Sihuan Pharmacuetical - Strong operating performance

We have raised our six-month target price to S$0.94, from S$0.70, to factor in an improved operating outlook for Sihuan Pharmaceutical (Sihuan), following the announcement of its 2Q FY09 results. Our target price is based on a PER of 5.5x (a 35% discount to the forward peer-median PER) on our FY10 earnings forecast (from FY09 previously).

Sihuan recorded a 2Q FY09 net profit of Rmb64.7m, up 6.6% YoY, which included a divestment gain of Rmb38.2m, and a Rmb73.3m write-down of intangible assets. As a result of the “house-cleaning” exercise, we no longer expect asset write- down to be a drag on future earnings.

Sihuan’s pretax profit, excluding the divestment gain and asset write-off, was 17.4% above our forecasts. Sales revenue rose 38.4% YoY, and contributions from its key products – Kelinao, Anjieli, Chuanqing, Quao and Ninxinao – also exceeded our expectations. We have lowered our FY09 net profit forecasts by 8.6% to factor in the asset write-down, and raised our net profit forecasts for FY10 and FY11 by 7-8% to factor in a stronger outlook.

We maintain our 2 rating for Sihuan in view of its strong operating performance for 2Q FY09. We have raised our six-month target price to S$0.94, from S$0.70, to factor in an improved operating outlook.

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Sihuan Pharmaceutical - Preliminary views of 1Q FY09 results

Sihuan's net profit of Rm61.0m was 13.7% below our forecasts, due mainly to its impairment charge on intangible assets.

We are concerned about the continued impairment of intangible assets, which has depressed earnings in the near term. We expect earnings growth to pick up when the provisioning subside.

We do not have much issues on the operations - sales and gross profit were in line with our forecasts.

However, we have a longer term concern over the two-invoice system to be implemented nation-wide in the PRC. We believe this will have an impact on Sihuan's future sales and earnings growth.

We will elaborate more about our concerns over impairment charges and two-invoice system in our coming report (just sent to production).

Sihuan Pharmaceutical - Eventful week ahead

Sihuan Pharmaceutical (Sihuan) is due to hold its AGM on 27 April and announce its 1Q FY09 results on 28 April, while the stock will go ex-dividend on 30 April.

We forecast Sihuan to record a 1Q FY09 net profit of Rmb70.7m, up 33.2% YoY, backed by continued sales growth for its key products. The main item to watch, in our view, should be the company’s sales-growth momentum.

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. We will publish an update after the results have been announced.Catalysts and action

We maintain our Buy rating for Sihuan, as we expect the AGM and 1Q FY09 results, as well as the coming dividend of Rmb0.153 per share (which gives a yield of about 4.5% at the current share price), to provide a positive boost to the share price over the near term.

Sihuan Pharmaceutical - Gaining from divestment

• Sihuan Pharmaceutical (Sihuan) is selling its 45% stake in Beijing Purenhong Pharmaceutical (Purenhong) for Rmb101.7m, resulting in a divestment gain of about Rmb38m, by our estimates.

• 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.

Sihuan Pharmaceutical - High-growth stock at cyclical-low prices

However, we have lowered our six-month target price to S$0.88, from S$1.46, in line with the recent market sell-down, and the decline in its peer-average PER to 6.6x (using a blended PER for 2007 and 2008), from 12.4x previously. Our target price is based on a 6.6x PER on our 12-month earnings forecast to 1Q09. We see the consistent delivery of growth and products as the key elements for sustaining our call.

Beyond the current market uncertainty, we see Sihuan Pharmaceutical (Sihuan) trading at S$2.72 in three years, based on a mid-cycle PER of 11.2x for the pharmaceutical sector, and our earnings forecast of Rmb525.1m for 2011. The company’s key growth drivers over the medium term include its traditional core products Kelinao, Anjieli and Chuanqing, new products Aogan and Edaravone Injection, possible patent sales from 2009, and a series of Category I products scheduled for launch from 2010.

Sihuan recorded a 52.9% YoY increase in 3Q08 net profit to Rmb66.5m, amidst the prevailing economic uncertainty. The strong performance was driven by the increasing penetration of its products in hospitals across China. We have revised up our FY08-10 earnings forecasts by up to 7.5%, to factor in the strong performance, and the potential contribution from new products.