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20% Upside Potential Not Difficult For Lee’s Pharma
Corporate Digest | 25 September 2014
By: Louis Kent Lee
Articles (199) Profile

With the Shanghai Hongkong connect exchange starting soon come October, we have been sniffing around for potential plays worth your money in Hong Kong.

Lee’s Pharmaceutical (Lee’s Pharma, stock quote : HK0950), is a niche drug producer that specifically focuses on cardiovascular and blood related diseases in China.

Cardiovascular related disease ranks in the top 4 highest mortality causing diseases in China. Lee’s Pharma’s top performing drug, which contributed more than 45 percent of its revenue last year, specifically targets cardiovascular related diseases.

Lee’s Pharma’s revenue comes from two main pies; proprietary drugs and licensed-in drugs.

Proprietary drugs pertain to drugs that are produced in-house by the company, and licensed-in drugs pertain to drugs brought in (exclusively or on an authorised basis) by the company.

Traditionally, margins are higher for Proprietary drugs, but proprietary drugs involve a lot of Research and Development commitment.

This is not withstanding the risks involved in the process, which include the non-approval by China’s Food and Drug Administration (FDA).

Below are my 3 main reasons on why I like Lee’s Pharma.

1. Top Performing Drug Set To Extend Market Share Reach

The top performing drug of Lee’s Pharma, Carnitine, commands a market share of some 27 percent within the drug class category; Levocaritine, that Carnitine operates within.

An example relatable to Singaporeans would be Panadol. Panadol is a class of drug that contains the element paracetamol, and within the paracetamol market share, Panadol commands a certain percentage of it.

Other than the part where Carnitine has been consistently over the past five years been an anchor revenue generator for Lee’s Pharma, the successful roll out of oral carnitine in January 2014 makes Lee’s pharma the company in China that offers both injection and oral formulations of Carnitine.

This is expected to further extrapolate the market reach of Carnitine. Carnitine’s revenue CAGR has reflected a growth of 43.5 percent over the past five years.

Besides the catalysts identified (oral Carnitine), the supplier that gave Lee’s Pharma the exclusive rights to market and distribute Carnitine in China, Sigma Tau, also has a 25 percent stake in Lee’s Pharma.

This represents an aligned motion of thoughts and interests between Sigma Tau and Lee’s Pharma, and it is quite unlikely Sigma Tau will revoke the exclusive Carnitine rights from Lee’s Pharma.

2. Good Pipeline Of Advanced Stage Trial Drugs, Rollout of Remoludin

Compared to its peers that are much bigger in size, Lee’s Pharma’s pipeline of drugs in the advanced stages is significantly more.

The difficulty in passing China’s FDA trial stages for a drug is not a new thing for drug producers.

Developmental drugs need to pass through different trial stages (I – IV). The entire process of obtaining a drug license can take between four and six years.

As seen from the table below, none of Lee’s Pharma’s much bigger peers have drugs in phases II and above.

The two developmental drugs of Lee’s Pharma in phase III suggests that once it transcends to phase IV and gets the stamp of approval, additional revenue catalysts for these developed drugs can be further expected.

Remoludin, which specifically targets hypertension related problems have also been rolled out in the second quarter of this year.

Together with the oral Carnitine rolled out, I expect strong performance from its licensed-in drugs revenue segment, lifting eventual bottom line figures.

3. Numbers And Valuation

Lee’s Pharma has consistently shown gross margins of around 70 percent, suggesting strong pricing power in its products.

Net margin has also reflected an average of some 23 percent over the past five years. Return on equity and return on invested capital also shows an average of some 29 percent for the past five years.

This also endorses Lee’s Pharma’s superior profitability, which is important for a company that has multiple drugs in the pipeline that needs R&D attention.

Moreover, its net gearing is negative, plus its huge cash chest, which have steadily been increasing over the years will give the company space to commit resources into R&D, or amp up its drug manufacturing abilities.

The peer comparison shows that Lee’s Pharma is largely in line with the valuations (PE, EV/EBITDA) assigned for bigger sized firms.

Although its price has risen quite a bit in the recent months, the catalysts identified above suggest continued steam in its business performance.

The consensus target price of HK$12 compared to that of HK$10.52 (as at time of writing), suggests a 14 percent upside possibility for Lee’s Pharma.

However, a 20 percent upside will not be too far off a stretch for the price to run towards as well.

*Disclosure: The author has positions in this company.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

Please click here for more information about this author.


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