Result Update

For the six months ended June 30, 2019, the company recorded operating income of RMB 2.964 billion, an increase of 11.7% YoY; if excluding the effect of the ¡§two-invoice system¡¨ revenue was RMB 3.402 billion, an increase of 14.4% YoY, mainly because of an increase in sales volume. Gross profit was RMB 2.218 billion, a YoY increase of 17.7%; excluding the effect of the ¡§two-invoice system¡¨, gross profit was RMB 2.023 billion, a YoY increase of 16.0%, mainly reflecting the increase in turnover. Gross profit margin was 74.8%, up 3.9ppt YoY; excluding the effect of the ¡§two-invoice system¡¨, gross profit margin was 59.5%, an increase of 0.8ppt YoY, mainly due to decreases in import duty rate and value-added tax rate. The selling expenses were RMB 883 million, up 20.1% YoY; selling expenses accounted for 29.8% of turnover, an increase of 2.1ppt YoY; excluding the effect of the ¡§two-invoice system¡¨, selling expenses accounted for 20.2% of turnover, with an increase of 0.2ppt YoY, mainly reflecting increases in academic promotion activities and human costs. The administrative expenses of the company was RMB 110.3 million, an increase of 12.0% YoY; the administrative expenses accounted for 3.7% of the turnover, which was the same as that of the same period of 2018; excluding the effect of the ¡§two-invoice system¡¨, administrative expenses accounted for 3.2, a YoY decrease of 0.1ppt, mainly due to the effective control over expenses and the benefit from economies of scale. Finance costs were RMB 29.1 million, a decrease of 31.3% YoY, mainly due to a decrease in utilization of loans. The profit for the period was RMB 1.168 billion, a YoY increase of 22.2%, mainly due to the continuous growth in turnover and an increase in other gains.

Accelerate the development of innovative product development

The company mainly invests in innovative products of different innovation levels and development stages by making equity investment in overseas R&D companies or achieving strategic collaboration with them. As of June 30, 2019, the company acquired four innovative products with sufficient competitive advantages to meet the clinical needs in Chinese market. Among them, two have been launched in the United States, the European Union and other regions, and the other two are in the clinical stage. The company's innovative products have expanded to 13 products in various fields, including ophthalmology, dermatology, nervous system, anti-tumor, immune system, digestive system. anti-infection and endocrine system.

In-licensing

Cyclosporine A, 0.09% Eye Drops

Cyclosporin A, 0.09% Eye Drops is a nanotechnology enabled-formulation in a clear, preservative-free, aqueous solution. It is the globally first patent protected innovative 0.09% cyclosporin ophthalmic solution using nanotechnology for the treatment of increasing tear production in patients with dry eye. The drug was marketed in the United States in August 2018. In June 2019, the company through its wholly-owned subsidiary signed a Licensing Agreement with a wholly-owned subsidiary of Sun Pharma, a global pharmaceutical company focusing on branded innovative products and complex generics, and gained an exclusive license with the right to grant sublicenses under Sun Pharma's intellectual property rights and regulatory documentation to develop and commercialize its product Cyclosporin A, 0.09% Eye Drops in greater China (including Hong Kong, Macao and Taiwan).

Tildrakizumab (A Monoclonal Antibody Specifically Targeting Interleukin-23 (IL-23))

Tildrakizumab-asmn is a humanized IgG1/k monoclonal antibody that specifically target IL-23 to treat adults with moderate-to-severe plaque psoriasis that meets systemic or phototherapy indications. The drug was marketed in the United States in March 2018. In June 2019, the company through its wholly-owned subsidiary signed a Licensing Agreement with a wholly-owned subsidiary of Sun Pharma, and gained and exclusive, royalty-bearing license with the right to grant sublicenses under Sun Pharma's intellectual property rights to develop, use, sell, offer to sell and import Tildrakizumab in Greater China (including Hong Kong, Macao and Taiwan).

