1H11 results Guangzhou Pharmaceutical (GPC) reported 1H11 EPS & profit attributable to shareholders of Rmb0.22 & Rmb180mn (+6% YoY),below our estimates of Rmb0.23 & Rmb187mn (+10% YoY) mainly due to weaker-than-expected pharma distribution/trading business.
Implications
1) Manufacturing gross margin under pressure: In 1H11, GPC’s manufacturing business delivered solid sales growth of 21% toRmb1.3bn, above our estimate of Rmb1.2bn (+13% YoY), driven by increasing sales and marketing efforts. Nevertheless, sales upside was largely canceled out by significant margin reduction due to rising raw material costs, resulting in a largely in line performance ofthe manufacturing business. 1H11 operating income frommanufacturing business was Rmb110mn vs. our estimate ofRmb104mn. 2) Distribution business decelerated in 1H11, due to stiffer competition and the company’s slower participation in M&A. GPC’s pharmaceutical distribution sales (incl. total revenue contribution from JV GP Corp) grew 15% (vs. 21% in 1H10, and below our estimate of 18%) to Rmb8.7bn in 1H211. The growth rate was significantly lower than those of Sinopharm (+53% YoY) andShanghai Pharma (+46% YoY). 3) Wang Lao Ji Pharmaoutperformed: Sales reached Rmb1.1bn in 1H11, +30% YoY, vs. +4% YoY in 2010, and higher than our estimate of +6% YoY. Wang Lao Ji contributed ~26% to GPC’s net profits in 1H11, up from 1H10’s 18%. 4) Trim 2011~13 EPS by Rmb0.03/Rmb0.01/Rmb0.01to Rmb0.37/Rmb0.45/Rmb0.51, on lower profit margins.
Valuation and recommendation:
We remain guarded over GPC due to its slower participation in consolidation and significant margin pressure due to rising costs. Trading at 14x/12x 2011/2012 EPS, we believe GPC’s current share price adequately reflects the challenging growth profile. We maintain our HOLD rating and 12-month TP of HK$7.2, based on a 2012 PEG of 0.8 , 3-year EPS CARG of 14% and 2012 EPS of Rmb0.45.
Risks:
Stiffer competition, severe drug price cuts, higher-than-expected raw material costs, faster-than-expected M&A in distribution, faster ramp-up in vaccine business.