurance for urban residents

Basic medical insurance for urban residents Private insurance

Major sponsor Government Employer and employee

Target healthcare institutions Rural primary healthcare institutions Urban hospitals

Urban community healthcare centres

Hospital/Institution mark-ups Zero mark-ups 15% mark-ups and gradually reduce

Tender trend Single-layer tender like Anhui model by technical and business two bidding reviews Multi-layer tender system by quality and innovation level

Pricing trend Uniform pricing with price bottom floor Differentiated pricing by drug quality and innovation level

Independent pricing with premium for qualified drugs with ‘proprietary’ and ‘encouraged’ nature

All under NDRC control for max retail price RDL drugs are under NDRC control for max retail price; Non-reimbursable drugs

market pricing

Investment theme Leader with scale and cost control Leader with ‘proprietary’ and ‘encouraged’ drugs

Source: Government website, IMS, MENET, Credit Suisse estimates

30 June 2011


The non-EDL market featured by innovative and high value drugs would play a bigger role in the pharma market, with more than 90% of the value share. We envision that although the government will continue the price-control measures just as what they did for last 10 years and past 27 rounds, ‘price cut’ will not be the single theme. Differentiated pricing levers will be implemented to differentiate and benefit true leaders with innovation and drug R&D capabilities. The government will continue to promote industry upgrade and encourage innovations. The price-control headwinds will not stop the market leaders to grow, on the contrary, the leaders in the non-EDL market with ‘proprietary’ and ‘government-encouraged’ drugs qualified for differentiated pricing and are actually better off under the current price-control headwinds. The crucial part is how to find those right safe harbours.

Investors can find safe harbour leaders to take advantage of government’s favourable policies Even if the whole sector could be under price-control headwind, investors have enough room to seek safe harbour market leaders with proprietary and government-encouraged drugs under differentiated pricing schemes in the non-EDL market. The current policy trend would allow proprietary and government-encouraged drugs for independent pricing with a premium. Thus, under the current market landscape and policy framework, those market leaders are actually at an advantage with more differentiated market positions, and hence gain from both volume and pricing premium.

Re-visit government policy to indentify the priorities, non-EDL market promoting innovations

Re-visit the governing milestone national healthcare reform policy ‘Opinions on Deepening the Health Care System Reform’ (hereinafter referred as ‘the Opinions’) released by the state council dated 8 April, 2009, we identify that innovation and industry upgrade are on government’s top agenda, it explicitly encourages ‘innovation with the price leverage’ and ‘optimize and upgrade the structure of the pharmaceutical industry’:

Figure 17: China government’s policy top agenda regarding drug innovation Section (vii) – ‘Establishing and completing a secured pharmaceutical supply system’

• ‘Efforts should be made to regulate pharmaceutical production and circulation. Efforts should be made to improve development policies and programs for the pharmaceutical industry, enforce rigorous market access and drug registration and approval, vigorously regulate and consolidate the production and circulation order, promote independent innovation capacity of pharmaceutical enterprises and optimize and upgrade the structure of the pharmaceutical industry.’

Section (xi) – ‘Establishing a sound health care pricing system’

• ‘Efforts should be made to reform the drug pricing mechanism. Rationally adjust the government pricing scope, improve the pricing methods, increase transparency, encourage enterprises to be engaged in independent innovations with the price leverage, and promote the production and utilization of national essential medicines.’

• ‘Carry out pilot projects, such as differentiated price mark-ups on drugs sold in hospitals, prescription service fees and etc. to guide hospitals on rational medication.’

Source: ‘Opinions on Deepening the Health Care System Reform’ (2009), State council, 2009 March

Re-visit the following ‘Implementation Plan for the Recent Priorities of the Health Care System Reform (2009-2011)’ (hereinafter referred as ‘the Implementation Plan’) released by the state council dated 8 April, 2009, we also identify that establishment of national essential medicine system is one of the near-term working priorities and price-control was on the agenda. It explicitly proposed ‘local governments are encouraged to explore purchasing means of further reducing the prices of essential medicines’:

The leaders in non-EDL market with qualified drugs are actually better off under current price-control headwinds

Current policy trend would allow proprietary and government-encouraged drugs for independent pricing with a premium

‘Innovation with the price leverage’ and ‘optimising and upgrading the industry structure’ were on national policy top agenda

30 June 2011


Figure 18: China government’s policy top agenda regarding EDL (essential drug list) Overview – ‘ Five reform programs should be carried out with emphasis from 2009 to 2011’

• ‘Firstly, accelerate the establishment of the basic medical security system. Secondly, preliminarily set up the national essential medicines system. Thirdly, improve the grass-roots health care services system. Fourthly, gradually press ahead with the equalization of basic public health services. And fifthly, push forward pilot projects for public hospital reform.’

Section (vii) – "Preliminarily establishing a secured supply system for essential medicines"

• ‘Essential medicines used in government-run health care institutions, shall be purchased through open tender organized by institutions designated by provincial governments, and unified distribution by distributors selected through the open tender is also required.’

• ‘The central government determines the guiding retail prices of essential medicines. Based on the result of tender, provincial governments set the unified purchasing prices within the range of the government-guided prices, with the distribution charge included in the purchasing price. Government-run health care institutions at grass-roots levels shall sell drugs with zero mark up. Local governments are encouraged to explore purchasing means of further reducing the prices of essential medicines.’

Source: ‘Implementation Plan for the Recent Priorities of the Health Care System Reform (2009-2011)’, State council, 2009 March

From the above script of government’s policy, people could read that essential drug system was one near-term provincial working priority and ‘local governments are encouraged to explore purchasing means of further reducing the prices of essential medicines’. That is why more actions are proposed for establishing provincial EDL tendering system and different means trying to reduce EDL drug prices at provincial levels are tested. However, this is not for the whole sector but is largely limited to the EDL market. For the other 90% market in non-EDL, the government explicitly encourages innovation with price leverage and optimise and upgrade the structure of the pharmaceuticals industry. Different priority should be given for different markets; the same applies for the investor picks. By addressing other priorities, such as improving basic medical insurances system, healthcare services provider system, public health systems, pilot reform of public hospital system and injection of more funding, would significantly improve patient affordability and access to healthcare. All these improvements would be sustainable, underlying drivers of the pharma industry growth.

NDRC proposed differentiated pricing for newly included RDL drugs

To follow the national healthcare reform guideline, NDRC officially updated national reimbursement drug list (National RDL A and RDL B 2009 version, collectively ‘RDL’) in 2009. Then individual provinces were in the process to update provincial RDL lists until mid 2011. In March 2011, NDRC released ‘The notice on pricing scheme for drugs newly included in reimbursement drug list (Draft seeking for suggestions)’. Although it is a draft policy seeking for industry and public inputs now, the direction is clearly to encourage innovation by independent pricing schemes.

