Another strong quarter as expected
Fosun recorded revenue/core profit of RMB3.7bn/542m in 3Q16 vs. ourestimates of RMB3.7bn/532m. These results represent YoY growth of17.4%/27.0% in 3Q16 vs. 17.1%/26.8% in 1H16. We highlight that core profitgrowth excluding Sinopharm’s contribution of 45% was achieved in 3Q16 vs.19% in 1H16. The company attributed the strong performance in 3Q16 mainlyto solid growth in all segments, continued margin expansion from product miximprovement, and economies of scale.
Solid growth in core segments
In drug manufacturing, management highlighted that Youlitong, Youdier, andthe artesunate series continued their strong performance in 3Q16. Thecompany expects to launch vero-cell rabies vaccines at the beginning of 2017and achieve a sales volume of 0.8-1m copies in 2017. According to the NIFDC,the total approval volume for rabies vaccines achieved 14-15m copies in 2014,while vero-cell type accounted for 94% with five manufacturers. In terms ofmedical devices, management expects accelerated acquisitions after thepotential listings of Yaneng Bio, Sisram (Alma Lasers), and Henlius. On thetwo-invoice system, management indicated that it is unlikely to book anadditional RMB1bn in revenue for Aodejin this year due to slower-thanexpectedimplementation.
Margin expansion continues
GM and OPM achieved 53.7%/14.5% in 3Q16 vs. 50.1%/13.2% in 3Q15.Management attributed the margin expansion to high growth in high-marginproducts, cost savings from centralized purchasing, and economies of scale.Going forward, management expects GM to continue to increase slightly,driven by drug manufacturing business. Management anticipates a higher R&Dexpense ratio in the near term, driven by a total cost of RMB250m on BEstudies for 42 drugs in 2017. As for R&D progress, the company expects tocomplete phase 3 patient recruitment for a Rituxan mimic in 2H16/1H17 andapply for manufacturing approval in 2H17/1H18. The launch of the Herceptinmimic will be slightly behind Rituxan, as it has just initiated the phase 3 clinicaltrial.
Raising target prices to HKD25.0 for Fosun-H and RMB22.5 for Fosun-A; risks
Our target prices of HKD25.0 for Fosun-H and RMB22.5 for Fosun A are bothbased on 24x 2017E core EPS of RMB0.82 and 45x non-core EPS from thehospital segment of RMB0.06. We believe that 24x/45x is justified, as HK-listeddrug peers are trading at 16x with 16% growth, A-listed drug peers are tradingat 29x with 20% growth (vs. 17% for Fosun), and Asian-listed hospital peersare trading at 35x with 16% growth (vs. 18% for Fosun). We believe that Fosundeserves a premium owing to its diversified revenue base and M&A firepower.Key upside/downside risks include M&A activities, product launches, and themagnitude of price cuts.