china phrama CPHI
January 26, 2009 - 11:14am EST by
oliver1216
2009 2010
Price: 1.15 EPS $0.43 $0.49
Shares Out. (in M): 42 P/E 2.7x 2.3x
Market Cap (in M): 49 P/FCF na na
Net Debt (in M): -6 EBIT 19 24
TEV: 43 TEV/EBIT 2.2x 1.8x

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Description

 

Overview

China Pharma Holdings, Inc. ("CPHI") is a leading Chinese generic drug manufacturer which will be a major beneficiary of the Chinese government's recently announced plan to increase spending on healthcare by an astonishing 44% annually (vs. 2007) for 2009-2011.  The company is also well positioned to capitalize on the aging and increasingly affluent Chinese population, which will create increasing demand for the Western drugs that CPHI manufactures.  Over the next few years, the company will also benefit from the introduction of several blockbuster new drugs that are currently underdevelopment.   Finally, CPHI is a natural beneficiary of the significant consolidation that is occurring in its market   While CPHI manufactures and sells all of its products in China, it is publicly traded in the USA. The company has grown revenue 48% annually over the past two years, is projected to grow EPS at least 40% over the next two years, has no debt and trades at only 2.2x 2008E EBIT, 1.8x 2009E EBIT, 2.7x 2008E EPS, 2.3x 2009E EPS, 1.9x 2010E EPS.  If the valuation isn't attractive enough on these multiples, consider that earnings growth should begin to grow even more significantly after 2010 when (i) some of the company's new products that are currently under development finally hit the market and (ii) the increased government spending (discussed below) really kicks in.  Importantly, CPHI's president/CEO owns over 25% of the company's stock, so she is clearly motivated to create shareholder value.

 

Description

Located in China's Hainan Province, CPHI develops, manufactures and markets off-patent blockbuster drugs, targeting those with $1bn+ in cumulative global sales.  The company has a diversified portfolio of over 30 drugs and specifically targets high incidence, high mortality diseases.  CPHI's portfolio of drugs focus on four major segments:

  • 1) Cardiovascular & Cerebrovascular diseases (41% of revenue)
  • 2) Infections diseases (24% of revenue)
  • 3) Central nervous system diseases (23% of revenue)
  • 4) Cold and flu (12% of revenue)

 

The first two of these segments are among the leading causes of death in China, so clearly there is a critical need for these products.

 

Despite the company's significant historical growth, the company's products will continue to experience increasing demand as a result of China's:

  • 1) Improved affluence/quality of life, which creates greater demand for healthcare;
  • 2) Aging population which creates additional age-related disorders; and
  • 3) Increasing government healthcare coverage (as discussed below)

 

The company is developing many new products and expects 8 -11 new product to be approved by the government by 2010.  Most exciting is a new generation antibiotic that is currently under clinical trials.  Analysts estimate that if the trials are successful, sales of this product in the first three years should exceed $40mm, which is highly meaningful considering the company's total 2008 revenues are projected to be $48mm.  Note that analysts' estimates do not include any sales of this product. 

 

Much of CPHI's growth has come from the introduction of its new drugs, in addition to organic sales growth of existing products.  Over the past three years, the company has had 9 new products approved by the SFDA (China's regulatory body).  As an example of how effective these new product launches can be, consider CPHI's leading cold & flu medicine, Pusenok, which is similar to Bayer's Aleve.  It was introduced in 2006 and its revenue increased 128% in 2007 to $4.1 million.  YTD September 2008, its revenues were up another 125%.  Revenue growth of this product will continue as the product is rolled out to new distribution points and as consumer acceptance of the product increases.

 

The company distributes its products through 16 sales offices in 30 provinces and is expanding its distribution network.

 

The company has modern, scalable and cost efficient manufacturing and does not need to invest heavily in PP&E to accommodate future growth.  The company has 8 production lines whose capacity utilization is currently between 23% - 77%.  We have visited the company's manufacturing facility and were favorably impressed.