In this proposal, we could identify that NDRC has taken differentiated pricing schemes for drugs under different quality and innovation levels. Although it considers uniform pricing for all RDL drugs, it explicitly proposed to grant independent pricing treatments to the following listed drugs on its retail prices to encourage innovation and industry upgrade:

National government encouraged local government to explore further means to reduce EDL drug prices; so EDL drug under price-pressure, however, in non-EDL market, government priority is different, it emphasises more for innovation and industry upgrade

NDRC has recently proposed differentiated pricing for ‘proprietary’ and ‘encouraged’ drugs to enjoy independent pricing with premium

30 June 2011


Figure 19: NDRC proposed differentiated pricing for the following products Drug Category Description Implication to SBP

Products under Chinese patent protection (at the same time registered as new drugs in SFDA such as under registration category 1* and 3*…etc)

• 33% of sales of SBP from ‘proprietary drugs’ in 2010

• SBP ‘proprietary’ drugs would have pricing premium

Proprietary products

Products under China administrative protection (mainly MNC products)

First to market generic drugs (FTM drugs) within 5 years after approval

• 46% of sales of SBP from ‘proprietary drugs’ in 2010

• SBP ‘FTM’ drugs would have pricing premium

Drugs obtained national award from state council (within 15 years after the award)

Encouraged products

Finished-dosage drugs manufactured in China and export to international mainstream market (exclude contracted manufacturing products from overseas enterprises)

Drugs under global patents protection within effective period but patent application date is before Jan.1st 1993 (China did not recognize patent protection before 1993)

Legacy products

Originated drugs made by domestic companies manufactured and launched before Jan.1st 1993 (within 20 years after launch)

*SFDA registration category 1: New chemical entity never marketed in any country

*SFDA registration category 3: Drug marketed abroad but not in China

Source: NDRC, ‘The notice on pricing scheme for drugs newly included in reimbursement drug list (Draft seeking for suggestions)’ (March

2011)

In summary, if the drug is eligible for independent pricing on its own, not only will it be devoid of any price-control pressure, but also it can enjoy the premium. More importantly, it will also face limited competition, as many provincial non-EDL tenders are conducted by multiple-layers based on drug quality and innovation level with similar criteria. Market leaders with such proprietary or encouraged drugs would be safe harbour picks for investors seeking to capture the lucrative future of China’s pharma market.

Shanghai has implemented pilot policy on differentiated pricing

Although NDRC’s differentiated pricing policy for newly included RDL drugs is a proposal under discussion now, we believe this is the trend for the industry. Furthermore, in some advanced regions such as Shanghai, similar policy has already been piloted. Shanghai NDRC had released the Shanghai Pricing Guideline for Innovative Biomedical Drugs in 2010 March:

We summarise the key selection criteria for drugs qualified for such special treatment and related benefits as below:

Shanghai NDRC has already piloted similar differentiated pricing in 2010 to encourage innovation and drug R&D

30 June 2011


Figure 20: Shanghai piloted differentiated pricing to support innovation and drug R&D Drug category Description Implication to SBP

Proprietary drugs • New drugs under the following SFDA registration category or equivalent:

• Chemical drugs under category 1.1 and 1.2 • TCM drugs under category 1-2 • Biological drugs under category 1-2

• 33% of sales of SBP from ‘proprietary drugs’ in 2010 • SBP ‘proprietary’ drugs would have pricing premium • High premium is allowed for high innovative drugs • Separate tendering channel to avoid competition

• Drugs under Chinese patent protection (compound patent)

• TCM drugs in national protection catalogue

Encouraged drugs • First-to-market generic drugs (FTM drugs) • 46% of sales of SBP from ‘proprietary drugs’ in 2010 • SBP ‘FTM’ drugs would have pricing premium • Separate tendering channel to avoid competition

• Drugs with national awards

• Other drugs encouraged by national or Shanghai industry policies

Pricing benefits • Price determined by a review panel with the full discussion of the company.

• Pricing method based on cost analysis but take into

consideration of R&D expenses, innovation level and market conditions

• High premium is allowed for high innovative drugs

• Separate tendering channel avoid direct competition with generics

-Chemical drugs under category 1.1: New chemical entity made from synthesis or semi-synthesis approach.

-Chemical drugs under category 1.2: New chemical entity made from natural resources.

-TCM drugs under category 1-2: New active ingredient made from plant, animal or other source and never marketed in China or newly

discovered TCM.

-Biological drugs under category 1-2: New biological product never marketed in any country or monoclonal antibody drug.

Source: Shanghai NDRC, ‘Shanghai Pricing Guideline for Innovative Biomedical Products’ (2010 March)

From the eligible drug list, it can be seen that it shares the NDRC’s pricing proposal’s pricing philosophy. All the governments, no matter national or local, are strongly supportive for ‘proprietary’ new drugs with Chinese patent protection and ‘encouraged’ drugs, such as FTM drugs and drugs with national awards. Most importantly, the benefits are not only in pricing but also in hospital tendering. A separate tendering channel would significantly reduce generic competition risks or potential price erosions.

To easily read the market, we can make a simple reference to the flight tickets. It just looks like the pharma market is classified by ‘First Class’, ‘Business Class’ and ‘Economy Class’ and each class would have different qualification requirements and would enjoy different privileges. ‘Proprietary drugs’ are in ‘First Class’, ‘Encouraged drugs’ are in ‘Business Class’ and ‘Non-differentiated generic drugs’ are in ‘Economy Class’. If you are in ‘First Class’ or ‘Business Class’, not only you will have spacious seats (larger market with fewer competitors and/or even exclusive monopoly rights) but also you are entitled to board to the flight first (separate tendering channel and enjoy privileges for speedy hospital listing too). We believe that the future pharma leaders in the Chinese market will come from ‘First Class’ and ‘Business Class’ players, as more privileges are given to maximise their gains from the market.

30 June 2011


It is time to check the other neglected government agenda – rising importance of R&D ■ New drug is still scarce, current stringent registration policy pays off for early

R&D investors

China has adopted very stringent drug registration policies in recent years after 2006. According to industry experts, the registration timeline for a new drug could be from three to five years depending on the progress and requirement of clinical trials after all the pre-clinical work. Therefore, the incumbent leaders having proprietary new drugs in the portfolio and those who invested in R&D early with a robust pipeline would have substantial advantage over their competitors, since competitors cannot easily match the time gap.

Under SFDA’s definition and NDRC’s proposed differentiated pricing criteria, the category 1 and category 3 drugs would be most valuable, as category 1 drugs generally represent innovative drugs with a new Chinese compound patent protection and category 3 drugs generally represent first-to-market generic drugs. Historically, China only approved handful of drugs under category 1. One reason is that China players lacked of R&D capabilities, so applications were fewer. However, the other reason is that historically, even if it is a generic drug, the player still can capture good returns and survive in the market. However, this will hardly work in the future due to stringent policy in drug registration and changing commercialisation landscape. To survive and grow in the future, it would have to rely on both strong R&D and commercialisation capabilities.

