Philippine Markets Daily

This company’s heavy R&D investments and drug portfolio expansion have resulted into robust Uniform returns of 31%

January 13, 2021

The coronavirus pandemic has broken biopharmaceutical supply chains, disrupting the global contract manufacturing market in the short term. Fortunately, some biopharma companies were flexible enough to adapt to the current environment.

Even with this company’s years of investment in R&D, as-reported accounting doesn’t display that the company is benefiting from these efforts. Uniform Accounting shows that this company’s real returns are more robust than you think. In its focus to further expand its R&D scope, this biopharmaceutical company invested a huge amount of money to support a COVID-19 vaccine that’s one of the first to be commercially rolled out globally.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus

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The pharmaceutical industry in China is considered the second largest in terms of annual pharmaceutical revenues globally, and is estimated to account for more than 10% of the total sales worldwide.

In 2020, around 25 biologics and biosimilar products were approved in China, and approximately 1,000 clinical trials were conducted to investigate several biologics and biosimilars that focus on treating a number of diseases.

However, the coronavirus pandemic created impediments to the biopharmaceutical industry by disrupting the supply chains due to restrictions and lockdowns and scarcities or shortages of drug products.

Although product approvals continued amid the pandemic, companies struggled to launch their products due to lower demand for non-COVID-19 medical products. Fewer patients visited hospitals and clinics for routine checkups, leading to fewer diagnoses and prescriptions.

Despite the current situation, some biopharma companies were able to adapt and turn risks into opportunities. These companies gauged the impact of the global health crisis and responded appropriately to it.

An example of this is China’s leading pharmaceutical conglomerate, Sino Biopharmaceutical Limited. This company was able to grow its revenues by almost 80%, from CNY 13.5 billion in 2016 to CNY 24.2 billion in 2019. Also, even with the pandemic, it was still able to increase its revenues year-over-year from CNY 6.3 billion in Q2 2019 to CNY 6.4 billion in Q2 2020.

Sino Biopharm comprises a full industry value chain from R&D platforms, manufacturing, to sales and marketing. Its manufacturing plants are equipped with top-of-the-line machines that allow the company to be the largest manufacturer of prescription drugs and other specific types of drugs.

The company is also an expert in several therapeutic fields, such as hepatopathy (liver diseases), oncology (tumors), and cardiovascular and cerebrovascular diseases. Sino Biopharm’s leading position in generic drugs paved the way for the company to evolve into formulating and selling novel drugs.

Novel drugs are defined by the U.S. FDA as “innovative products that serve previously unmet medical needs.” In China, these drugs require the approval of the National Medical Products Administration (NMPA), formerly known as the China Food and Drug Administration (CFDA).

One of Sino Biopharm’s novel drugs providing robust growth for the company is Anlotinib, an innovative anti-cancer drug. For an R&D-focused company, the launch of Anlotinib is very important. It showcases Sino Biopharm’s ability to develop small-molecule target drugs in the field, and displays the company’s ability as an early adopter of innovative drugs.

The company also constantly broadens its line of products through business development. In December 2020, Sino Biopharm announced its USD 515 million investment in Sinovac Life Sciences Co., Ltd., a developer of COVID-19 vaccine CoronaVac.

Not only does this investment boost Sinovac’s R&D and production capacity for CoronaVac, but it also allows Sino Biopharm to venture into vaccine R&D. With Sino Biopharm’s existing pipeline of drugs, it makes sense that it would expand its R&D into preventive vaccines.

Moreover, its stake in Sinovac would also allow Sino Biopharm to expand its network globally. The scale and rollout of Sinovac’s COVID-19 vaccine would enable Sino Biopharm to interact with foreign governments, regulatory authorities, and different companies or stakeholders.

With these aggressive R&D strategies and its focus on novel drugs to fulfill unmet medical needs, many might think that Sino Biopharm would be a big winner in the biopharmaceutical space, with skyrocketing returns. However, as-reported metrics show that its returns have been falling in the last three years, and is currently just at 6%.

