摩根士丹利-中国-医疗保健行业-中国医疗保健行业2019年展望-2019.2.18-94页.pdf

Sean.WYolanda.HLaurence.TEthan.DAttractiveMORGAN STANLEY ASIA LIMITED+Sean WuEQUITY ANALYST+852 3963-0755Yolanda HuEQUITY ANALYST+852 2848-5649Laurence TamEQUITY ANALYST+852 2239-1753Ethan DingRESEARCH ASSOCIATE+852 3963-0546Morgan Stanley appreciates your support inthe 2019 Institutional Investor All-AsiaResearch Team Survey.Request your ballot.China HealthcareAsia PacificIndustryViewChina HealthcareChina Healthcare|Asia Pacific Asia Pacific2019 Outlook:Implementationof 4+7 Centralized Procurementa Key Theme;Focus onInnovation and R&D ServicesWe continue to see policy headwinds for drug names into2019,but we favor those with rich innovative pipelines such asHengrui and Innovent.R&D Service companies should berelatively immune and we continue to OW WuXi Biologics andWuXi AppTec.These four are our top picks for 2019.What matters in 2019:We think policy headwinds will persist into the rest of2019-centralized procurement for high-volume generic drugs,control ofadjuvant medicines,and centralized procurement for high-end medicalconsumables.We expect healthcare multiples may not have much room toexpand in 2019,especially for generic drug names.At the same time,zeromarkup,drug income control,and reimbursement control may still hamstringhospital finances.We like business models that are more resistant to suchheadwinds,such as service companies-WuXi Biologics and WuXi AppTec.Innovators will benefit from a more favorable regulatory environment if they areable to deliver on their clinical timetables,such as Hengrui and Innovent.Our segment views and key calls:We like CDMOs like WuXi Biologics and WuXiAppTec because they are not directly affected by the negative policies and willbenefit from Chinas R&D boom.Distributors with national scale could benefitfrom more reimbursement dollars spent on innovative oncology drugs,e.g.Herceptin,where MNCs mostly retain the top distributors such as Sinopharm.Westay cautious with drug names that have large earnings exposure to generics,likeShanghai Pharma(EW)but are positive on 3SBio and SSY(OW).We are extracautious on names that have additional exposure to adjuvant drugs,e.g.Livzon(UW).This year we view TCM or consumer names with steady growth as safehavens,e.g.BJTRTCM(OW)and CR Sanjiu(OW).For devices,we like innovatorslike Microport(OW)but will keep an eye on potentially major price cuts on highvalue consumables.Summary of changes to our stock coverage:We have revised our earningsforecasts and hence PTs to a number of stocks under our coverage.We havealso changed ratings on two.Overall changes are summarized in the table below.Exhibit 1:Ratings and Price TargetsStockRatingPrice TargetsAction3SBioOWHK$21 to HK$17Cut PTAier Eye HospitalEW to OW Rmb30 to Rmb35Upgrade ratingBeijing TongrentangUWRmb25 to Rmb24Cut PTBeijing Tongrentang Chinese MedicineOWHK$17.8 to HK$18.5Raise PTChina Medical SystemOWHK$18 to HK$10Cut PTChina Resources MedicalOWHK$10.5 to HK$7.0Cut PTChina Resources SanjiuOWRmb33 to Rmb34Raise PTCSPCOWHK$24 to HK$18Cut PTFosun Pharma AOWHK$57 to HK$30Cut PTFosun Pharma HOWRmb52 to Rmb31Cut PTHarmonicareEW to UW HK$3.0 to HK$1.5Downgrade ratingJiangsu HengruiOWRmb88MaintainLees PharmaOWHK$12.0 to HK$8.8Cut PTMicroPort ScientificOWHK$11.5 to HK$10.0Cut PTShinewayEWHK$16.5 to HK$10.0Cut PTSino BiopharmaEWHK$9.33 to HK$8.50Cut PTSSYEW to OW HK$6.5 to HK$8.5Upgrade ratingWuXi AppTec HOWHK$81 to HK$104Raise PTWuXi AppTec AOWRmb84 to Rmb90Raise PTWuXi BiologicsOWHK$70.00 to HK$85.00Raise PTSource:Morgan Stanley Research Estimates.Morgan Stanley does and seeks to do business withcompanies covered in Morgan Stanley Research.As aresult,investors should be aware that the firm may have aconflict of interest that could affect the objectivity ofMorgan Stanley Research.Investors should considerMorgan Stanley Research as only a single factor in makingtheir investment decision.For analyst certification and other important disclosures,refer to the Disclosure Section,located at the end of thisreport.+=Analysts employed by non-U.S.affiliates are not registered withFINRA,may not be associated persons of the member and may notbe subject to NASD/NYSE restrictions on communications with asubject company,public appearances and trading securities held bya research analyst account.1February 18,2019 09:00 PM GMT Executive Summary1)Centralized procurement to spread:Recall that in 2018,the centralized procurement4+7 pilot scheme was set out by the State Council,favoring high quality generics withlow prices.The pilot scheme is expected to be rolled out in the 11 pilot cities in March2019.This year we expect the impact from centralized procurement to expand,withregards to:1)Drug categories.It is likely that more drugs that passed the QualityConsistency Evaluation(QCE)would be included in the central procurement list.2)Drugprices.While winning bidders largely adjusted down prices to win 60-70%of the market,the losing bidders are also required to cut their prices by 