Furthermore, category 1 new drugs are still scarce assets in China. According to a study Innovative drug R&D in China published on nature reviews in drug discovery in May 2011, the study has analysed all novel drugs for which new drug applications (NDAs, approval for new drug manufacturing and marketing) and investigational new drug applications (INDs, approval for conducting clinical trials) were approved in China between 2003 and 2010. The study only included chemical drugs in classes 1.1 and 1.2 and biological drugs in class 1, as these represent most innovative applicants, which are defined by the SFDA as not being previously approved for marketing as a drug anywhere else in the world. In the period analysed, on average only ~25 drug candidates were approved for entry into clinical trials and an average of only ~four drugs were approved for marketing per year. Since it is scarce, the company which has category 1 new drugs in the portfolio would be quite valuable if the drug can appropriately address market’s unmet clinical needs.

Figure 21: Innovative drugs are scarce assets as only small number of drugs approved

each year

14

29 30

27

24

21

27

24

7

4

11

2 2 2 1 00

5

10

15

20

25

30

35

2003 2004 2005 2006 2007 2008 2009 2010

No.

of i

nnov

ativ

e dr

ugs

IND (investigational new drug application , approval for clinical tria ls)NDA (new drug application , approva l for marketing)

Source: Nature Reviews in Drug Discovery, May 2011, Volume 10

Drug registration policy becomes more stringent, it takes 3-5 years to get a new drug approved; incumbent leaders with robust pipeline benefits the most from time gap

Category 1 for innovation drugs and Category 3 for FTM drugs under SFDA new drug registration category are most valuable in the future

30 June 2011


■ ‘National Major Drug Initiative’ is an under-recognised government milestone push for drug R&D

‘National Major Drug Initiative’ is a dedicated national government push to transform drug industry from generic-domination to innovation-driven model in China. The initiative was one of the 16 major initiatives proposed by the state council in ‘National Medium-Long Term Science and Technology Strategic Planning 2006 to 2020’ in 2006. The specific implementation guideline was released in August 2008 by the state council. In May 2011, the 12th Five Year implementation guideline was issued. The committed funding from central government has increased from Rmb6.6 bn to Rmb10 bn from the 11th five-year plan to 12th five-year plan. The total investment injections into drug R&D would be significantly higher, as most funded projects would require a matching funding from the applicant by 1:1 to 1:4. According to a study ‘Innovative drug R&D in China’ published on nature reviews in drug discovery in May 2011, US$2.7 bn was invested from 2008 to 2010 and another US$6 bn will be invested in the next five years in China’s drug R&D. The government has funded hundreds of research programmes from pre-clinical to clinical projects. The funded projects would be a significant contributor to generate future ‘proprietary’ drugs under Chinese patent protections in China. By end of September 2010, there were 16 new drugs approved from funded programs and another 41 projects were under Phase III clinical trials. China is on the way to develop its own innovative drug pipeline.

Figure 22: National government committed increasing funding into drug R&D

180

3450

6600

10000

0

2000

4000

6000

8000

10000

12000

9th Five Year Plan 10th Five Year Plan 11th Five Year Plan 12th Five Year Plan

RMB mn

National government investment in “National major drug initiative”

Source: MOST, MOH

‘National Major Drug Initiative’ is the milestone push from the national government for new drug R&D and total investments could reach US$6 bn in the next five years

30 June 2011


Find safe harbour under price-control headwinds Competition is key; invest in differentiated leaders

Under the current price-control headwinds, we would recommend investors to pick safe harbour leaders who are less vulnerable to the potential price-control impact and who would be better off under the government’s moving trend to encourage innovation and drug R&D. We would recommend investors to focus more on the value-driven non-EDL market to pick for the leaders with rich proprietary and government-encouraged products and pipelines.

Generally, since China has broadly differentiated into two market segments of non-EDL and EDL markets, the investment criteria would be different while picking leaders in each segment. We would recommend investing in market leaders of each market segment with the following characteristics:

Figure 23: Criteria to invest in China pharma leaders Invest in differentiated leaders with sustainability in ‘value’ driven non-EDL market • Differentiated and diversified drug portfolio: For example, focus on proprietary under Chinese patent

protection (compound patent) and/or FTM generic drugs (Benchmark is overseas blockbusters with good potential in China) and/or exclusive drugs (only supplier with unique formulation, special technology or other features)

• Comprehensive and effective commercialisation capabilities

• Solid R&D with promising pipeline

• Visionary management team with efficient execution team

Invest in cost-effective leaders with scale in volume-driven EDL market

• Cost management is better than peers

• Market leader with scale

• Integrated model

• Strong execution team

Source: Credit Suisse estimates

We would recommend Sino Biopharm (1177.HK), the leader in non-EDL market with rich ‘proprietary’ and ‘government-encouraged’ first-to-market generic drugs, as a safe harbour pick under current headwinds because it has less exposure to price-control and could even benefit from the emerging policy trend to grant qualified products for independent pricing with premium. Although it may take time to implement the new policies, it indicated an emerging trend, and SBP should be one of the best candidates to benefit the most in the future.

Five key commercialisation barriers to win in China’s pharma market:

Conquering China’s pharma market is not an easy task. There are at least five challenging commercialisation barriers to address – from drug registration, hospital tendering, and hospital listing to retaining physician prescription and patient usage. The following are the selective key steps to win; investors could take as a reference to evaluate which players are outperforming peers along these dimensions:

■ Select the right drug portfolio: The company should not rely on a single drug but it should be backed by a group of balanced drugs. The drug ideally should address China’s huge unmet medical needs with a unique differentiation

■ Get drug on the market in time: The speed to launch a new drug is important for success. This requires local regulatory know-how and effective R&D capabilities

■ Win government tendering with favourable pricing: Understand local regulatory policy framework and have a strong execution team, as there are 30+ provincial tendering schemes

Investing in different leaders of different market segments

China pharma market is not easy to conquer; five major commercialisation barriers have been identified

30 June 2011


■ Expand broad hospital coverage and affordable patient pool: Strong commercialisation network to reach extensive hospital coverage and be able to reach broader affordable patient pool by appropriate pricing strategy and/or enlist of RDL

■ Retain physician prescription preference: Compelling drug effectiveness and risk profile with differentiated drug positioning, key opinion leader’s endorsement and effective physician/patient educations are all desired actions

Figure 24: Five major commercialisation barriers to overcome

Drug Registration

HospitalListing

GovernmentTender

PhysicianPrescription

Patient Purchase

InsurancePrograms

Pricing

Out-of-pocket

•More stringent •30+ tenders to bid

Key Barriers

Time Frame

•20k hospitals to penetrate •One drug two formulations required

•2 million+ physician pool to target

•13bn population to cover

2-5 years In general, once per year for each tender

In general, once per year for each hospital

Frequent visit /detailing required

•Limited affordability•Multiple insurance programs

Reimbursement list is not regulatory updated. If missed, need to wait for years

*Note: above is rough estimation. The market varies a lot in local level and evolves quickly

Drug Registration

HospitalListing

GovernmentTender

PhysicianPrescription

Patient Purchase

InsurancePrograms

Pricing

Out-of-pocket

•More stringent •30+ tenders to bid

Key Barriers

Time Frame

•20k hospitals to penetrate •One drug two formulations required

•2 million+ physician pool to target

•13bn population to cover

2-5 years In general, once per year for each tender

In general, once per year for each hospital

Frequent visit /detailing required

•Limited affordability•Multiple insurance programs

Reimbursement list is not regulatory updated. If missed, need to wait for years

*Note: above is rough estimation. The market varies a lot in local level and evolves quickly

Source: Credit Suisse research

Leading pharma distributors, another alternative pick

Since price-control effects are mainly on maximum retail selling price to end user, the pharma distributors have less direct impact as their business is related to whole industry transaction value and volume. As we identified, although government implemented multiple rounds of price cut, the actual overall industry impact is minimal with only 3% price erosion each year; the overall translated impact to distribution business could be minimal too. We prefer the national pharma distribution leaders, which have more diversified product portfolio and scale leadership as close proxy to the whole pharma market. Both Sinopharm (1099.HK) as the No.1 national leader and Shanghai Pharma (2607.HK) with an integrated business model and leading position in drug distribution business could be alternative safe harbour for investors.