Uniform Accounting, however, paints a different picture. Sino Biopharm’s aggressive R&D strategies are resulting in a much higher profitability than what as-reported metrics show. Uniform ROAs have been notably robust, consistently above 27% in the past sixteen years.

One key metric that causes distortions in as-reported ROAs is R&D expenses.

We have highlighted how Sino Biopharm puts a premium on its research and development strategies and continues to expand its portfolio of generic and novel drugs. In as-reported metrics, these investments in R&D were recorded as outright expenses. Because of this, as-reported metrics fail to follow the accounting principle that expenses should be recognized in the period when the related revenue is incurred. This distorts the company’s earning power.

R&D investment is actually an investment in the long-term cash flow generation of the company. If this remains treated as an expense, the company’s profitability may appear substantially weaker than it actually is.

After R&D and other adjustments are made, we can see that Sino Biopharm isn’t actually performing poorly, as shown by as-reported metrics. In fact, its current Uniform returns are 5x stronger than what is reported.

Sino Biopharmaceutical Limited’s profitability is more robust than you think

As-reported metrics are distorting the market’s perception of the firm’s profitability. If you were to just look at as-reported ROA, you would think that the company is a weaker business than real economic metrics highlight.

Sino Biopharm’s Uniform ROA has been higher than its as-reported ROA in the past sixteen years. For example, Uniform ROA was 31% in 2019, while as-reported ROA was only 6%.

The company’s Uniform ROA for the past sixteen years has ranged from 27% to 53%, while as-reported ROA has ranged only from 3% to 13% in the same time frame.

From 52% in 2005, Uniform ROA fell to 27% in 2006 before reaching a peak of 53% in 2009. Uniform ROA then compressed to 30% in 2011 before rising to 34%-39% levels in 2012-2016 and subsequently fading to 31% in 2019.

Sino Biopharmaceutical Limited’s Uniform earnings margins are weaker than you think, but its Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in Uniform earnings margins and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

After decreasing from 24% in 2004 to 15% in 2006, Uniform margins rose to 20%-21% levels from 2007-2009 before falling to 16% through 2011. It then gradually increased to 27% in 2018 before decreasing to 25% in 2019.

Uniform turns rose from 1.9x in 2004 to 2.3x in 2005, before falling back to 1.8x in 2006 and subsequently reaching a peak of 2.5x in 2009. It then gradually decreased to 1.3x levels in 2017-2019.

SUMMARY and Sino Biopharmaceutical Limited Tearsheet

As the Uniform Accounting tearsheet for Sino Biopharmaceutical Limited (1177:HKG) highlights, its Uniform P/E trades at 18.2x, which is below corporate average valuation levels, but above its own recent history.

Low P/Es require low EPS growth to sustain them. In the case of Sino Biopharm, the company has recently shown a 2% Uniform EPS growth.

Sell-side analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, sell-side analysts’ near-term earnings forecasts tend to have relevant information.

We take sell-side forecasts for Hong Kong Financial Reporting Standards (HKFRS) earnings and convert them to Uniform earnings forecasts. When we do this, Sino Biopharm’s sell-side analyst-driven forecast is a 35% earning shrinkage in 2020, followed by a 28% earnings growth in 2021.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Sino Biopharm’s HKD 7.57 stock price. These are often referred to as market embedded expectations.

Sino Biopharm can have an immaterial Uniform earnings shrinkage for each of the next three years and still justify current market expectations. What sell-side analysts expect for Sino Biopharm’s earnings is below what the current stock market valuation requires in 2020, but above that requirement in 2021.

The company’s earning power is 5x the corporate average. Moreover, cash flows and cash on hand are also 5x its total obligations. Together, this signals a low credit and dividend risk.

To conclude, Sino Biopharm’s Uniform earnings growth is well below its peer averages in 2020. However, the company is trading above its peer valuations.

About the Philippine Markets Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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