Foundation Supports Strong Revenue
Since 2003, Sinovac’s revenues have grown at a compounded annual rate in excess of 75%. The principal driver of this growth has been Sinovac’s Healive vaccine, which is the first inactivated hepatitis A vaccine developed, produced, and marketed in China.
Strong growth in Healive sales is expected to continue as a result of China’s National Institute for the Control of Pharmaceutical and Biological Products [NICPBP] decision to drop liquid formulations of attenuated hepatitis A vaccines from their vaccine batch approval list effective as of January 1, 2006.
In 2005, liquid formulations of attenuated hepatitis A vaccines represented roughly 80% of the entire market for Chinese hepatitis A vaccines (estimated at 19 million doses annually). The attenuated hepatitis A vaccine is being rapidly replaced by inactivated vaccines for which Sinovac is a primary supplier.
In 2006, Sinovac sold approximately 2.6 mm doses of Healive. Given its current production capacity of 6 mm doses/year of Healive and the ongoing market trend towards the expanded use of inactivated hepatitis A vaccines, Sinovac is well positioned to experience continued strong revenue growth from this product.
Last September, China’s NICPBP gave final approval for Sinovac to begin selling Anflu, an inactivated seasonal split flu vaccine. For the 2006-2007 flu season, Sinovac produced a marketing batch of 300,000 doses of this vaccine so its impact on 2006 revenues were likely minimal. However, going forward Anflu is positioned to increasingly impact Sinovac’s overall sales.
In China, there is a large shortage of domestically produced seasonal influenza vaccine which results in the need to import about 20 million doses of flu vaccine annually. Additionally, flu vaccines are believed to be the fastest growing segment within the Chinese vaccine industry and are expected to double in size over the next five years. Sinovac’s current production capacity for Anflu is 2 million doses which offers additional diverse revenue growth potential without the need for further capital investment.
See below for a summary of Sinovac’s financial results since 2002, along with our estimates for the second half of 2006 and first, second half of 2007. Sinovac does not yet report results on a quarterly basis, although it recently began doing so for its revenues. The company reports results on a half year basis (unaudited) and on a yearly basis (audited).
For the first half of 2006, Sinovac reported a loss of $970,000 or 3 cents a share on revenue of $4.68 mm. For the second half of 2006, Sinovac reported unaudited revenue of $10.73 mm, an increase of 81.6% over the same period in 2005. As shown in Key Data section of this report, we believe the level of second half revenues generated a profit sufficiently large enough to offset the first half loss and as such are forecasting full year 2006 earnings of about 4 cents per share. Full year results for 2006 are expected to be released by Sinovac in April.
Financial Forecast Rationale
For 2007, we expect that given Sinovac’s current product portfolio of 3 vaccines Anflu™; Healive; and Bilive (a combined Hepatitis A & B vaccine) that the company will experience another year of very strong double digit percentage revenue growth. We are forecasting full year revenues of $25.3 million, an increase of 64.3% over 2006’s unaudited revenues of $15.4 million. This should translate into a very profitable year for Sinovac with earnings of 15 cents per share. We believe this is much higher than Street expectations as well as what the company has been indicating in past SEC filings. Our aggressive optimistic forecast is based on four major assumptions.
1. Healive sales will continue to grow at a pace close to what has been experienced over the last 3 years. We are fairly confident of this given the market situation in China for Hepatitis A vaccines and Sinovac’s enviable position.
2. Sinovac’s overall gross margin will remain in the 80% area. The company’s gross margin improved steadily from 61.8% in 2003 to 79.9% in the first half of 2006. This trend is a result of the overall growth in Healive™ sales as well as a shift towards increased sales of Healive™ in higher margin vial form as opposed to pre-filled syringe form. These factors are expected to continue and should boost Healive™ gross margins beyond the 80% level in 2007. However, this is likely to be offset by lower gross margins from sales of Anflu™ at this early stage of product launch where production efficiencies are yet to be fully realized. The net result, in our opinion, will be an overall gross margin in the 80% area for 2007.
3. The ongoing decline in Sinovac’s operating expenses as a percentage of revenue will accelerate. This number, which largely consists of selling, general and administrative expenses (SG&A) was 146.6% of revenue in 2004 and we are projecting it to fall to 47.1% of revenue in 2007. On this front too, we are encouraged for several reasons. First, Sinovac displayed in the second half of 2006 its ability to substantially grow revenues with little additional personnel. (The number of employees grew from 238 on June 30, 2006 to 249 on December 31, 2006). Second, Sinovac has reined in its employee stock option program which appeared to be excessive in previous years and contributed to a large noncash SG & A expense. Additionally, Sinovac appears to have stabilized its level of overhead spending which translates into falling operating expenses as a percentage of revenue in the current environment of rapidly increasing sales.