Price-control has less direct impact on leading pharma distributors, national leaders with scale could be an alternative safe harbour

30 June 2011


Key risks investing in China’s pharma market We highlight the following potential key risk factors related to China pharma market:

■ Policy risks. China’s pharma market is regulated by the government – from drug registration, hospital tendering to pricing and reimbursement, any material changes in the policy framework could place new risks to the industry players.

■ Competition risks. With over 4,000 manufacturers in China’s pharma market, it is a fragmented market; with fierce or irrational competition, any company or even the industry could be affected.

■ Operational risks. A pharmaceutical company’s success is subject to significant operational risks, including management’s ability to implement its business strategies. We believe any delay or inappropriate implementation or key personnel loss is also a potential risk to the company.

■ Drug risks. A pharmaceutical company’s success relies on enhancing existing drugs as well as developing new ones. If a marketed drug is alleged to be unsafe, the company may have to recall its drugs. We believe this may materially affect the company’s financial conditions and reputation.

■ Pipeline risks. The company’s pipeline would be important for its future success and business continuity. Any delay or failure in pipeline development would negatively impact the company’s financial conditions. However, the drug development has a high failure rate nature and Chinese pharmaceutical companies on average have limited R&D capabilities and resources for innovative drug R&D. We believe this could be one of the key risks for the industry.

■ IP infringement risks. The IP law enforcement is improving in China; however, there are risks if there are IP infringement cases for the company’s key drugs. On the other hand, generic drugs dominate China and selective companies may have IP dispute with multinational original developers, the specific dispute may materially impact the company’s financial conditions. We believe this is one of the risks for the industry.

■ Compliance risks. There are specific legal or regulation requirements that qualify the industry players to conduct the business in China’s pharma market such as good-manufacturing practice (GMP), good-supply practice (GSP) and drug registration certificates. Furthermore, the players need to follow anti-bribery regulations during drug distribution and commercialisation. We believe any violation of these compliance dictates may bring risks to the company’s financial conditions and reputation.

30 June 2011


Asia Pacific / Hong Kong Major Pharmaceuticals

Sino Biopharmaceutical Limited (1177.HK / 1177 HK)

The good medicine ■ Initiate coverage with an OUTPERFORM rating. Sino Biopharm (SBP) is

an integrated pharmaceuticals group engaged in the R&D, manufacturing and marketing of prescription drugs. It has the largest market share in the hepatitis market and is well regarded for its R&D commitment and robust pipeline.

■ The biggest winner under the innovation-driven policy trend. We believe the market is overly concerned about government price controls, but under appreciative of China’s trend to promote drug R&D and innovation. We believe SBP is likely to be the biggest winner owing to: (1) a favourable policy trend to grant premium pricing power to qualified drugs, (2) its successful track record, (3) the fact that 80% of its sales come from qualified ‘proprietary’ and ‘first-to-market’ (FTM) generic drugs that have premium pricing power.

■ R&D, sales and team – Three key value drivers to sustain growth. Commitment to R&D (highest among peers), extensive sales infrastructure and a stable management team for the last 14 years is expected to continue to underpin SBP’s future success. These drivers, combined with a balanced product portfolio and a robust pipeline, should enable SBP to deliver a sustainable growth over the next 5 to10 years.

■ CS’s proprietary ‘PharmaValues’ valuation approach applied first. CS’s proprietary NPV-based ‘PharmaValues’ method is widely used to evaluate pharmaceuticals companies globally. We have applied PharmaValues to derive SBP’s fair value. Our target price of HK$3.6, implies a 35% upside, and is based on HK$17.64 bn NPV from marketed drugs, excluding any pipelines. Key risks include pipeline failure, holding company structure, unsuccessful M&A efforts and a severe drug price cut.

Share price performance

0

2

4

6

Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11

0

200

400

600Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the MSCI China Free index which closed at 65.12 on 28/06/11 On 28/06/11 the spot exchange rate was HK$7.79/US$1

Performance over 1M 3M 12M Absolute (%) -3.6 1.1 -13.1 Relative (%) 0.1 3.7 -17.7

Financial and valuation metrics

Year 12/10A 12/11E 12/12E 12/13E Revenue (HK$ mn) 4,086.1 5,386.4 7,000.1 9,123.6 EBITDA (HK$ mn) 937.0 1,256.1 1,627.4 2,117.0 EBIT (HK$ mn) 851.4 1,159.4 1,514.7 1,984.2 Net income (HK$ mn) 566.9 622.6 807.8 1,052.6 EPS (CS adj.) (HK$) 0.11 0.13 0.16 0.21 Change from previous EPS (%) n.a. Consensus EPS (HK$) n.a. 0.12 0.15 0.18 EPS growth (%) 30.5 9.8 29.8 30.3 P/E (x) 23.2 21.1 16.3 12.5 Dividend yield (%) 3.0 2.6 3.4 4.4 EV/EBITDA (x) 12.5 9.3 7.1 5.3 P/B (x) 3.6 3.3 3.1 2.8 ROE (%) 18.5 16.4 19.8 23.4 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix).

