1H22 results in line with our forecast
　　Pharmaron Beijing announced 1H22 results: Revenue grew 41.06% YoY to Rmb4.63bn and attributable net profit rose 3.65% YoY to Rmb585mn, in line with our expectations. Profit growth was slower than revenue growth, as: 1) overseas operating costs rose due to inflation in Europe and the US; 2) domestic COVID-19 resurgence weighed on the firm’s clinical business in 1H22, and profit came under pressure as this business was still in its infancy.
　　Trends to watch
　　Demand: Main businesses seeing rapid growth; demand stays strong. In 1H22, Pharmaron booked revenue of Rmb2.86bn for lab services (up 41.1% YoY), with gross margin up 1.71ppt YoY to 43.7%. The revenue contribution from biological science services rose 1.75ppt YoY to 47.51%, showing further expansion. Revenue from chemistry, manufacturing & controls (CMC) rose 42.29% YoY to Rmb1.08bn with about 76% of the revenue derived from existing clients in lab services and biological science services. Gross margin fell 3.49ppt YoY to 33.16% due to capacity ramp-up. The volume and quality of CMC orders improved further. As of end-1H22, the firm covered 714 drug molecules or intermediates, including 22 in Phase III clinical trials and 10 in the process validation and commercialization stage.
　　Supply: Continuous capacity expansion to facilitate order ramp-up. Capex for internal construction rose 26.96% YoY to Rmb1.31bn in 1H22 and M&A spending reached Rmb854mn, mainly for improving lab animal supply system and CMC capacity. The Shaoxing Phase I project (200cbm) began operating in early 2022, and Pharmaron estimates the remaining 400cbm of capacity will begin operating in 2H22. Pharmaron completed the acquisition of production facilities in Cramlington in the UK and Coventry in the US in 2021. These two facilities can provide cGMP API manufacturing services from pilot to commercial scale, boding well for the firm’s global capacity deployment.
　　Upbeat on development of cell and gene therapy business. Revenue from large molecule, cell, and gene therapy services rose 33.22% YoY to Rmb95.47mn in 1H22. Its cell and gene therapy business has been growing at a CAGR of over 95% since 2020, and it has more than 50 programs at various stages for analytical release testing including two potency assays for commercial manufacture. After acquiring Pharmaron Biologics UK in 2021, the firm has continued to strengthen its contract development and manufacturing organization (CDMO) capacity for gene therapy. It boasts full-process CDMO service capabilities, including plasmid development and manufacturing, development and manufacturing of viral vector with extensive purification toolbox, and complete analytical testing capabilities for QA/QC of gene therapy products. Its service platform started to take external orders in 2021, with about 20 programs completed or ongoing.
　　Financials and valuation
　　We maintain our 2022 and 2023 net profit forecasts unchanged. Pharmaron A-shares are trading at 38.4x 2022e and 29.2x 2023e P/E, and H-shares are trading at 24.8x 2022e and 18.9x 2023e P/E. Considering systematic correction in the pharmaceutical sector, we maintain OUTPERFORM for A-shares but cut our target price 30.0% to Rmb91.00, implying 52.3x 2022e and 39.8x 2023e P/E with 36.1% upside. We maintain OUTPERFORM for H-shares, but cut TP 32.0% to HK$68.00, implying 33.6x 2022e and 25.5x 2023e P/E with 35.2% upside.
　　Risks
　　Forex fluctuations; disappointing capacity development; fluctuations in orders; uncertainty in new drug R&D; disappointing new business expansion.