10-30%to compete in theremaining 30-40%of the market.Therefore,more companies are likely to experienceprice cuts and narrow their gaps compared with winning prices.3)Regions.Right afterthe bidding led by Shanghai in December 2018,non-4+7 cities such as Sichuan,Shandong,Anhui,and Gansu also encouraged linking drug prices to the bidding results.Meanwhile,the Fujian government has recently announced that it will be opting into the4+7 for the entire province with implementation starting on April 1,after Xiamen startsimplementing it on March 1 as a part of the 4+7.Nevertheless,a nationwide price linkageis not likely to form in 2019,in our view,given higher listing prices for drugs that passedQCE in provinces such as Shandong,Hainan and Inner Mongolia.Moreover,though weexpect centralized procurement to expand,another round of centralized procurementwith more drugs may not happen as fast as the market feared.Overall,we have a more balanced view of the impact from centralized procurement.Webelieve in the central thrust of the centralized procurement,the price cuts,savings in thesales marketing and consolidated generic industry-sensible and achievable in the longterm.We believe the government will not rush to expand the 4+7 centralizedprocurement to more cities and drugs quickly,and we expect the government to allowthe pilot program to run its course,for at least half a year.We also do not expect thecentral government to encourage the prices of 4+7 to be adopted nationally,but it maynot forbid it either.Hence,we are not as pessimistic as some on the impact from the 4+7Centralized Procurement.On the other hand,we believe it is highly unlikely that the 4+7scheme is once and for all or that the central theme will be modified drastically.It isvery difficult to see a quality company offering to cut a drug price by 90%and thegovernment allowing for it to be raised by a lot in the next round.Given the willingnessthe drug companies have demonstrated in the first round to cut the prices of generics,itis a major opportunity for the government to explore so it can re-prioritize spending tomore expensive and innovative drugs addressing unmet medical needs.It is not aboutwhether but about when the 4+7 Centralized Scheme will be expanded to more cities,provinces,and more drugs,in our view.Hence,while we are encouraged to see an overall sector rebound in early 2019,we donot believe the generic drug companies are completely out of the woods yet.We expecthigh volatility going forward and stocks may zig-zag up but are unlikely to reach their2018 highs in 2019.2)Adjuvant drug control may harm profitability of some pharma companies:InDecember 2018,the NHC(National Health Commission of the Peoples Republic ofChina)put out rules for building the National Adjuvant Drugs List.The provincial lists2each comprising 20 adjuvant drugs with top sales in the region were submitted to NHCby the end of 2018.The national list is being developed by NHC.Moreover,the StateCouncil recently added the share of adjuvant drug sales to total hospital income as anew indicator in the hospital evaluation metrics.As the government rushes to reinforcethe regulation on clinical use of adjuvant drugs,drugs with no proven efficacy but thatconsume a great amount of insurance fund are likely to be strictly controlled.Therefore,inclusion in the adjuvant drug list will potentially harm the profitability ofmanufacturers.3)Approval and reimbursement for innovative drugs to accelerate:With more cost-savings from generic drugs,reimbursement on innovative drugs is likely to be improved,potentially benefiting R&D focused companies.Recall that in 2018,17 cancer drugsentered the reimbursement list via price negotiation,after an average price cut of 56.7%.Among those,10 were novel drugs launched after 2017.Regarding approval forinnovative drugs,in 2018,nine Class 1.1 drugs were proposed for priority review in China.Up to date,five novel cancer drugs by Chinese manufacturers that joined the queue forpriority review in 2017-18 have been approved,including toripalimab,sintilimab,anlotinib,fruquintinib and pyrotinib.We expect approvals for innovative drugs tofurther accelerate given favorable policies.2019,a year of policy implementation and adjustments:We will pay close attention tohow fast the centralized procurement pilot program in 4+7 will be rolled out in thewhole country,as well as how many drugs will be added to the list and how fast.In ourview,a nationwide price linkage,and another round of central procurement with moredrugs are unlikely to happen as fast as the market feared.In 2019 we expectreimbursement control to continue.We expect potential changes in the reimbursementratio for certain drugs and wider implementation of reimbursement prices at provinciallevels.We believe quality domestic products could be increasingly favored over MNCoriginals because of their favorable quality/price trade-off after patients and physiciansare convinced by the results from QCE studies.We expect the industry