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Rating OUTPERFORM* [V] Price (29 Jun 11, HK$) 2.66 Target price (HK$) 3.60¹ Chg to TP (%) 35.8 Market cap. (HK$ mn) 13,135 Enterprise value (HK$ mn) 11,620 Number of shares (mn) 4,956.65 Free float (%) 54.0 52-week price range 3.28 - 2.32

30 June 2011


Figure 25: Income statement Year-end 31 Dec (HK$ ’000) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Revenue 1,164,274 2,282,213 3,234,975 4,086,144 5,386,390 7,000,128 9,123,550

Total COGS (205,764) (473,245) (639,636) (784,858) (1,034,607) (1,330,570) (1,715,938)

Gross profit 958,510 1,808,968 2,595,339 3,301,286 4,351,784 5,669,559 7,407,612

Selling and distribution costs (503,751) (876,591) (1,287,499) (1,677,386) (2,154,556) (2,800,051) (3,649,420)

Administrative expenses (154,708) (305,493) (416,852) (539,866) (711,656) (917,865) (1,187,167)

Other income and gains 98,367 95,006 61,899 243,391 40,000 40,000 40,000

Finance income/ expense (2,575) (9,135) (2,773) (5,804) (6,353) (6,353) (6,353)

Income before tax 342,316 600,263 799,475 1,087,515 1,194,075 1,549,321 2,018,805

Income tax (33,972) (118,260) (135,028) (228,146) (250,756) (325,357) (423,949)

Reported net income total 308,344 482,003 664,447 859,369 943,319 1,223,964 1,594,856

Minority interests 83,991 184,388 267,485 292,472 320,729 416,148 542,251

Reported net income to equity holder 224,353 297,615 396,962 566,897 622,591 807,816 1,052,605

Reported diluted EPS (HK$) 0.05 0.07 0.09 0.11 0.13 0.16 0.21


Figure 26: Balance sheet Year-end 31 Dec (HK$ ’000 ) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Total current assets 2,073,885 2,458,779 2,639,829 4,029,719 4,505,419 5,145,026 6,153,450

Total non-current assets 508,214 808,601 1,126,492 1,591,117 1,872,736 2,191,589 2,595,625

Total assets 2,582,099 3,267,380 3,766,321 5,620,836 6,378,155 7,336,614 8,749,076

Total current liabilities 323,600 579,619 687,004 1,095,560 1,450,607 1,838,340 2,414,447

Total non-current liabilities 38,196 35,827 51,373 223,728 223,728 223,728 223,728

Total liabilities 361,796 615,446 738,377 1,319,288 1,674,335 2,062,068 2,638,175

Equity attributable to equity holders of the parent 2,019,248 2,228,928 2,474,348 3,647,685 3,928,474 4,243,416 4,745,594

Non-controlling interests 201,055 423,006 553,596 653,863 775,347 1,031,130 1,365,307

Total equity 2,220,303 2,651,934 3,027,944 4,301,548 4,703,820 5,274,546 6,110,901


Figure 27: Cash flow statement Year-end 31 Dec (HK$ ’000) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Cash flow from operating 252,483 415,547 686,692 502,671 963,862 1,272,680 1,768,979

Cash flow from investing (142,796) (154,514) (320,607) (1,346,688) (390,199) (441,135) (546,105)

Cash flow from financing (134,177) (177,783) (412,449) 647,265 (508,762) (709,457) (913,199)

Net (decrease)/increase in cash (24,490) 83,250 (46,364) (196,752) 64,902 122,088 309,676

Cash at the beginning of year 1,684,162 1,680,287 1,794,727 1,738,980 1,619,122 1,684,024 1,806,112

Cash at the end of year 1,680,287 1,794,727 1,738,980 1,619,122 1,684,024 1,806,112 2,115,788


Figure 28: Key ratios Year-end 31 Dec (HK$ ’000) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Profitability (%)

Gross margin 82.33 79.26 80.23 80.79 80.79 80.99 81.19

Operating margin 21.16 22.54 22.86 20.84 21.53 21.64 21.75

Net margin 19.27 13.04 12.27 13.87 11.56 11.54 11.54

Growth (%)

Net revenue growth 96.02 41.75 26.31 31.82 29.96 30.33

Gross profit growth 88.73 43.47 27.20 31.82 30.28 30.66

Net income growth 32.65 33.38 42.81 9.82 29.75 30.30

Growth of CS adjusted net income to equity holders 60.82 65.37 -3.45 80.09 31.79 31.88


30 June 2011


Asia Pacific / China Major Pharmaceuticals

Shanghai Pharmaceutical (Group) Co. (2607.HK / 2607 HK)

High growth, without sacrificing margins Shanghai Pharmaceuticals (Shanghai Pharma) is among the largest integrated pharmaceutical companies in China, with leading position in both pharma products and distribution markets. Its key business divisions are pharma: (1) manufacturing; (2) distribution and supply chain solutions; and (3) retail.

■ Vertical integration and broad offerings diversify risks. Amid current market concerns about drug price cuts, we believe Shanghai Pharma stands out as a leader with much lower policy risk compared with peers. With its broad product offerings, the impact of price cuts should likely be minimal. By vertically integrating the manufacturing, distribution and retailing of its products, it should benefit from potential cross-selling opportunities, as well as diversify its potential risks in particular parts of the industry value chain.

■ Facilities relocation is a near-term catalyst. We expect Shanghai Pharma to sign an agreement with the Shanghai government this year to relocate its multiple downtown plants to a consolidated location. Besides the land prices-related one-time gain, we also expect this to reduce Shanghai Pharma’s staff costs and improve manufacturing efficiency.

■ Acquisitions on track. The company is committed to making acquisitions without sacrificing margins. We expect more drug distribution acquisitions this year, and drug manufacturing acquisitions shortly thereafter.

■ Initiate with OUTPERFORM. With improving operating margins, we expect core profits to grow by 33% and 51% in 2011E and 2012E, respectively. Our target price of HK$24.3 is based on 20x 2012E core earnings.

■ Key investment risks: (1) operational risks; (2) risks from competition; (3) policy risks; (4) acquisition risks; (5) orders risks; (6) product risks; (7) elimination or changes to incentives; and (8) key personnel risks.


2021222324

Jun-11

949698100102

Price (LHS) Rebased Rel (RHS)


Performance over 1M 3M 12M Absolute (%) -9.8 — — Relative (%) — — —


Year 12/10A 12/11E 12/12E 12/13E Revenue (Rmb mn) 37,381.6 52,694.3 67,602.4 83,195.1 EBITDA (Rmb mn) 2,417.4 3,062.8 4,437.3 5,991.6 EBIT (Rmb mn) 2,038.4 2,611.8 3,870.3 5,314.7 Net income (Rmb mn) 1,350.8 1,802.6 2,715.0 3,630.5 EPS (CS adj.) (Rmb) 0.50 0.67 1.01 1.35 Change from previous EPS (%) n.a. 0 0 0 Consensus EPS (Rmb) n.a. 0.77 0.91 1.22 EPS growth (%) 81.0 33.5 50.6 33.7 P/E (x) 34.2 25.7 17.0 12.7 Dividend yield (%) 0.68 0.44 0.54 0.74 EV/EBITDA (x) 4.8 2.3 1.6 1.0 P/B (x) 5.1 2.2 2.0 1.7 ROE (%) 15.5 12.0 12.2 14.5 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix).

