丽珠集团(000513)

Key points

The decline of Shenqi Fuzheng and Likangle should continue into 2019…

…offset by a rise in western drugs in gastrointestinal & hormone diseases.

We initiate coverage at Outperform and a TP of Rmb40.72, 19% upside.

East in trouble

Livzon has had a tough 2018, facing a harsh policy environment and weak stockmarket sentiment as well as product-specific issues with no remedies in the nearterm. Since late 2016, authorities have been more seriously supervising theusage of “adjuvant TCM” at hospitals, resulting in a severe sales decline from thepeak. Adjuvant means drugs that supplement but do not have a clear clinicalbenefit to patients. Shenqi Fuzheng, which falls under this category, accountedfor 19% of the company’s 2017 revenue. We see a stable gross margin, at 80%,but a 37% decline in revenue for 2018 and another 15% in 2019. Anotherproduct, Likangle, which is the mouse nerve growth factor, also will suffer adecline of 15% in 2018, according to our forecasts. It faces competition fromthree other manufacturers and has the lowest market share.

West comes to the rescue

Yilian, with active drug ingredient ilaprazole, should post sales of Rmb620m in2018, up 40% YoY. We estimate sales will hit Rmb1bn by 2020, making it thecompany’s best-selling drug. In Livzon’s traditional forte of fertility drugs, Beiyi (依) is doing well. Beiyi contains the extended release form of Leuprorelin (亮丙瑞林微球) using microspheres and should achieve Rmb0.73bn in sales in 2018, up35% YoY. We project the drug to hit Rmb1bn by 2021. We believe, over the nextthree years, the rise of Beiyi and Yilian together should almost exactly offset thedecline of Shenqi Fuzheng and Likangle combined. The former two should alsoenjoy higher gross margins and lower operating costs.

Blue sky of biological drugs under development

Livzon is one of the few established TCM drug companies with early exposure tothe development of biological drugs. Thanks to its JV subsidiary, Zhuhai LivzonMAB Biotechnology, 51/49 owned by Livzon and its listed parentco, Joincare, thecompany now has a total of eight biologic candidates. They cover all of the hottargets including HER2, CD20, RANKL, PD-1 and IL-6. We estimate that if all themonoclonal antibodies can be launched successfully in the market, their peaksales potential should be around Rmb10bn, almost doubling the current scale ofoperations and likely enjoying 30 ppts more than current gross margin.

Without a lot of near-term catalysts

We apply a 25x PE on 2019E EPS of diagnostic, GI and antibiotic drugs, and 20xon hormones, TCM, API & others to arrive at our TP of Rmb40.72, implying a20.5% TSR. We believe the multiple is justified in view of strong earnings growth(we see 31% in 2018E and 20% in 2019E). The stock is inexpensive after a YTDstock price correction of 59%, but we do not see a lot of near-term catalysts.

Key risk

Increasingly fierce policy adversity impacting Shenqi Fuzheng.