4. Our estimate of Net Income based on our calculation of Operating Income is fairly accurate. The difference between these two numbers consist primarily of interest income/expense; income taxes; and minority share of income/loss. The last two categories are challenging to estimate, but we believe we have been conservative in our forecast of them.
Our 2007 estimates do not include any revenue from Panflu, Sinovac’s vaccine for avian flu which is currently in development and discussed below.
Status of Avian Flu Vaccine Development (H5N1)
Although we have not factored into our 2007 revenue forecast any contribution from Panflu, Sinovac’s vaccine for avian flu, this product could be a source of substantial future revenues. Sinovac successfully completed Phase 1 trials of Panflu™ last summer. The results from this trial were the source of positive coverage in a September 2006 edition of The Lancet, the prestigious British medical journal. In November, Sinovac filed an application with China’s State Food and Drug Administration [SFDA] to commence Phase 2 clinical trials. Since its Phase 2 filing, Sinovac has had at least two meetings with the SFDA as part of the review process and is currently awaiting their decision which is believed to be on a fast track status.
China's Commitment To Sinovac's Vaccine Production
There are several reasons to be encouraged. First, Sinovac recently received a $2.6 million grant from the Chinese government to fund expansion of its flu vaccine production line. This expansion, targeted for completion by year’s end, would allow Sinovac to produce 20 million doses annually of Panflu. We believe this funding is a significant event and is a sign of real commercial potential for Panflu.
Global Commitment To Vaccine Production and Stockpiling
Second, several countries have either placed orders or are in the midst of placing them with other vaccine manufacturers for their version of a pre-pandemic Avian Flu vaccine. This includes, the United States, United Kingdom, Denmark, Switzerland, and Taiwan among others. Importantly, with Taiwan indicating that they will be producing a pre-pandemic vaccine by the end of this year, it seems only logical that China will want to do the same. Additionally, with the 2008 Summer Olympics coming to Beijing, it seems likely to us that China would want to stockpile a pre-pandemic vaccine as either a defense or insurance against a potential pandemic.
A Phase 2 announcement regarding Panflu seems unlikely to occur until after the Chinese New Year Celebrations which begin in mid-February.
Additional Company developments
Wang Debt owed to Sinovac
Last week, Sinovac announced that it had received full repayment in the amount of $562,515.31 from Lily Wang, a former director and CFO, for the outstanding balance of a loan owed to the company arising from her earlier acquisition of Tangshan Yian’s equity interest in Sinovac Beijing. As indicated in an initial research report on Sinovac issued last October, we believed this would be transparently resolved , which has come to pass.
There is one other loan outstanding to another former officer, Heping Wang. This loan is related to Mr. Wang’s assumption of Tangshan Yian’s loan obligations and is in the amount of RMB 10.8 million (approximately $1.35 million US). During last week’s announcement Sinovac indicated that it was working with Mr. Wang to resolve this outstanding issue. We expect that this matter will be resolved to Sinovac’s satisfaction as well.
China Bioway Minority Share Ownership in Sinovac China
As reported in a January 31st update by the Financial Trader, Sinovac announced that China Bioway Biotech Group Co., Ltd. recently received approvals from the PRC Ministry of Education and the PRC Ministry of Commerce to restructure China Bioway’s 28.44% equity interest in Sinovac’s 71.56% PRC subsidiary, Sinovac Biotech Co., Ltd. (“Sinovac China”). The proposed restructuring contemplates China Bioway transferring its equity interest in Sinovac China to an offshore company, and eventually exchanging this equity interest for shares in Sinovac.
We continue to see this development as a positive for Sinovac shareholders with the potential for an accretive impact on earnings. Sinovac has stated its desire in the past to continue increasing its stake in Sinovac China, its Beijing operating subsidiary, at a price that represents an attractive valuation. It appears it now has this opportunity.
Although our analysis is focused primarily on fundamentals, technically, Sinovac’s chart pattern suggests that the decline in its shares, which began in October 2005, may be over and that a sustainable trend reversal might now be underway. As shown in the chart below, recently Sinovac’s stock price crossed and closed above a downward trend line that goes all the way back to its October 2005 high of $7.92. Typically, such action has a strong tendency to be bullish.
We believe that Sinovac’s improving fundamentals driven by its continued strong growth and high gross margins will attract the interest of both value and growth investors. At its current price, Sinovac is at the low end of its three year trading range and appears ripe for accumulation.