Research Analysts

Jinsong Du 852 2101 6589

[email protected]

Lefei Sun 852 2101 7658

[email protected]

Rating OUTPERFORM* [V] Price (29 Jun 11, HK$) 20.70 Target price (HK$) 24.30¹ Chg to TP (%) 17.4 Market cap. (HK$ mn) 15,854 Enterprise value (Rmb mn) 7,150 Number of shares (mn) 765.89 Free float (%) 85.7 52-week price range 22.95 - 20.25

30 June 2011


Financial summary Figure 29: Income statement Year-end 31 Dec (Rmb mn) 2008 2009 2010 2011E 2012E 2013E

Turnover 27,441 31,228 37,382 52,694 67,602 83,195

- Pharmaceuticals 6,014 6,370 7,012 9,071 12,235 15,825

- Distribution & supply chain 19,684 23,118 28,348 41,329 52,788 64,471

- Retail 1,414 1,522 1,726 1,984 2,252 2,556

- Others 329 219 296 311 326 343

Gross profit 5,174 5,816 6,658 8,287 10,915 13,833

SG&A (4,171) (4,464) (4,849) (5,691) (7,065) (8,543)

Other operating income/(costs) 174 87 230 16 20 25

Operating profit 1,177 1,440 2,038 2,612 3,870 5,315

Net interest income/(cost) (260) (168) (167) (158) (60) (59)

Associates/JV 288 308 283 354 386 417

Exceptional items 1 551 17 445 0 0

Profit before tax 1,206 2,130 2,173 3,253 4,196 5,673

Taxation (210) (465) (394) (605) (806) (1,123)

Minority interests (298) (368) (411) (400) (676) (919)

Net profit 697 1,297 1,368 2,248 2,715 3,631

Core net profit 696 746 1,351 1,803 2,715 3,631 Source: Company data, Credit Suisse estimates

Figure 30: Balance sheet Year-end 31 Dec (Rmb mn) 2008 2009 2010 2011E 2012E 2013E

Cash 3,266 4,887 6,338 8,108 8,237 9,511

Inventories 3,431 3,701 5,041 6,956 8,247 9,983

Account receivables 5,499 6,078 8,581 11,593 14,399 17,305

Other current assets 10 10 3 3 3 3

Net fixed assets 4,077 4,052 4,101 10,658 13,606 16,257

Other non-current assets 3,496 3,146 4,177 4,532 4,918 5,335

Total assets 19,781 21,875 28,241 41,849 49,412 58,395

Short-term debt 3,771 3,332 4,818 2,018 2,018 2,018

Accounts payable 6,685 7,461 10,912 14,754 18,929 23,295

Other current liabilities 129 185 212 605 806 1,123

Long-term debt 113 84 66 66 66 66

Other non-current liabilities 261 378 348 348 348 348

Total liabilities 10,959 11,439 16,357 17,792 22,167 26,850

Share capital 569 569 1,993 2,321 2,321 2,321

Reserves and share premium 6,493 7,713 7,142 18,587 21,099 24,479

Minority interests 1,760 2,153 2,750 3,150 3,825 4,744

Total shareholders’ equity 8,823 10,435 11,884 24,057 27,245 31,544


Figure 31: Ratio analysis Year-end Dec 31 FY08 FY09 FY10A FY11E FY12E FY13E

Turnover growth (%) 13.8 19.7 41.0 28.3 23.1

EBIT growth (%) 22.3 41.6 28.1 48.2 37.3

Net profit growth (%) 86.1 5.5 64.3 20.8 33.7

Gross margin (%) 18.9 18.6 17.8 15.7 16.1 16.6

EBIT margin (%) 4.3 4.6 5.5 5.0 5.7 6.4

Net profit margin (%) 2.5 4.2 3.7 4.3 4.0 4.4

Inventory turnover (days) 54 54 54 51 51 50

A/c receivable collection period (days) 65 64 66 62 62 62

A/c payable payment period (days) 70 72 83 81 81 83


30 June 2011


Asia Pacific / China Pharmaceutical Distribution

Sinopharm Group Co (1099.HK / 1099 HK)

Margin concerns overdone, upside surprise for 1H11E ■ The pace of M&A faster than expect. Sinopharm is China’s largest drug

distributor with 12% market share. Benefiting from the Chinese government’s key 12th five-year plan focus of consolidating the drug distribution industry, Sinopharm’s M&A has been faster than expected. We expect Sinopharm’s 1H11 revenue to beat consensus of Rmb43,984 mn.

■ Drug price cuts’ impact minimised. Sales of drugs in the Essential Drug List (EDL) are less than 10% of Sinopharm’s total revenue, according to company management. Therefore, it expects the drug price cuts to only reduce its gross margin (8.4% in 2010A) by around 0.1%.

■ Margin concern is overdone. We believe Sinopharm’s recent underperformance was mainly due to the concerns on margin erosions. We believe 1H11E net margin should be similar to the 2010A level of 1.7%, which should serve as a near-term positive catalyst for the share price.

■ Recent placement leads to EPS revision. Sinopharm raised US$440 mn of new shares, and another US$309 mn of mid-term notes with an interest rate of 4.89%. As a result, we reduce our 2011E and 2012E EPS by 13.4% and 24.4%, respectively.

■ Still a key proxy to play China healthcare growth. Despite near-term margin concerns, we expect Sinopharm’s earnings to grow by more than 30% over the next few years. It remains the only pure play in the drug distribution industry’s consolidation story. Maintain OUTPERFORM.


2025303540

Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11

100120140160180

Price (LHS) Rebased Rel (RHS)


Performance over 1M 3M 12M Absolute (%) -4.4 -5.4 -10.8 Relative (%) -0.7 -3.0 -15.5


Year 12/10A 12/11E 12/12E 12/13E Revenue (Rmb mn) 69,233.7 90,213.9 116,595.3 149,872.4 EBITDA (Rmb mn) 2,709.3 3,627.6 4,602.3 5,775.3 EBIT (Rmb mn) 2,408.8 3,135.4 4,015.1 5,143.1 Net income (Rmb mn) 1,208.8 1,529.4 1,937.2 2,438.2 EPS (CS adj.) (Rmb) 0.53 0.64 0.81 1.01 Change from previous EPS (%) n.a. -13.4 -24.4 Consensus EPS (Rmb) n.a. 0.72 0.95 1.25 EPS growth (%) -0.2 19.3 26.7 25.9 P/E (x) 40.6 34.0 26.8 21.3 Dividend yield (%) 0.74 0.53 0.67 0.84 EV/EBITDA (x) 16.6 12.2 9.7 7.8 P/B (x) 4.2 3.9 3.8 3.5 ROE (%) 10.3 12.3 14.5 17.1 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts

Jinsong Du 852 2101 6589

[email protected]

Rating OUTPERFORM* Price (29 Jun 11, HK$) 26.05 Target price (HK$) 40.00¹ Chg to TP (%) 53.6 Market cap. (HK$ mn) 58,992 Enterprise value (Rmb mn) 44,309 Number of shares (mn) 2,264.57 Free float (%) 27.0 52-week price range 32.40 - 25.35

30 June 2011


Figure 32: Income statement (FYE 31 Dec) (Rmb mn) 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Net revenue 23,737 31,110 38,187 52,668 69,234 90,214 116,595 149,872

Total COGS (21,747) (28,560) (35,153) (48,261) (63,398) (82,695) (106,943) (137,520)

Gross profit 1,990 2,550 3,035 4,407 5,836 7,519 9,652 12,352

Selling and distribution (779) (945) (966) (1,404) (1,960) (2,544) (3,276) (4,196)

G&A (748) (840) (967) (1,166) (1,544) (1,839) (2,361) (3,012)

