• We are positive on the divestment, as we believe it would allow Sihuan to focus on its core operations, and also free up cash to support its organic growth and new acquisitions. Sihuan acquired the 45% stake in Purenhong, the largest privately-owned pharmaceutical-product distribution company in Beijing, for Rmb50.7m in May 2008. The selling price of Rmb101.7m is pegged at 7.3x the FY08 net profit for Purenhong, based on our estimates.
• As mentioned in our previous report (A tale of two pharmaceutical companies, published on 24 June 2008), we believe the acquisition was strategic but not core. The acquisition of Purenhong was to help Sihuan consolidate its strong presence in Beijing, but this should be maintained after the divestment, as Sihuan intends to continue selling products through Purenhong in Beijing.
• In addition, there is a difference between the selling methods employed by the two companies. Sihuan sells to distributors on cash terms, and avoids carrying receivables from hospitals. Purenhong, on the other hand, sells to hospitals on credit terms, and its demand for cash and working capital increases as sales rise. Sihuan would have to inject cash continually into Purenhong to fund its growth, in our view.
• We have revised up our earnings forecast for FY09 by 9.1% to factor in the divestment gain, and revised down our earnings forecasts for FY10 and FY11 by 2-3% to factor in the loss of the associated-company contribution from Purenhong. We estimate that Sihuan should have a war chest of more than Rmb400m following the divestment.
• Our six-month target price of S$0.93 is based on a peer-average PER of about 7.5x on our 12-month earnings forecast (excluding one-off items) to 2Q FY09.Catalysts and action
• We maintain our 1 (Buy) rating for Sihuan, and expect continued positive news flow to lift the performance of its share price.
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