 

Industry Overview

CPHI is well positioned in the Chinese market.  Generic western medicine (CPHI's core business) makes up approximately 75% of China's drug market, with the remaining 25% representing traditional Chinese medicine (i.e. herbs).  In China, 80% of the drugs are generic, an area which is CPHI's focus.  Finally, imported medicines are generally not covered by China's Social Medical Insurance so there are huge barriers to entry for foreign players.

 

The Chinese pharmaceutical industry is highly fragmented and is rapidly consolidating.  There are currently over 3,000 pharmaceutical companies, with the top 10 accounting for only 15% of total industry sales.  The consolidation is being driven by the usual forces (i.e. economies of scale) and equally important, the increasingly stringent governmental regulations.  Anyone who has followed the tainted milk scandal in China understands the government's increased emphasis on quality control for many products.  Given its high profile nature, the pharmaceutical industry is of particular interest to the government, so it reacts quickly if it determines a company's products or manufacturing may be deficient.  As a result, smaller industry players with less sophisticated manufacturing capabilities are being forced out of business or into a competitor's arms as a result of the tighter and more expensive government regulation.  This consolidation trends benefits CPHI is several ways.  First, it will gain market share as many smaller players leave the industry.  Second, it can acquire other smaller competitors at very attractive valuations.  Thirdly, CPHI may be an acquisition target for a larger domestic or foreign player.  Considering many larger drug companies trade at significantly higher multiples than does CPHI, these companies could pay a huge premium for CPHI and still have the acquisition be accretive.

 

Management

Management is strong and is lead by President and CEO Li Zhilin who owns 25% of CPHI's stock.  Unfortunately she does not speak English well, but there are people at the company who do speak English and can help translate should you wish to call her or the CFO.  The company's NY based investor relations firm can also be helpful and can provide CPHI's latest investor presentation.  On a related note, we speak Chinese and also have staff in China who meet or speak with the company on a regular basis.

 

Valuation

Below is the company's valuation.  Several important factors to consider include:

 

  • 1) Projections do not include any new drugs that have not yet received government approval;
  • 2) Projections have not been increased to reflect recent government increases in healthcare;
  • 3) Projections do not include any acquisitions, which if consummated could be highly accretive given the consolidation occurring;
  • 4) Projections are not dependant on the company raising more capital;

 

 

 

Stock Price

 $   1.15

 

 

 

 

 

 

 

 

EBIT

$

EV/

Shares Outstanding

42.2

 

2008E

19.1

2.2x

 

 

 

 

2009E

23.6

1.8x

Equity Market Cap

48.5

 

2010E

30.3

1.4x

 

 

 

 

 

 

 

Cash

 

5.8

 

 

 

 

 

 

 

 

EPS

$

P/

Debt

 

0.0

 

2008E

0.43

2.7x

 

 

 

 

2009E

0.49

2.3x

Enterprise Value

42.7

 

2010E

0.62

1.9x

 

 

 

 

 

 

 

 

 

Most comparables stocks trade at high-single digit or low double digit 2009 P/Es.  Most of these companies are larger than CPHI but have significantly lower growth rates.  We will let you determine what's an appropriate multiple for this stock, but the below table illustrates that significant stock price appreciation should the company's multiple increase from its currently ridiculous level to a variety of more reasonable multiples.  For example, if the stock were to trade at a 5x 2009 p/e, CPHI would trade at $2.50 per share, up over 100% from current levels.