Operating profit 480 789 1,172 1,892 2,409 3,135 4,015 5,143

Depreciation & amortisation 127 135 173 249 301 492 587 632

EBITDA 607 924 1,345 2,141 2,709 3,628 4,602 5,775

Financial costs (90) (133) (242) (231) (272) (367) (438) (570)

Income before tax 364 820 1,077 1,909 2,398 3,034 3,843 4,837

Income tax (182) (284) (259) (465) (568) (718) (910) (1,145)

Net income 182 536 818 1,444 1,830 2,316 2,933 3,692

Minority income 81 155 232 477 622 787 996 1,254

Net income attributable to shareholders 101 381 586 967 1,209 1,529 1,937 2,438

EPS-diluted 0.06 0.23 0.36 0.53 0.53 0.64 0.81 1.01


Figure 33: Balance sheet (FYE 31 Dec) (Rmb mn) 2006A 2007A 2008A 2009 A 2010 A 2011E 2012E 2013E

Total current assets 9,398 11,955 13,664 29,107 34,863 37,907 48,404 57,056

Total Non-current assets 2,193 2,332 2,462 3,540 7,151 7,666 8,335 9,022

Total assets 11,590 14,287 16,125 32,647 42,014 45,573 56,739 66,077

Total current liabilities 8,270 10,947 11,881 17,418 25,754 26,998 36,522 43,058

Total Non-current liabilities 730 722 831 1,206 1,541 1,591 1,806 2,072

Total liabilities 9,000 11,669 12,712 18,624 27,295 28,589 38,329 45,130

Minority interest 831 935 1,146 2,156 3,008 3,794 4,791 6,045

Shareholders' equity 1,760 1,684 2,267 11,867 11,711 13,189 13,620 14,903

Total liabilities and shareholders' equities 11,590 14,287 16,125 32,647 42,014 45,573 56,739 66,077


Figure 34: Cash flow statement (FYE 31 Dec) (Rmb mn) 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Cash flow from operating 638 441 654 1,118 1,203 1,374 1,941 2,106

Cash flow from investing (271) (14) (148) (3,312) (1,831) (2,365) (1,379) (1,412)

Cash flow from financing 120 (310) (749) 7,699 536 227 (2,407) (1,097)

Cash at the end of year 1,839 1,956 1,712 7,568 7,475 6,710 4,864 4,461


Figure 35: Key ratios (FYE 31 Dec) (%) 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Profitability

Gross margin 8.38 8.20 7.95 8.37 8.43 8.33 8.28 8.24

Operating margin 2.02 2.54 3.07 3.59 3.48 3.48 3.44 3.43

Net margin 0.43 1.22 1.53 1.84 1.75 1.70 1.66 1.63

Growth

Net revenue growth 31.06 22.75 37.92 31.45 30.30 29.24 28.54

Gross profit growth 28.18 19.01 45.22 32.41 28.84 28.37 27.97

Net income growth 275.91 53.75 65.14 24.98 26.53 26.67 25.86


30 June 2011


Companies Mentioned (Price as of 29 Jun 11) Shanghai Pharmaceutical (Group) Co. (2607.HK, HK$20.70, OUTPERFORM [V], TP HK$24.30) Sino Biopharmaceutical Limited (1177.HK, HK$2.66, OUTPERFORM, TP HK$3.60) Sinopharm Group Co (1099.HK, HK$26.05, OUTPERFORM, TP HK$40.00)

Disclosure Appendix Important Global Disclosures Jinsong Du, Lefei Sun & Duo Chen each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for 2607.HK 2607.HK Closing

Price Target

Price

Initiation/ Date (HK$) (HK$) Rating Assumption 23-Jun-11 20.85 24.3 O X 24

23-Jun-11

O

20

21

22

23

24

25

26

29-Ju

n-08

29-Aug-0

8

29-O

ct-08

29-Dec-

08

28-Feb

-09

29-A

pr-09

29-Ju

n-09

29-A

ug-09

29-O

ct-09

29-D

ec-09

28-Feb

-10

29-Apr-

10

29-Ju

n-10

29-Aug

-10

29-O

ct-10

29-Dec-

10

28-Feb-1

1

29-Apr-1

1

Closing Pr ice Target Price Initiation/Assumption Rating

HK$

O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

3-Year Price, Target Price and Rating Change History Chart for 1177.HK 1177.HK Closing

Price Target

Price

Initiation/ Date (HK$) (HK$) Rating Assumption

0

0.5

1

1.5

2

2.5

3

3.5

29-Ju

n-08

29-A

ug-08

29-O

ct-08

29-Dec

-08

28-Feb

-09

29-A

pr-09

29-Ju

n-09

29-Aug

-09

29-O

ct-09

29-D

ec-09

28-F

eb-10

29-Apr-

10

29-Ju

n-10

29-A

ug-10

29-O

ct-10

29-Dec

-10

28-Feb-1

1

29-A

pr-11


HK$


3-Year Price, Target Price and Rating Change History Chart for 1099.HK 1099.HK Closing

Price Target

Price

Initiation/ Date (HK$) (HK$) Rating Assumption 4-Jan-10 28.8 36 O X 30-Apr-10 35.65 40

36

40

4-Jan-10

O

18

23

28

33

38

29-Ju

n-08

29-A

ug-08

29-O

ct-08

29-Dec

-08

28-Feb

-09

29-A

pr-09

29-Ju

n-09

29-A

ug-09

29-O

ct-09

29-D

ec-09

28-F

eb-10

29-Apr-

10

29-Ju

n-10

29-A

ug-10

29-O

ct-10

29-Dec

-10

28-Feb-1

1

29-A

pr-11


HK$


The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities.

30 June 2011


Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks a 22% and a 12% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively, subject to analysts’ perceived risk. The 22% and 12% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively, subject to analysts’ perceived risk. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. Credit Suisse’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 48% (62% banking clients) Neutral/Hold* 40% (56% banking clients) Underperform/Sell* 10% (51% banking clients) Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein.

Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.html

Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

See the Companies Mentioned section for full company names. Price Target: (12 months) for (2607.HK) Method: Our target price of HK$24.3 is based on 20x 2012E core profit 1.01 RMB (1.22 HKD) Risks: Our target price is HK$24.3, key risks include (1) operational risks; (2) risks from competition; (3) policy risks; (4) acquisition risks; (5) orders risks; (6) product risks; (7) elimination or changes to incentives; and (8) key personnel risks. Price Target: (12 months) for (1177.HK) Method: Globally Credit Suisse widely uses proprietary "PharmaValue" method for valuation of pharmaceutical companies. We have applied this NPV/DCF-based valuation approach for Sino Biopharm by projecting each of its 30 plus market and pipeline products to derive the fair value reference. Our target price HK$3.6 per share is based on HK$17.64 billion total NPV of SBP marketed products. Risks: Key investment risks include (1) Holding company structure (2) Business diversification (3) Unsuccessful M&A (4) Severe price cut Price Target: (12 months) for (1099.HK) Method: China's integrated distributors are trading at various price to earnings (P/E) multiples but similar price to sales (P/S) multiples. Our target price of HK$40 for Sinopharm Group is based on 0.9x FY11E total sales, the average of its peer group. Risks: Key investment risks and risks to our HK$40.00 target price for Sinopharm Group include: 1) working capital commitments, 2) margin pressure for its side businesses, such as drug stores.