Equity Investment

MTD201 (A Q-SpheraTM Polymer Microsphere Formulation of Octreotide), MTX110 (Panobinostat)

In January 2019, the company through its wholly-owned subsidiary made an equity investment in a UK-based international specialty pharmaceutical company, Midatech Pharma, which specializes in R&D of a pipeline of medicines for oncology and immunotherapy, and gained exclusive, perpetual, transferable, sub-licensable rights to develop and commercialize its current products mainly including MTD201 and MTX110, and certain new pharmaceutical products or line extension in China (including Hong Kong, Macao and Taiwan) and specific Southeast Asian countries. MTD201 is a Q-SpheraTM polymer microsphere formulation of Octreotide developed for the treatment of neuroendocrine tumors (NETs) and acromegaly. MTX110 is primarily developed for the treatment of diffuse intrinsic pontine glioma (DIPG).

Continuous optimization of existing product portfolio

The company divides its existing products into cardio-cerebrovascular line, digestion line, ophthalmology line and dermatology line. The main products of cardio-cerebrovascular line include Xinhuosu, Plendil and Deanxit. As of 1H2019, the cardio-cerebrovascular line realized revenue of RMB 1.341 billion, a year-on-year increase of 3.7%. If excluding the effect of "two-invoice system", the income from the cardio-cerebrovascular line will reach RMB 1.940 billion, showing a year-on-year increase of 14.7%, accounting for 57% of the company's turnover excluding the effect of ¡§two-invoice system¡¨. The main products of the digestion line include Ursofalk, Salofalk, Bioflor and Combizym. As of 1H2019, the digestion line realized revenue of RMB 1.027 billion, representing a year-on-year increase of 19.6%, accounting for 30.2% of the company's turnover excluding the effect of ¡§two-invoice system¡¨. The main product of the ophthalmology line is Augentropfen Stullen Mono Eye Drops. As of 1H2019, the ophthalmology line realized revenue of RMB 115.2 million, a year-on-year increase of 9.5%, accounting for 3.4% of the company's turnover excluding the effect of ¡§two-invoice system¡¨. The main product of dermatology line is Hirudoid. As of 1H2019, the dermatology line realized revenue of RMB 86 million, a year-on-year increase of 16.5%, accounting for 2.5% of the company's turnover excluding the effect of ¡§two-invoice system¡¨. As of1H2019, the company's other sales and promotion products realized revenue of RMB 395 million, an increase of 21.8% year-on-year; if excluding the effect of ¡§two-invoice system¡¨, the realized revenue was RMB 233 million, a decrease of 5.1% year-on-year, accounting for 6.8% of the company's turnover excluding the effect of "two-invoice system".

Continue to promote network development

In 1H2019, the company used digital marketing tools and digital internal management systems to implement a new academic promotion model, making business data easy to analyze, traceable, and employee behavior management more standardized. At the same time, the company optimized the personnel and compensation system and upgraded the training system to improve employee execution efficiency. The company also steadily promoted the construction and development of the retail team, maintaining and expanding the coverage and channel layout of the retail business. For1H2019, the company's promotion network covers more than 57,000 hospitals and medical institutions across the country, covering all provincial administrative regions and most prefecture-level administrative regions, and also China's tertiary hospitals, secondary hospitals and the main departments of the tertiary hospital.

Financial Forecast and Valuation

We forecast that the company's FY19/FY20/FY21 income will be RMB 5.98/6.30/6.74 billion, representing an increase of 10.12%/5.36%/6.95% YoY; net profit attributable to shareholders will be RMB 2.19/2.30/2.45 billion, increasing 18.23%/5.07%/6.65% YoY; corresponding EPS will be RMB 0.88/0.93/0.98. We use DCF model and residual income model to value the company. Assuming equity cost is 10.65%, debt cost is 5%, and WACC is 10.14%. We get PT of HKD 11.34 and HKD 11.31 respectively. The higher valuation result corresponds to FY19/FY20/FY21 12.86x/12.24x/11.55x PE, which has an increase of +12.74% compared to the current price (HKD 10.06 as of October 18, 2019), giving an ¡§Accumulate¡¨ rating.

Risk

The launch of new products fails expectations; Industry policy risk.

Financials

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