 

 

2009 p/e multiple

 

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

implied stock price

 

 $   1.00

 $   1.50

 $   2.00

 $   2.50

 $   3.00

 $   3.50

 $   4.00

implied stock price change

-13%

30%

74%

117%

161%

204%

248%

 

 

 

Why is the stock trading so cheaply

 

  • 1) It is a microcap and the entire sector has been crushed due to hedge fund liquidations. In 2008, CPHI's stock was down 62% even though 2008E eps (not yet released) is projected to grow 27%.
  • 2) The Chinese market also got crushed last year.
  • 3) It is a relatively unknown company with only limited sell side coverage. The company recently hired a new, NY based investor relations firm and is committed to increasing its awareness among U.S. investors. In November, 2008 management spoke at two conferences in the USA. We expect management to be in the USA meeting with investors on a regular basis.
  • 4) The company has relatively high accounts receivable balances. Most of the company's sales are to government owned hospitals in China. While the company has never not collected on a receivable, it sometimes takes a while for the hospitals to pay the company, which negatively impacts CPHI's working capital. The company is working with the hospitals and outside financing sources in an effort to improve this situation.
  • 5) The stock is relatively illiquid given its small market cap and concentrated shareholder base. We do not believe any of the major shareholders are interested in selling their shares, but as we have seen on numerous occasions with these kind of stocks, a stock's liquidity often increases dramatically once the stock begins to get some investor attention.
  • 6) Management does not speak English well - While this may scare away some investors, it creates a significant opportunity for investors willing to do a little extra work. As mentioned, there are people at the company who can translate during a call with the CEO or CFO and the company's i.r. firm can also be helpful. On a related note, we speak Chinese and also have staff in China who meet or speak with the company on a regular basis.

 

Recent Regulation

On January 21, 2009 the Proposal of China Healthcare Reform was released by the Chinese government.  According to Susquehanna Financial Group, " The Chinese government will increase its spending on healthcare by 44% annually (vs FY 2007) to ~$42 billion for 2009- 2011, up from 15% growth of government healthcare spending over the past five years.  Part of the new budget will be used to increase the government subsidy for 84% of the Chinese population by 20%-50% each year, starting in 2010.  The new guidelines also established a more aggressive timeline on providing basic national insurance coverage by 2011, instead of 2020.  Based on these new details, we estimate a potential $31 billion annual increase of drug sales (domestic drug sales in China reached ~$67 billion in 2008) benefiting directly from the healthcare reform."

Catalyst

 

  • - Increased awareness of CPHI from increased investor relations
  • - Increased interest in Chinese stocks (Cramer very bullish on them)
  • - Increased awareness in USA regarding new China health plan
  • - EPS results expected in March
  • - New drug approvals
  • - Possible acquisition of the company - it is just too cheap and there are many logical buyers
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    Description

     

    Overview

    China Pharma Holdings, Inc. ("CPHI") is a leading Chinese generic drug manufacturer which will be a major beneficiary of the Chinese government's recently announced plan to increase spending on healthcare by an astonishing 44% annually (vs. 2007) for 2009-2011.  The company is also well positioned to capitalize on the aging and increasingly affluent Chinese population, which will create increasing demand for the Western drugs that CPHI manufactures.  Over the next few years, the company will also benefit from the introduction of several blockbuster new drugs that are currently underdevelopment.   Finally, CPHI is a natural beneficiary of the significant consolidation that is occurring in its market   While CPHI manufactures and sells all of its products in China, it is publicly traded in the USA. The company has grown revenue 48% annually over the past two years, is projected to grow EPS at least 40% over the next two years, has no debt and trades at only 2.2x 2008E EBIT, 1.8x 2009E EBIT, 2.7x 2008E EPS, 2.3x 2009E EPS, 1.9x 2010E EPS.  If the valuation isn't attractive enough on these multiples, consider that earnings growth should begin to grow even more significantly after 2010 when (i) some of the company's new products that are currently under development finally hit the market and (ii) the increased government spending (discussed below) really kicks in.  Importantly, CPHI's president/CEO owns over 25% of the company's stock, so she is clearly motivated to create shareholder value.

     

    Description

    Located in China's Hainan Province, CPHI develops, manufactures and markets off-patent blockbuster drugs, targeting those with $1bn+ in cumulative global sales.  The company has a diversified portfolio of over 30 drugs and specifically targets high incidence, high mortality diseases.  CPHI's portfolio of drugs focus on four major segments:

     

    The first two of these segments are among the leading causes of death in China, so clearly there is a critical need for these products.