30 June 2011


Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (1099.HK) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (1099.HK) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (1099.HK) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (1099.HK) within the past 12 months. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (1177.HK, 1099.HK) within the next 3 months. Important Regional Disclosures Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report.

The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (2607.HK, 1177.HK, 1099.HK) within the past 12 months.

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml.

As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.

Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at anytime after that.

To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. • Jinsong Du, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. • Lefei Sun, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. • Duo Chen, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. Taiwanese Disclosures: Reports written by Taiwan-based analysts on non-Taiwan listed companies are not considered recommendations to buy or sell securities under Taiwan Stock Exchange Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at www.credit-suisse.com/researchdisclosures or call +1 (877) 291-2683. Disclaimers continue on next page.

30 June 2011 Asia Pacific / China

Equity Research

PH0110.doc

This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Credit Suisse AG, the Swiss bank, or its subsidiaries or its affiliates (“CS”) to any registration or licensing requirement within such jurisdiction. All material presented in this report, unless specifically indicated otherwise, is under copyright to CS. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of CS. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of CS or its affiliates. The information, tools and material presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. CS may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. CS will not treat recipients as its customers by virtue of their receiving the report. The investments or services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about such investments or investment services. Nothing in this report constitutes investment, legal, accounting or tax advice or a representation that any investment or strategy is suitable or appropriate to your individual circumstances or otherwise constitutes a personal recommendation to you. CS does not offer advice on the tax consequences of investment and you are advised to contact an independent tax adviser. Please note in particular that the bases and levels of taxation may change. CS believes the information and opinions in the Disclosure Appendix of this report are accurate and complete. Information and opinions presented in the other sections of the report were obtained or derived from sources CS believes are reliable, but CS makes no representations as to their accuracy or completeness. Additional information is available upon request. CS accepts no liability for loss arising from the use of the material presented in this report, except that this exclusion of liability does not apply to the extent that liability arises under specific statutes or regulations applicable to CS. This report is not to be relied upon in substitution for the exercise of independent judgment. CS may have issued, and may in the future issue, a trading call regarding this security. Trading calls are short term trading opportunities based on market events and catalysts, while stock ratings reflect investment recommendations based on expected total return over a 12-month period as defined in the disclosure section. Because trading calls and stock ratings reflect different assumptions and analytical methods, trading calls may differ directionally from the stock rating. In addition, CS may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and CS is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. CS is involved in many businesses that relate to companies mentioned in this report. These businesses include specialized trading, risk arbitrage, market making, and other proprietary trading. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgement at its original date of publication by CS and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADR’s, the values of which are influenced by currency volatility, effectively assume this risk. Structured securities are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured security may be affected by changes in economic, financial and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility, and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct their own investigation and analysis of the product and consult with their own professional advisers as to the risks involved in making such a purchase. Some investments discussed in this report have a high level of volatility. High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment, in such circumstances you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report may provide the addresses of, or contain hyperlinks to, websites. Except to the extent to which the report refers to website material of CS, CS has not reviewed the linked site and takes no responsibility for the content contained therein. Such address or hyperlink (including addresses or hyperlinks to CS’s own website material) is provided solely for your convenience and information and the content of the linked site does not in any way form part of this document. Accessing such website or following such link through this report or CS’s website shall be at your own risk. This report is issued and distributed in Europe (except Switzerland) by Credit Suisse Securities (Europe) Limited, One Cabot Square, London E14 4QJ, England, which is regulated in the United Kingdom by The Financial Services Authority (“FSA”). This report is being distributed in Germany by Credit Suisse Securities (Europe) Limited Niederlassung Frankfurt am Main regulated by the Bundesanstalt fuer Finanzdienstleistungsaufsicht ("BaFin"). This report is being distributed in the United States by Credit Suisse Securities (USA) LLC ; in Switzerland by Credit Suisse AG; in Canada by Credit Suisse Securities (Canada), Inc.; in Brazil by Banco de Investimentos Credit Suisse (Brasil) S.A. or its affiliates; in Mexico by Banco Credit Suisse (México), S.A. (transactions related to the securities mentioned in this report will only be effected in compliance with applicable regulation); in Japan by Credit Suisse Securities (Japan) Limited, Financial Instrument Firm, Director-General of Kanto Local Finance Bureau (Kinsho) No. 66, a member of Japan Securities Dealers Association, The Financial Futures Association of Japan, Japan Securities Investment Advisers Association; elsewhere in Asia/Pacific by whichever of the following is the appropriately authorised entity in the relevant jurisdiction: Credit Suisse (Hong Kong) Limited, Credit Suisse Equities (Australia) Limited , Credit Suisse Securities (Thailand) Limited, Credit Suisse Securities (Malaysia) Sdn Bhd, Credit Suisse AG, Singapore Branch, Credit Suisse Securities (India) Private Limited, Credit Suisse Securities (Europe) Limited, Seoul Branch, Credit Suisse AG, Taipei Securities Branch, PT Credit Suisse Securities Indonesia, and elsewhere in the world by the relevant authorised affiliate of the above. Research on Taiwanese securities produced by Credit Suisse AG, Taipei Securities Branch has been prepared by a registered Senior Business Person. Research provided to residents of Malaysia is authorised by the Head of Research for Credit Suisse Securities (Malaysia) Sdn. Bhd., to whom they should direct any queries on +603 2723 2020. In jurisdictions where CS is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Non-U.S. customers wishing to effect a transaction should contact a CS entity in their local jurisdiction unless governing law permits otherwise. U.S. customers wishing to effect a transaction should do so only by contacting a representative at Credit Suisse Securities (USA) LLC in the U.S. Please note that this report was originally prepared and issued by CS for distribution to their market professional and institutional investor customers. Recipients who are not market professional or institutional investor customers of CS should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents. This research may relate to investments or services of a person outside of the UK or to other matters which are not regulated by the FSA or in respect of which the protections of the FSA for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. Any Nielsen Media Research material contained in this report represents Nielsen Media Research's estimates and does not represent facts. NMR has neither reviewed nor approved this report and/or any of the statements made herein. If this report is being distributed by a financial institution other than Credit Suisse AG, or its affiliates, that financial institution is solely responsible for distribution. Clients of that institution should contact that institution to effect a transaction in the securities mentioned in this report or require further information. This report does not constitute investment advice by Credit Suisse to the clients of the distributing financial institution, and neither Credit Suisse AG, its affiliates, and their respective officers, directors and employees accept any liability whatsoever for any direct or consequential loss arising from their use of this report or its content. Copyright 2011 CREDIT SUISSE AG and/or its affiliates. All rights reserved.

CREDIT SUISSE (Hong Kong) Limited Asia/Pacific: +852 2101-6000

china pharmaceutical sector - credit suisse

Documents