growth to be in high single digits,roughly in line with 2018.Thegrowth may be hurt by 1)the impact from implementation of centralized procurement;2)limitations on use of adjuvant drugs;and 3)further implementation of DRGs(Diagnosis Related Groups).Counterbalancing that,we have the launch of innovativedrugs such as PD-1 from domestic companies,better reimbursement of expensiveoncology drugs,and the governments determination to make cancer drugs,orphandrugs,and pediatric drugs more accessible and affordable.Sector views and key calls:Positive on innovative drugs and cautious on generics:We remain cautious oncompanies with large exposure to generics and we like companies with strong innovativepipelines such as Hengrui(OW)and Innovent(OW).Innovators will benefit from a morefavorable regulatory environment if they are able to deliver on their clinical timetables.We expect reimbursement on innovative drugs to be improved with more cost-savingsfrom generic drugs,potentially benefiting R&D driven companies.Medical devices facing policy uncertainties;innovation highly valued:There areaccelerating policy changes,including implementation of zero markup,2-invoice policyand potential price cuts via GPO(Group Purchasing Organization)or cross-region3alliances.However,despite the policy headwinds in 2019,we think the pricing pressureon local players may not be as severe as on generics.These policies will lead to furthermarket consolidation and import consolidation.Notably,in light of low penetration ofimplantable and domestic substitution,we think companies like Microport(OW)willeventually benefit as the government will continue supporting medtech innovation.Welike Microport(OW).Full H-share floating may further boost management incentivesand drive stock performance of Weigao(EW).TCMs see opportunities,but concerns remain:As centralized procurement is mostlyfocused on chemical drugs,TCMs seem to be immune from the policy impact.However,market deregulation on formula granules will raise concerns for the segment.The mostlikely or the best scenario will be maintaining a 25%markup for formula granules andopening up sales to all hospitals.The OTC market has been growing at double digits inthe past few years,potentially benefiting TCM drugs,while TCM prescription sales keptdeclining(-3.4%YoY in 2018 vs.-6.0%YoY in 2017).In addition,strict control on use ofTCM injections will continue given safety concerns.Famous brands like TRT still warrantpremium multiples,as seen in the high PEs(600085-SH 30.5x,1666-HK 16.8x,3613-HK17.7x).We continue to OW TRT Chinese Medicine(3613-HK)given its stable 20%growth.We EW Dong E E Jiao,Tasly,CTCM and Yunnan Baiyao.Medical services continue to face differentiated market dynamics:We like businessmodels that are more resistant to such policy headwinds,such as R&D servicescompanies-WuXi Biologics(OW)and WuXi AppTec(OW,both A and H).We expectpublic hospital management companies to fare differently from private hospitaloperators.Expansion of DRGs and dramatic price cuts for generics shall benefit publichospitals alongside private hospitals.However,dramatic price cuts of generics will likelyaffect the profit from third-party supply chain management,a major source to thepublic hospital management companies such as CR Healthcare.Private hospitals shouldenjoy flexibility,and might be able to exploit difficulties faced by public hospitals andtake advantage of development of commercial insurance.We are upgrading Aier EyeHospital to OW for its long-term sustainable growth while downgrading Harmonicare toUW because of the continued struggles by the government to bring up the birth rateafter many years of planned birth control.Distributors could see a mixed operating environment:According to a PharmaTrustsurvey of 690 class 3 and class 2 hospitals,prescription sales started to rebound in2018(5.4%YoY in 2018 vs.+0.9%YoY in 2017),primarily driven by oncology drug sales(+16.5%YoY in 2018).We think this will drive growth of distributors in 2019,especiallyfor those with national scale,as more insurance funds are likely to be allocated toinnovative drugs reimbursement.MNCs would favor those top distributors likeSinopharm.However,large price cuts on generics will continue to exert margin pressureson companies and dampen industry growth to below 10%.After losing some marketshares to large local provincial players in 2018 due to the implementation of a 2-invoicesystem,we expect large national distributors to start picking up market share leftbehind by small third-tier or lower distributors as they can be absorbed through M&A ordisplaced with extending distribution to lower-tier cities.Concurrently,bank borrowingrates are ticking down and AR(accounts receivable)days may see improvement withimplementation of the 4+7 scheme.Hence,distributors may see a turnaround in 2019and our EW-rated Sinopharm,Shanghai Pharma and CR Pharma may be attractive toinvestors who want to play defensive while investing in the healthcare space as generic4drug comp