     

    Despite the company's significant historical growth, the company's products will continue to experience increasing demand as a result of China's:

     

    The company is developing many new products and expects 8 -11 new product to be approved by the government by 2010.  Most exciting is a new generation antibiotic that is currently under clinical trials.  Analysts estimate that if the trials are successful, sales of this product in the first three years should exceed $40mm, which is highly meaningful considering the company's total 2008 revenues are projected to be $48mm.  Note that analysts' estimates do not include any sales of this product. 

     

    Much of CPHI's growth has come from the introduction of its new drugs, in addition to organic sales growth of existing products.  Over the past three years, the company has had 9 new products approved by the SFDA (China's regulatory body).  As an example of how effective these new product launches can be, consider CPHI's leading cold & flu medicine, Pusenok, which is similar to Bayer's Aleve.  It was introduced in 2006 and its revenue increased 128% in 2007 to $4.1 million.  YTD September 2008, its revenues were up another 125%.  Revenue growth of this product will continue as the product is rolled out to new distribution points and as consumer acceptance of the product increases.

     

    The company distributes its products through 16 sales offices in 30 provinces and is expanding its distribution network.

     

    The company has modern, scalable and cost efficient manufacturing and does not need to invest heavily in PP&E to accommodate future growth.  The company has 8 production lines whose capacity utilization is currently between 23% - 77%.  We have visited the company's manufacturing facility and were favorably impressed.

     

    Industry Overview

    CPHI is well positioned in the Chinese market.  Generic western medicine (CPHI's core business) makes up approximately 75% of China's drug market, with the remaining 25% representing traditional Chinese medicine (i.e. herbs).  In China, 80% of the drugs are generic, an area which is CPHI's focus.  Finally, imported medicines are generally not covered by China's Social Medical Insurance so there are huge barriers to entry for foreign players.

     

    The Chinese pharmaceutical industry is highly fragmented and is rapidly consolidating.  There are currently over 3,000 pharmaceutical companies, with the top 10 accounting for only 15% of total industry sales.  The consolidation is being driven by the usual forces (i.e. economies of scale) and equally important, the increasingly stringent governmental regulations.  Anyone who has followed the tainted milk scandal in China understands the government's increased emphasis on quality control for many products.  Given its high profile nature, the pharmaceutical industry is of particular interest to the government, so it reacts quickly if it determines a company's products or manufacturing may be deficient.  As a result, smaller industry players with less sophisticated manufacturing capabilities are being forced out of business or into a competitor's arms as a result of the tighter and more expensive government regulation.  This consolidation trends benefits CPHI is several ways.  First, it will gain market share as many smaller players leave the industry.  Second, it can acquire other smaller competitors at very attractive valuations.  Thirdly, CPHI may be an acquisition target for a larger domestic or foreign player.  Considering many larger drug companies trade at significantly higher multiples than does CPHI, these companies could pay a huge premium for CPHI and still have the acquisition be accretive.

     

    Management

    Management is strong and is lead by President and CEO Li Zhilin who owns 25% of CPHI's stock.  Unfortunately she does not speak English well, but there are people at the company who do speak English and can help translate should you wish to call her or the CFO.  The company's NY based investor relations firm can also be helpful and can provide CPHI's latest investor presentation.  On a related note, we speak Chinese and also have staff in China who meet or speak with the company on a regular basis.

