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Wednesday, October 04, 2006

Landwind @ 46 cts ( Medical equipment / China ) 7 comments

Final Poll Results: 8:3

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1. Entire China healthcare sector facing regulatory uncertainty

2. Not cheap compared to peers that have corrected

3. Dependence on distribution strength rather than intellectual property

Just half a year ago the China healthcare sector, comprising the pharmaceutical companies and the medical equipment companies, were acquiring growing investor following --- not just retail investors, but also institutional investors. The logic was compelling --- medical services was always going to be necessary for the largest population in the world, and healthcare is both a defensive sector (being necessary services/products) as well as a growth sector equal to the best consumer products. And so they thought --- and since then Templeton has lost a fair bit of their Celestial gains in their subsequent investment in Asiapharm which has corrected sharply. Most other China healthcare-related firms listed on the SGX have been hit in their share prices --- C&O, Sunray, Star Pharmaceutical, Reyoung, Pharmesis.

The trigger event has been an ongoing reform of the medical products market in China. The government measures implemented include a campaign launched in mid-2006 to curtail ‘kickbacks’ or corruption within the medical equipment sector, introduction of more stringent requirements in the medical equipment and pharmaceuticals approval process by the State Food and Drug Administration (“SFDA”) to raise the quality of medical products in China closer to international standards, and restricting percentage of revenue from the sales of prescription drugs in hospitals (hence controlling drug costs).

It appears that this series of reforms has deep implications for the profitability of the healthcare-related companies, or at the very least has increased near to medium-term earnings risk. In the past, because of the government's long-time efforts in cost containment, physicians and medical institutions have been forced to deliver basic services at below-cost prices, but they have typically recouped losses through charges for medicines and high-tech tests (and hence equipment). In these two areas, the government allowed medical providers to charge prices that exceeded costs. So the price of physician consultation is extremely low, but medications and tests are overpriced. That is the reality; now the government appears to be clamping down on these two areas as well. That means margins for pharmaceutical and medical equipment manufacturers and distributors will be crimped.

This is a sector-wide phenomenon, and although some might argue that specific companies might have proprietary competitive advantages, discretion is the better part of activity when the sector faces a true headwind. This is corroborated by the operational difficulties that have afflicted previously steadily growing companies: AsiaPharm reported slowing profit growth, Sunray released a business update noting the "industry-wide slowdown" and more or less hinted at significant negative company impact due to this measures, and C&O released a thinly-veiled profit warning just yesterday albeit due mainly to lower contribution from an acquisition (where the explanation was rather convoluted).

In particular, it is worthwhile tracking the business update of Sunray, the most comparable company to Landwind since both are distributors of medical equipment (Sunray in gynaecological equipment, Landwind in ultrasound). Sunray is particularly worried about the "crack-down on corruption and commercial bribery in the healthcare sector, and the ensuing inspections of various medical institutions and hospital personnel", which have "led to delays in the procurement of medical equipment, affecting industry sales of medical equipment in recent months". Medical equipment are increasingly being procured through tender systems, which I interpret to mean takes some of the margin away due to increased transparency and a clearly-defined set of procurement decision rules. Notwithstanding the light that this throws on the shadiness of the purchasing deals done under the current system, it appears that the reforms suggest that medium-term outlook does not look good.

Landwind has corrected less than the rest, and has indeed recovered in price recently, probably due to recent coverage by brokers such as GK Goh who are projecting RMB83M FY06 net profits when HY06 profits was only RMB24M. The bullish projection was on the basis of new radiography products rollout in 2H06 but we have already seen the abovementioned trend of hospitals delaying/slowing down their purchases. Landwind is trading at 3X NTA and 12X trailing (FY05) PE: not exactly exorbitant but not cheap either, especially given the tepid medium-term outlook and lower peer comparables (Sunray at 7.5X PE). Note that its revenue base is not founded on in-house products, but rather primarily on distribution of foreign products from Siemens, Philips and Honda Electronics (85-90% of total revenue, with house products filling the rest). There are two further negative issues associated with its niche: it deals mainly in premium range equipment (as opposed to lower-end "standard range equipment") which are expected to see most impact from the government healthcare reforms, and its main value-add being an equipment distributor suggests that its most important asset is its China-wide distribution network --- and that is exactly what is being reformed now.

Expect to see some downward correction in profit margins in its next set of results.

(1) article: Perspectives on Growth of the Outsourcing Market in China's Healthcare Sector
(2) People's Daily article 22 Aug 06: NDRC deals with medicine and medical service price hikes
(3) Various announcements in SGX website, pertaining to Asiapharm, Sunray, Landwind
(4) CIMB GK Goh 28 Sep 06 report on Landwind

Poll(please vote)
I agree that Landwind is a hot-stock-not: Yes/No




Blogger gsg said...

hi danielxx,

any chance you see sunray as also a hot-stock-not, and any insights on sunray?


10/06/2006 3:48 AM  
Blogger DanielXX said...

Hi gsg,
Given that the China healthcare industry is in a state of flux, plus the fact that the acquisition of that TFT-related company by Sunray was only recent and yet to establish a track record under group consolidation, it may be more prudent to avoid. But probably the best play on the China medical equipment sector, though that's not saying much.

From all past investor interest and company performances, the best China healthcare stock would be Asiapharm. That's my 5-cent view :-)

10/08/2006 10:25 AM  
Blogger gsg said...

well noted and will value yr input. 5cts is definitely 2.5 times that of 2cts.....cheers

10/18/2006 8:29 AM  
Blogger morris said...


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