Chinese Pharmaceuticals to Watch Part 1

by Zack Buckley, GeoTeam Contributor

When shopping in the supermarket, shoppers always flock to the half off sales. In the stock market, a half off sale creates worldwide panic. Although these circumstances are actually exceptional for long term investors, most people fear the world is ending. I welcome half off sales in the stock market because they are a great way to build long term wealth.

The Chinese pharmaceutical industry presents multiple bargains for value investors. Pharmaceuticals sales in China have been growing at a rate of 15.5% annually from 2005-2010. There is a strong demand for pharmaceutical products in China due to growing income, a larger middle class, and a rapidly aging population. The elderly population in China grew from 130 million in 2000 to 171 million in 2010. Healthcare spending by the elderly is 5 times higher.

In addition the government has made healthcare one of its primary initiatives; as a result, a Universal Health plan package geared to deliver $123 billion in the next three years has been issued.

The industry is rapidly consolidating, where the market leaders are rapidly growing in value. Characteristics of future markets leaders are

1. A strong nationwide sales and distribution network
2. Strong research and development capabilities
3. Access to capital in order to expand

While some companies trade with P/E ratios as high as 63, Lotus pharmaceuticals has a P/E of only 5.12. You would expect a low P/E to be indicative of a stalwart company. However, Lotus Pharmaceuticals grew revenues at 59% from 2005-2008 and has net income up 700% since 2005. Lotus Pharmaceuticals revenue streams are a combination of pharmaceuticals wholesaling and the development and sale of proprietary drugs. Their primary growth strategies are expanding their distribution sales channels in order to increase sales, expanding production capacity through the building of a large factory, and bringing new drugs to the market by partnering with top R&D institutions. We believe a company this cheap should not be overlooked. In summary, lotus is a comprehensive company with both strong manufacturing capability and a nationwide distribution network, great R&D capabilities with a new drug pipeline including a Class I drug, and a very attractive valuation.

China Medicine Corp (OTCBB:CHME) has a current P/E ratio of 5.91 and P/S of 0.69. The company is rapidly growing and has developed a proprietary product rADTZ, which is made to decrease animal mortality rates by fighting Aflatoxins, should substantially enhance revenues. They estimate the addressable market for rADTZ is up to $4 billion and that the successful commercialization and licensing of rADTZ has the potential to substantially improve revenue and profit picture in the years to come. Their distribution consists of 300 hospitals and 500 other medical companies, which leads to 2000 drug stores. Revenues are up to 53 million in 2008 from 15 million in 2005. A company like this is extremely cheap. A comparable company is 3sBio, which has a P/E of 22 and a P/S of 3.96. China medicine is much cheaper than 3sBio with better return on equity and profit margins.

China Yongxin Pharma Inc (OTCBB:CYXN) has a current P/E ratio of 4.9 and a P/S ratio of .25. The company has three divisions, they run 93 retail drugstores in China, similar to Walgreens, they are a distributor of pharmaceutical products, and they have their own proprietary ginseng products. The company’s products are Chinese traditional medicines, chemical pharmaceuticals preparations, flower teas, natural health products, healthy food, cosmetics, and medical equipment. CYXN will focus on expanding its retail chain across China. The company has continued to grow its wholesale business and is moving to expand the higher margin retail and manufacturing activities in the pharmaceutical business. Management also plans to eventually uplist, once the company qualifies.

It is clear that these are three great bargains in the Chinese pharmaceuticals industry. I have a hard time believing markets are efficient when I look at these companies. These companies seem to be trading well below their intrinsic values, although I reserve the right to be wrong. In fact, I have founds tons of undervalued Chinese ADRs. That is why I am going to China this summer to visit as many publicly traded companies as I can fit into two and a half months. In the past three years on their trips to China, The Motley Fool researchers have identified companies that are now all up between 100-500% since their recommendations, I hope to do the same.

Author Disclosure: Long all mentioned stocks, at time of this writing.

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