     

    Valuation

    Below is the company's valuation.  Several important factors to consider include:

     

     

     

     

    Stock Price

     $   1.15

     

     

     

     

     

     

     

     

    EBIT

    $

    EV/

    Shares Outstanding

    42.2

     

    2008E

    19.1

    2.2x

     

     

     

     

    2009E

    23.6

    1.8x

    Equity Market Cap

    48.5

     

    2010E

    30.3

    1.4x

     

     

     

     

     

     

     

    Cash

     

    5.8

     

     

     

     

     

     

     

     

    EPS

    $

    P/

    Debt

     

    0.0

     

    2008E

    0.43

    2.7x

     

     

     

     

    2009E

    0.49

    2.3x

    Enterprise Value

    42.7

     

    2010E

    0.62

    1.9x

     

     

     

     

     

     

     

     

     

    Most comparables stocks trade at high-single digit or low double digit 2009 P/Es.  Most of these companies are larger than CPHI but have significantly lower growth rates.  We will let you determine what's an appropriate multiple for this stock, but the below table illustrates that significant stock price appreciation should the company's multiple increase from its currently ridiculous level to a variety of more reasonable multiples.  For example, if the stock were to trade at a 5x 2009 p/e, CPHI would trade at $2.50 per share, up over 100% from current levels.

     

     

    2009 p/e multiple

     

    2.0x

    3.0x

    4.0x

    5.0x

    6.0x

    7.0x

    8.0x

    implied stock price

     

     $   1.00

     $   1.50

     $   2.00

     $   2.50

     $   3.00

     $   3.50

     $   4.00

    implied stock price change

    -13%

    30%

    74%

    117%

    161%

    204%

    248%

     

     

     

    Why is the stock trading so cheaply

     

     

    Recent Regulation

    On January 21, 2009 the Proposal of China Healthcare Reform was released by the Chinese government.  According to Susquehanna Financial Group, " The Chinese government will increase its spending on healthcare by 44% annually (vs FY 2007) to ~$42 billion for 2009- 2011, up from 15% growth of government healthcare spending over the past five years.  Part of the new budget will be used to increase the government subsidy for 84% of the Chinese population by 20%-50% each year, starting in 2010.  The new guidelines also established a more aggressive timeline on providing basic national insurance coverage by 2011, instead of 2020.  Based on these new details, we estimate a potential $31 billion annual increase of drug sales (domestic drug sales in China reached ~$67 billion in 2008) benefiting directly from the healthcare reform."

    Catalyst

     

    Messages


    SubjectRE: auditor
    Entry01/27/2009 09:35 AM
    Memberoliver1216

     

    That is an issue we confront with many microcap stocks.  On one hand we wish they had the credibility of a top 5 firm, on the other hand we are glad they are not paying the expense for a top 5 firm.  We have spoken with and diligenced CPHI's accounting firm and found nothing that concerned us.


    SubjectRE: RE: RE: Yikes
    Entry01/29/2009 11:22 PM
    Memberroc924

    Gary, you wrote the company made an acquisition and it should be excluded from free cash flow. I didn't see an acquisition as far back as I looked (2006); maybe you meant intangible purchases? I included the purchase of intangibles in the definition of free cash flow since I view it as an ongoing cost for a generic drug company. The company defines intangibles: Intangible assets represent the costs on patents, trademarks, licenses, techniques and formulas. What really caught my eye was that the company burned cash while reporting cumulative earnings of over $30m from 2006 through Sep08; meanwhile the company has an auditor I've never heard of, a material weakness in financial reporting and it had to restate accounts, one of which was purchase of intangibles.

    Oliver, I forgot to thank you for the report. Thanks! I sincerely hope this stock goes up a lot. You have a severely depressed stock and Chinese market and probably the right sector. Good luck. Cheers, roc.

     


    SubjectQuestions
    Entry02/04/2009 02:04 PM
    Memberbentley883

     

    Oliver

    I found your idea on China Phrama very interesting and agree that the shares appear to be very attractively priced. As I have been looking at investment ideas in China I wanted to ask you a couple of questions. Given your work on CPHI and your comments about your firm having staff in China, I though you could provide insights on some of the issues I (and likely other VIC members) am wrestling with regarding a China investment such as this.

     1) In reading the China Phrama 10K it appears that the company has lets say a very interesting history prior to its present day formation as a generic drug manufacturer. Is that the case with many US listed China based public companies?

