Recently Listed Simcere, Tongjitang Appear Attractively Priced

In a Wall Street Journal article, stock analysts in Hong Kong considered the future of two China pharmaceutical companies that have listed recently on U.S. exchanges, Simcere Pharma (SCR) and Tongjitang China Medicine (TCM). Here’s the problem: China is seeking to end the self-dealing inherent in China’s current pharmaceutical distribution system.

Doctors and hospitals prescribe drugs to their patients, and then sell the products to these same patients. Because most of their profits come from these drug revenues, the doctors and hospitals are under an altogether too-natural pressure to over-prescribe.

According to the analysts, talk about reform has been instrumental in bringing down the share prices of both Simcere and Tongjitang. However, the analysts believe that reform (or, more precisely, its supposedly attendant lower revenues) will be incremental, not sudden. And the companies are in decent shape, even if some pressure on revenues is figured into the numbers.

Simcere Pharmaceutical Group, for example, dropped 17% in the second half of July. Jinsong Du, healthcare analyst with Credit Suisse in Hong Kong, laid the fault for the slide on the toothpaste scandal, which was in the news at the same time. That seems a bit far-fetched, although the various health and safety problems did take some of the exotic allure off companies from China.

In its IPO, Simcere was priced at $14.50 and it subsequently rose to $18 per share. But now it is stuck around $13, putting the IPO investors under water. In its generally strong Q2 financial report, the growth for its mainstay products came in below expectations, even though its overall numbers were strong. The stock traded 10% lower after the Q2 report was released.

Simcere concentrates on high-end generics. Its anti-stroke injection, Bicun, which contributes one-third of the company’s revenues, saw its sales increase 20% from the year-earlier quarter. The new cancer drug, Endu, out just a year, increased its revenues 55% over the first quarter. That is a spectacular increase, but it was not enough for investors who wanted more from Bicun.

More than the toothpaste scandal, investors were most likely adjusting downward their expectations for the company. As a result, Simcere has been pushed down to a point where it is currently valued at a 21 P/E multiple (trailing 12 months). Annualize the current quarter and the jump in earnings has the effect of lowering the P/E to 18.

The other recent IPO in the States was Tongjitang Chinese Medicines, which dropped 22% in August. Perhaps the most daunting part of the Tongjitang story is that 80% of its revenues come from a single product: Xianling Gubao, which translates (freely) to “magical bone treasure.” Xianling Gubao is an osteoporosis drug. The traditional Chinese herbal remedy commands an 80% of the TCM segment for osteoporosis. Because Tongjitang is so dependent upon the drug, it is vulnerable to bureaucratic fiddling with its markets.

Tongitang priced its IPO at $10 and it is virtually unchanged from that after six months of trading. Of course, it reached close to $13 when the market mood was more ebullient, and now it has just bounced off a near-$8 low. At its current price, Tongjitang is trading at a P/E of 14, which if the current quarter’s earnings are annualized, will slip even further to 11. That is a level of pessimism that leaves room for a couple of setbacks.

Disclosure: none.

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Note that TCM entered into an agreement last week with Guizhou to acquire that company which has 10 additional traditional Chinese medicines for indications other than osteoporosis, including: rheumatoid arthritis, nausea and other effects of chemotherapy, and support for the immune system.

2007 Sep 18 07:31 AM