Health Care 2013 Investment Strategy

Chinese health care stocks (offshore listed) rebounded in 2012, posting a 34% gain vs. the HSI’s 21% rise. Sector multiples also recovered from the mid-teens to the high teens, which we believe adequately reflects the sector’s growth potential of 15~20% over the next few years. We remain positive on the sustainable growth prospects of China’s health care industry; we also think the industry is ripe for accelerated consolidation, which should benefit well-positioned sector leaders.

Key trends in 2013

New health reform phase focuses on cost reductions, leading to moderated growth and margin pressure. Key measures include reform of the payment system in a bid to contain escalating medical costs and prevent over-prescription, as well as increase controls over drug prices.

Rising industry standards to accelerate consolidation pace. Government has been introducing more measures to raise standards for the pharmaceutical industry. Those that are unable to upgrade will be eliminated. We thus anticipate increasing pharmaceutical acquisitions. Strategically sound M&As will be viewed favorably.

Expansion of private hospital sector. Government has implemented favorable policies to develop the private hospital sector, aiming to double its contribution from the current 10% to 20% by 2015.

2013 investment strategy

Industry consolidators: We favor Fosun Pharma and Sinopharm as the best positioned to ride the consolidation wave.

First movers in the private hospital sector: Leaders should enjoy fast growth of ~20%, and margin improvement due to pricing upside and operating leverage. We favor Fosun Pharma and Concord Medical.

Turnaround stories: We are positive on stocks with significant potential to see improved fundamentals and attractive valuations. We favor Shandong Weigao and Shanghai Pharmaceuticals.

Valuation and recommendation

We maintain our BUY ratings on Fosun Pharma (02916.HK, 12-month TP HK$15.5), Shandong Weigao (01066.HK, 12-month TP HK$10), Mindray (MR.US, 12-month TP US$36), and Sinopharm (01099.HK, 12-month TP HK$28.5). We also maintain our ACCUMULATE ratings on Shanghai Pharma (02607.HK, raise 12-month TP from HK$15 to HK$17.5), Trauson (00325.HK, raise 12-month TP from HK$3 to HK$3.1) and Concord Medical (CCM.US, 12-month TP of US$5.2). We maintain our HOLD rating on Guangzhou Pharma (00874.HK, raise 12-month TP from HK$8 to HK$11.5).

Risks

Slower economic growth; less favorable government policy; stiffer competition; product development failures; price cuts; Rmb appreciation weakens competitiveness of Chinese products in international markets.