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The pharmaceuticals market is one of the top 10 largest industries of the world experiencing a booming trend. The growth in the industry is backed by an increase in disposable income, augmenting urbanization and a rise in the aging population. It is for this reason that the pharmaceutical industry emerges as a sector with immense growth potential. The industry is in its transitional stage undergoing new regulations, new market entrants and innovation. China Biologic (NASDAQ:CBPO), operating in the biotechnology industry, is no different. In this article, I would discuss the high growth potential associated with CBPO by analyzing in detail what the future holds for this company.

What Does The Company Do?

China Biologic is a leading fully integrated plasma-based biopharmaceutical company heavily involved in the research, development and manufacturing of plasma-based pharmaceutical products. It is headquartered in Beijing and manufactures over 20 plasma-based products through its indirect majority-owned subsidiaries, Shandong Taibang Biological Products Co., Ltd. and Guiyang Dalin Biologic Technologies Co., Ltd. It also has a pronounced ownership in Xi'an Huitian Blood Products Co., Ltd.

Its principal products include human albumin and immunoglobulin product. Human albumin is used to treat critically ill patients by replacing lost fluid and maintaining adequate blood volume and pressure. Immunoglobulin is used for certain disease prevention and treatment to boost specific immunity. Human plasma is the principal raw material used by the company.

Unlike other advanced economies, a majority of the sales in China are derived from human albumin products. In 2012, total immunoglobulin products and human albumin products accounted for approximately 41% and 10%, respectively, in developed countries. On the other hand approximately 27% and 61% of the sales were attributed to the same products in China, respectively.

Clientele

The company sells its products primarily to hospitals and inoculation centers directly through a well-integrated distribution system. The nature of contracts with its customers is mostly short-term given the short-term life of the products. The company relies on a concentrated customer base with the five most important customers accounting for 11%, 13% and 12% of the total sales in 2012, 2011 and 2010, respectively. The figure is expected to change in the coming years as the management plans to diversify its geographic presence, clientele and product mix.

Financials

The company capitalizes on the high growth rates of the pharmaceutical industry and has been able to deliver strong financials. The recent quarter of 2012 marked an increase in revenues of 15% amounting to $54 million. Analyzing the business on an annual basis, the operational performance remains robust. In 2012, the company reported an increase in revenues of 17% while net income showed a three digit increase year-over-year amounting to $45 million. Consistent with the annual performance, the three-year revenue and net income growth amounts to 15% and 173.6%, respectively. The cumulative increase in earnings translated into a higher EPS of $1.62 as compared to $0.37 for the same year. The operating margins stand at 42.6% giving it a cost-effective advantage over its competitors.

Similarly, on the balance sheet side, the enterprise was able to achieve an increase in its asset base of 21% amounting to $311 million in 2012. The increase was brought about via reinvestment of revenues back into the business. Hence the high CAGR seems resilient and sustainable in the coming years. The liquidity position of the company improved substantially in 2012 brought about by an 87% increase in its cash from operations.

Growth Strategy

Given the transitional stage of the industry China Biologic focuses on innovation and a lot of focus is put on research and development. The management has designed a creative strategy to expand its business.

Firstly, it intends to maintain a secure supply of plasma, its core raw material. For this purpose management has built plasma collection stations all over the country. At the end of 2012, a total of 11 plasma stations were in an operative state. A new plasma station is expected to be completed by the end of this month to facilitate a continuous supply in the Shandong region. It has also collaborated with local authorities to obtain a permit for its subsidiary in the Guangxi area.

Secondly, management continues to expand via acquisitions of small biologic companies. The stringent regulations and reforms characteristic of the industry prevent less competitive businesses to shut down. The latter category therefore presents itself as potential acquisition targets. Furthermore, plans to acquire complementary businesses in the biologic related sectors appear on the company's agenda.

The company heavily relies on research and development to maintain its competitive edge in this extremely volatile industry. It plans to launch 8 additional products, 5 of which are at its completion stage. Research and development expenses comprised around 1.6% of total sales in 2012. A figure showed a decline from 2.6% in 2011 due to the heavy expenditure associated with FVIII in early 2012. However, capital expenditure increased by a sheer 250% for the same year.

Lastly, the business plans to enhance its product penetration using existing customers and introducing new products. Plans to diversify its existing geographic markets in other areas with significant potential continue to be a part of the growth strategy. The growth potential of the stock is backed by management's claim of reinvesting all its earnings into the business. It does not plan to pay out any dividends in the near future.

Sales, Marketing and Distribution

Given the stringent regulations of the industry, the company is only allowed to market prescriptive drugs to mostly hospitals and inoculation centers both directly and indirectly. In 2012, direct sales to hospitals constituted about 66% of total sales. Its presence is most prominent in the Shandong and Guizhou province contributing around 24% and 7%, respectively, to net revenues in 2012. Other than that, it is well-situated in the 24 other provinces and 4 municipal cities with further plans to expand.

Competition

With high profitability comes competition as more and more market entrants try to take advantage of lucrative returns. China Biologic faces competition from a wide array of local and foreign sources. It competes on the basis of product quality, cost synergies, product portfolio and logistical capabilities. Roche Holdings (OTCQX:RHHBY), Novo Nordisk (NYSE:NVO) and Gilead (NASDAQ:GILD) present themselves as major threats to the company given their large market capitalization. Nonetheless, it has firmly gripped the Chinese market with 34 registered patents and 10 pending patent applications and a registered Trademark under the label of "CTBB."

Risks

The company is subject to changes in regulation imposed by the regulatory authorities. Recently, the company built a new production facility in accordance with the new GMP Standard. The upgrade is expected to begin in June suspending operations in that region. Total production will be adversely affected by this change. The increase in imports of human albumin, its core product, will lead to a significant decline in its sales. Furthermore, expansion of the company's operations in complementary markets will expose its sales to a great deal of seasonality. Lastly, fluctuations in the inflation rates will lead to an increase in costs of the company.

Looking Forward

The stock currently trades at $22.51 with a total market capitalization of $604 million. The current P/E ratio stands at 12.8 with a downward projection of 7.6. The Price to Book ratio and Price to Sales ratio stand at 2.8 and 3.1, respectively. The enterprise multiple for the recent year amounts to 6.1 with the ratio expected to decline in the next 12 months.

The stock has substantial upside potential as the growth is expected to continue due to the organic growth and a booming trend in the industry. The expansion plans of the company are expected to generate an increase in the stream of cash flows giving the stock a solid backing.

Conclusion

As I stated in the introduction, the pharmaceutical sector is growing at an exceptional rate. China Biologic has a solid market position in one of the biggest economies of the world. There is a lot of potential for the company to grow, and looking at the strategy of the company, it is clear that the company is set to take advantage of the growth opportunity. I believe the stock will move up over the next six month.

Source: China Biologic: A Star Small-Cap Pick From China