1. Company
Sino Biopharmaceutical Ltd. (HKSE:01177, Financial)(OTCPK:SBMFF, Financial) is one of the largest publicly traded health care companies in China. It was established in 2000 – a young pharmaceutical company compared to large Western peers. It is not only young but tiny, with a $7.99 billion market cap. Currently China is the largest emerging market for medicines with an aging society and growing number of mid-class people. Its products are mainly generic and traditional Chinese medicines, but it is also engaged in the distribution and sale of these medicines and is constantly developing new drugs.
China has a plan to grow value-added businesses and compete with Western countries. The "Made in China 2025” project intends to renew China’s profile from a copying, manufacturer industry to a more precious, value-based industry. That’s why they are supporting this strategically important sector – they would likely to be a major player in the global drug market. On the other hand, there is also speculation and concern about a potential drug cost-cut by the government. That’s why Chinese pharma stocks plunged last year – the last decline comparable to this was in 2009.
Last year, the stock lost more than two-thirds of its market value.
Here are share prices, price-earnings and price-book ratios from 2000:
2. Business
The company's management follows an aggressive growth strategy. Last year, it spent 11% of revenue on research and development. It employs the largest sales staff in the country – over 11,000 people – covering 90% of all Chinese hospitals.
Sino Biopharmaceutical is a market leader in the hepatitis therapeutic segment with 25% market share. Its product line consists of hepatitis, oncology, cardio-cerebral, orthopedic, anti-infectious, anorectal, respiratory, parenteral nutritious medicines and others (such as diabetic medicines). So the company has an in-demand line up and is currently developing new drugs such as antitumor Focus V (Anlotinib Hydrocloride), which was added to the National Drug Catalogue, meaning that it is covered by medical, work-related or maternity insurance – making it a potentially sought-after drug.
According to the third quarter's results, regarding R&D performance, the company secured clinical approval for five Category 1 drugs and filed 128 new patent applications. In the last year, the group suffered from the U.S.-China trade war and centralized government regulations on drug prices and sales.
Sino continually records growing revenues and profits from operations. Sales of the new products accounted for approximately 18.1% of total revenue. Earnings compared to last year’s third quarter results also grew significantly.
Therefore, it seems that Sino Biopharmaceutical has a wide moat due to its size, large sales network, good margins and efforts in research and development. It is extremely difficult to start a biotech or drug manufacturing business almost anywhere in the world. This is a very competitive but lucrative sector. It is also the government’s interest to support these large pharma companies in the long run, not to stifle the business by overly strict laws. With a new patent, a pharma company may have a monopoly on health market segments – although it is questionable how well drug patents work in China.
3. Financials
Number of shares outstanding, revenue and net income
The biotechnology company has continually growing revenue and net income with a recently falling share price. The number of shares seemed to remain flat since 2012.
Net income and free cash flow
Free cash flow grows also consistently.
Cash, inventories, intangible assets, goodwill and others
According to GuruFocus, Sino had $1.39 billion in cash and cash equivalents and $342 million in debt at the end of the second quarter. The data indicates that the company is dynamically growing via acquisitions, while the growth of intangible assets may sign a well-working R&D department. Still, goodwill remains flat, which is also a good sign.
ROE, margins and ROIC
Over the past six years, the return on equity (ROE) is between around 20-25%. The return on invested capital (ROIC) between around 25-40%. The company has spectacular margins, with an operating margin between around 16-22% over the period, and a 79.1% gross margin and net margin around 14.7% last year, meaning that the group grows by leaps and bounds. In the past, the reinvested capital made better returns than the safer bond yield or common benchmarks.
4. Management
The company has no world-known management team like big Western pharma companies. Sino Biopharm also has unrealized losses on equities like Cinda International Holdings. Cinda is a fund management, insurance brokerage company with a market cap of $48.28 million. It bought 5% of the company for $747 million at a share price of HK$3.05. Now the share price is trending around HK$0.59. However, this does not mean anything bad – it may be a profitable cooperation in the future. The best way to assess management’s efforts in this situation is to check the past ROE, ROIC and margins along with share buybacks and stock option programs.
The company maintained really high margins for a long period. If the business can keep pace with such good numbers, the stock can become a multibagger in the future.
Overall, it seems that the company allocates capital well. It has no share buyback programs and it also has a stock option program. Sino held 47,667,000 shares back for its 2013 share option scheme and 2018 share award scheme. The current CEO established the company, and he and his family have a large stake in it. They are also members of the management team. It looks like they have no interest in heavily diluting shares.
5. Valuation
Sino Biopharm is not a well-known stock with extensive analyst coverage. The target price of analysts in China is around $1.10 per share. Currently, with a 19.31 price-earnings ratio and 17.67 forward price-earnings ratio, the company does not look so spectucularly cheap.
There are large biotech companies like Abbvie or Gilead Sciences with a lower forward price-earnings ratio. But Sino seems to be an early-stage growth company. China has great growth potential regarding value-added medicines, but exporting those goods is also a possibility.
I believe that they can make good quality products for an affordable price. Therefore, it is better to use a discounted cashflow method for valuation. If the past performance goes on, Sino is worth around 93 cents per share. Regarding the current share price of 63 cents, you can buy this stock with a 33% margin of safety. I think that it is a fair price if you have an outlook of 10 or more years.
6. Risks
The biggest risks are centralized regulations by government and increased competition from big pharma. The stock has lost nearly 68% of its market value due to concerns about a feasible, stricter government regulation and a potential increase of Western competition. The Chinese government makes efforts to control drug prices – like eliminating 15-20% surcharges on common medicines in hospitals.
However, pharma companies can also manipulate the drug prices by piling on inventories or pushing retailers to raise prices. There are near-monopoly segments (like Sino’s hepatitis product line), and the health care system depends on these companies. China also gave preferential tax rates for generic drugmakers to relieve discrepancies. I believe that increased Western competition may cause some trouble in the short term, but for the future, it can make the best Chinese drug companies structurally healthier.
Trade war and market downturn
This is a risk factor if you can not help selling your stocks with a 50% loss or you will need cash in the near future. But it can be also a great opportunity to buy shares of great businesses for an attractive price.
7. Outlook
Nowadays, many investors do not really like Chinese equities. The Hang Seng Index experienced an 18% plunge last year. Chinese tech and pharma stocks lost a lot more. The Chinese economy may slow down. However, if you believe that the Chinese economy will continouosly grow and will stay investor-friendly in the long term, Sino Biopharmaceutical may be a thriving investment.
The company has a very attractive past performance, great margins and returns on equity and invested capital – and it was able to keep those for a long interval. It is also financially sound. With a low debt level, it could easily repay its debt by using 65% of its cash and cash equivalents. It is ready for harsh times. Interest coverage is around 44.44. If interest rates go higher, it will be able to pay interest easily. The current trailing dividend yield around 0.81% is trivial. Nevertheless, reinvesting the profit seems more prosperous because of its great past record and prosperous market forecasts.
In the long run, Sino Biopharmaceutical has the potential to become a behemoth, and a great investment.
Disclosure: no position.
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