     2) I was told that in China, local companies are not allowed to list overseas unless you are a state owned entity (SOE). To circumvent that rule, many private Chinese companies will buy or create an offshore entity, sell most of its assets of the domestic entity to the foreign entity which will then be allowed to list. As title to land is not allowed to be transferred to a foreign entity as per Chinese law, they will have to create a lease arrangement. The same is true of factories and in many cases these leases are way below market price. This helps Chinese companies reduce their cost structure and undercut any competitors. As a result profitability is artificially inflated and little depreciation or maintenance cap-ex gets reported. As reporting is lax, most investors, who are attracted to the rich margins in the business, are not aware of this practice (until it is too late!). Note, I am NOT saying that this is the case here. However, as you clearly have done a lot of work on Chinese entities, can you please speak to this issue in general (i.e. is it widespread, how would an investor detect such a potential issue?).

     3) Given the well documented past accounting related issues (i.e. fake invoices and bank accounts, phony sales, etc.) as well as the accounting from Mandarin to US GAAP standards, how do you get comfortable with this risk? Have you had the opportunity to speak with the company's China based auditors? What key questions made you feel comfortable with the numbers? What are the major red flags you look for?

     4) Looking at the past financials for China Phrama and its stock price it appears that despite delivering strong growth on the top and bottom line the stock has not been rewarded. That said, while I read the reasons you state why the stock is trading so cheaply, will China Phrama (and for that matter other Chinese based growth companies) unlikely to be accorded a more reasonable valuation until the overhang of investor uncertainty regarding the issues associated with Chinese stocks clear up?

     Thanks in advance

    Bentley


    SubjectRE: Questions
    Entry02/04/2009 06:13 PM
    Memberoliver1216

    1&2) Like many US listed chinese companies, cphi came public by merging with a public shell.  As you mentioned in quetion 2) it is very difficult for most chinese companies to go public in china , so they use the shell  to quickly get public and raise capital.  thus , the biz that cphi legally may have been (as per the 10k?) in was really the biz of the shell, before it became an empty shell..if that makes sense.  The issue you raised in question 2 is not applicable to cphi or other us listed chinese stocks we invest in, so i cant really comment on how cos listed elswhere might be.

    3) My firm has a team in china (native born chinese) as well as people in the usa who speak english and mandarin.  As a result, we can probably due dili a chinese company better and more easily than can most us investors.  We speak the companies' languages, literally andd figurateivily.  We can also due dili/visit suppliers and customers.  Our local presence has helped us get verey comfortable that there is no fraud here.  We also speak with mang frequently and have known them for some time.  We have spokenn with the accountants and cfo.  Would we be more comforatable if they used a larger , well know accoutning firm> yes in the sense that it would give the investment community more confidence, but no b/c we know a larger firm would charge (the relatively small) cphi a lot more $.  Over time i think you will see CPHI and other chinese firms upgradin their accountants.  We found no related or questionable accounting transactions..the only issue is the a/r, but that is a matter of timing, not collectabiltiy and the company takes a reserve against the a/rs even though they have never not collected on an a/r.

    4) i dont have an answer to that one..in my opinion its only a matter of time.  These stocks are so cheap tht i view my downside to be limited and know that the upside is signficant.  Many of these stocks have seen their stocks been destroyed and are now willing to listen to the advice of us investors regarding how to create shareholder value (better i.r., better accounting, etc).  there is also a lot of private equity $ looking at china and manhy of these stocks are logical buyouts.  Many of these stocks are just unknown to the investment community and i think /hope that with some more i.r. their stock will trade up.  CPHI has had nice vol since this write up andd had there not been a large seller at $1.30(i dont know who it is), i suspect the stock would be higher. 

    Hope my answers werent too disjointed.

     


    SubjectSafety?
    Entry02/10/2009 10:49 PM
    Membercarbone959

    Simple question - are you 100% sure that the products they make are safe and/or that there is no corruption at the SFDA?

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