This will never work (Vol 1, No 28)
It’s been a while since we looked into the Mass Consumption theme. This time around, we’re looking at Healthcare.
According to the National Bureau of Statistics, although healthcare is only the sixth biggest per capita spending category, it is the fastest growing. It currently make up around 7.3% of per capita spending but grew at 15.8%.
While’s China’s 7.3% per capita spending may appear low, it’s not. In the US, healthcare expenditure make up around 8% of annual household expenditure. The big difference is in the nominal amount of spending (US$4,612 per family Vs Rmb352 per capita).
Healthcare Index Representation – 13.9% Vs. 1.2%
Where there is a really big discrepancy between the US and China is index representation. In the US, the healthcare sector carries a 13.9% weighting but in Hong Kong, that’s only 1.2%.
Intuitively, the call should be straight forward, healthcare representation in the HSI should rise. But’s it’s not that easy. Remember my Investing Junkfood posts about trying to avoid investing on (i) 52 week highs and (ii) high valuation multiples?
+123% off the 52 week low and 49x PE
The three largest healthcare stocks in Hong Kong are CSPC Pharma (US$19b market cap), Sino Biopharmaceutical (US$14bn) and Sino Pharm Holdings (US$13bn). Compared to the US giants like JNJ (US$332bn), Pfizer (US$214bn) and Amgen (US$122bn), the China pharma stocks are minnows.
What gives me pause is the current valuation and recent performance. CSPC and Sino Biopharm are both trading at 49x PE (JNJ and Pfizer at 20-23x) and are up 193% and 123% off their 52 week lows.
By comparison, Sinopharm appears a bit more palatable. It’s only up 17% off its 52 week low and its US$15bn market cap only implies 15x earnings.
But hang on, it’s not that simple.
Distributor vs. Manufacturer
While they all have the word “Pharm” in their names, Sinopharm’s business is actually very different from CSPC and Sino Biopharm. It’s a drug distributor and not a drug manufacturer.
This difference becomes very stark when you look at their gross and operating margins. In 2017, CSPC and Sino Biopharm enjoyed gross margin of 60% and 80% and operating margins of 23% and 26%. As a distributor, Sinopharm only earned gross margin of 8.3% and operating margin of 4.4%.
China vs. US Pharma companies – Two key differences
When I was previously looking into some of the US biotech companies, I was struck by their low PEs and high dividend yields. For the likes of Gilead, Amgen and AbbVie, uncertainty about their drug pipeline had turned them into value plays.
Across the pond, with PEs near 50x, growth expectations are very high for CSPC and Sino Biopharm. But how are they similar and where are they different?
Comparable gross margins
Looking across Gilead, Amgen, Celgene and AbbVie, their gross margins range from 75% to 96%. The average gross margin of 84% is not dissimilar to Sino Biopharm’s 80%. For CSPC, given their generic and vitamins business, it has a lower gross margin at 60%.
Much lower R&D expenses in China
One key difference is in the research and development spending. For the four US companies, R&D expenses were around 23% of their revenues (range of 14.3% for Gilead to 43% for Celgene).
For Sino Biopharm, R&D was 10.8% and for CSPC R&D spending was only 5.3% of revenues.
This difference becomes much bigger when you consider it in nominal terms. In 2017, Sino Biopharm spent US$249mn in research and development and CSPC spent US$127mn. In the US, Celgene spent US$5.9bn, AbbVie US$5.3bn, Amgen US$3.6bn and Gilead US$3.7bn.
M&A has not been a big driver for the Chinese
Another key difference is M&A. For the more mature US companies, one source of innovative drugs is acquisitions.
Among the four US biopharm companies, goodwill and intangibles are often the biggest assets on their balance sheets. These range from around 30% for Gilead and Amgen to 61% for AbbVie.
But for the Chinese pharma companies, perhaps due to the relative infancy, goodwill and intangibles were only 1-4% of their total assets.
Hepatitis Meds – One man’s poison is another man’s medicine
As a final point of contrast, take a look at their best sellers list.
In China, meds to treat hepatitis account for 44.2% of Sino Biopharm’s revenues. In 2017, this rose by 11% YoY.
In the US, HCV anti-viral meds account for 36% of Gilead’s revenues. This fell 38% YoY in 2017.
This only goes to highlight that often times, one man’s poison is another man’s medicine.
So what would you go for, value or momentum?
Choose your poison carefully.
This will never work