At this late stage of the China bubble, I’m looking around for great Chinese names with fair valuation. One such name is Tongjitang Chinese Medicines (TCM). Here are some of the reasons I think it will be a winner in the next decade:
1. “Tongjitang” is a Chinese name brand with more than a century-old history. The brand dates back to 1888, is known by many Chinese households, and was officially honored by the central government. Company CEO Mr. Wang Xiaochun was a career lawyer until 1997, when he bought Xianling Pharmaceutical. He clearly understood what’s in the name and merged Xianling with Tongjitang in the early 2000s under encouragement from the Guiyang city government.
2. Tongjitang’s flagship product Xianling Gubao [XLGB] has become a leading traditional Chinese medicine for treating osteoporosis as measured by revenue, according to a report by the SFDA-affiliated China Southern Medicine Economy Research Institute [SMERI]. SMERI estimated XLGB to have accounted for 70% of sales of traditional Chinese medicines for the treatment of osteoporosis from 2003 to 2005. SMERI also ranked XLGB No. 10 in terms of market share, at 0.74%, among all modernized Chinese medicines in seven leading Chinese cities’ hospital prescription market for the first half of 2006. That is, 0.74% of market for the thousands of all modernized Chinese medicines.
3. According to a recent report by China’s Xinhua news agency, over 11% of Chinese above age 20 suffer from osteoporosis and there are about 35M to 40M osteoporosis patients nationwide (read this Seeking Alpha post also). An earlier report from the same agency on 2003’s World Osteoporosis Day indicated that osteoporosis related fracture rate exceeded 9% and was on a trend to increase year over year. Interestingly, back then it put the osteoporosis patient population at an even more alarming 90M, or 7% of the entire Chinese population, making the world’s most populous county also the largest in terms of osteoporosis patients.
4. China's aging population translates into an increasing number of osteoporosis patients and more medical spending.
5. China’s phenomenal GDP growth is set to continue and every 1% of GDP growth is accompanied by approximately 1.7% growth of the medical and healthcare market.
6. Tongjitang’s XLGB, Zaoren Anshen Capsules, Moisturizing and Anti-itching Capsules and Dianbaizhu Syrup are in the national and provincial medicine catalogs of the National Medical Insurance Program. Participants in this program get 80 to 100% reimbursement for purchases of these medicines (from either hospitals or OTC stores). The Chinese government expects the enrollment in the National Medical Insurance Program to almost double to 300M by 2010, from 157M as of end of 2006.
7. Although XLGB is the company’s main revenue source (77% of total revenue as of FY 2006, 78% as of Q2 2007), TCM is not exactly a one-trick pony. It also has ten other SFDA-approved Chinese medicines in its portfolio. In Q2, sales from other core products (Zaoren Anshen Capsules, Moisturizing and Anti-itching Capsules and Dianbaizhu Syrup) increased 193% vs. XLGB’s 11%. Similar trends should continue in the future. There are also a couple of other traditional Chinese medicines (for treating depression, menstrual pain and anxiety) in different stages of clinical trial.
8. One of the key reasons Chinese pharmaceutical stocks remain attractively priced is due to the 20+ large-scale, drug-price-cutting campaigns mandated by the central government since 1997. However, the main targets of these price cuts have mostly been low-quality copycats. Government has consistently indicated willingness to protect high quality name brands, particularly top traditional Chinese medicines. The price cuts have not affected TCM’s products, while in July 2005 the 50-pack XLGB capsules actually got an 11.1% boost on price ceiling. I’m cautiously optimistic about the continuation of this discriminative policy in the future.
9. The company has a good OTC strategy.
The Chinese OTC market has grown at an annual rate of over 20% in
recent years. By 2010, its market size is expected to reach that of the
United States in 1995. Compared to the hospital market, OTC market is
also much less susceptible to the government’s price-cutting
initiatives. Government actually encourages patients to purchase
medicines from the OTC market as a way to decrease the medical
insurance cost. Therefore, to a great extent OTC market serves as a
safe harbor for pharmaceutical producers.
TCM has a strong sales force (of 500 as of March) targeting the OTC market. Revenues from the OTC market have brought in a higher gross margin to the company, compared to those generated from hospitals. So far the OTC market has made a significant contribution to TCM’s total revenue and its contribution is expected to increase further in the future.
10. XLGB promises to become the first ever FDA-approved traditional Chinese medicine, thus entering the U.S. market. TCM contracted Synarc to perform clinical study of XLGB as a drug for the treatment of osteoporosis in late 2005. Synarc co-founder, Chairman Emeritus and renowned authority in osteoporosis Mr. Harry K. Genant also serves on TCM’s board as an independent director. On Thursday, Oct. 25, China’s official newspaper People’s Daily republished a report by Health Times on a positive result from XLGB's efficacy and safety verification study by Synarc, in which centralized imaging and biochemical marker techniques were used. The randomized, double-blind, multi-center study lasted two years and has proved XLGB’s efficacy and safety for the treatment of post-menopause osteoporosis. XLGB has been found to inhibit bone resorption and increase bone density significantly. The study also found that simply taking calcium and vitamin D supplements does not have the beneficial effect of improving bone density. With this encouraging result, TCM can now begin the FDA regulatory submission process. According to the U.S. National Osteoporosis Foundation, osteoporosis is a major public health threat for an estimated 44 million Americans. Based on the positive efficacy and safety result, I feel the company might also begin regulatory processes in Europe and other regions as well sometime in the future.
11. China’s strong economy has created great soil for consolidation in fragmented industries like pharmaceuticals. TCM sees itself as a leading consolidator in its industry. In September it entered into a purchase agreement to acquire 100% registered capital of Guizhou LLF Pharmaceutical for RMB 42.2M. Guizhou LLF is a profitable company with about RMB 50M of revenue in 2006 and will add more than 10 OTC and prescription traditional Chinese medicines to TCM’s product portfolio once the acquisition is complete. This acquisition should help to reduce the company’s dependency on XLGB. Combined with other existing products, it promises to bring down XLGB’s revenue contribution from 77% in 06 to the 70% level. Thanks to its IPO earlier this year, TCM had RMB 772M of cash as of the end of Q2. So one can expect to see more deals announced going forward.
12. The company also manufactures 37 western medicines. One such medicine is in clinical trials for the treatment of post-surgical acute pain. Although revenue contribution from these products is insignificant at present, they appear to be paving the way for a more diversified product portfolio. Given proper execution, these insignificant products could just be on their way to ride on the reputation of the Tongjitang brand and be significant one day.
Q3 earnings release is right around the corner, you want to keep your
excitement at bay since this is seasonally the weakest quarter of the
year. XLGB’s positive clinical results on efficacy, safety and FDA
application might serve to cheer up traders and investors a bit. But
the three-day spike earlier this week likely has discounted the news
somewhat. Moreover, the actual FDA approval is still years away. If you
are a long-term investor, however, you would not need to be concerned
with the quarterly fluctuations or any event-driven price movements.
And you want to buy when price goes down instead of when it goes up.
Disclosure: the author is long TCM as of this writing. This post is not a recommendation to buy or sell TCM stock.