Philippine Markets Newsletter

This Chinese pharma giant took the top position by investing heavily in research and development, leading to its Uniform ROA of 32%

April 14, 2021

Thanks to technological innovations, diseases that were previously incurable can now be treated.

Today’s company has taken a leading position in the Chinese pharmaceutical industry thanks to its investment in research and development.

However, as-reported metrics do not seem to reflect how this company’s efforts to innovate are boosting its returns. Uniform Accounting shows that the business has a better Uniform return on assets (ROA) than what you might think.

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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New discoveries in the field of medicine and science become possible because of evolving technologies. Innovative pharmaceutical companies making medicines and drugs commercially available and accessible has made it easier to treat certain diseases.

In a previous article about Sino Biopharmaceutical Limited, we talked about China’s position as one of the largest pharmaceutical industries in terms of revenues, taking 11% of the global market share. Today, we discuss China’s largest pharmaceutical company and its focus on research and development.

Founded in 1970, Jiangsu Hengrui Medicine Co., Ltd. is a pharmaceutical company based in China that is engaged in manufacturing pharmaceutical drugs, injections, and other related products.

Like most notable pharmaceutical companies, Jiangsu Hengrui puts the most importance in research and development (R&D). This company takes this a notch further by investing a higher percentage in R&D, spending 16.7% of its revenues in 2019 on R&D compared to the industry average of around 1% to 10% of revenues.

Thanks to its massive R&D investments, the company was recently successful in its launch of cancer immunotherapy drugs like docetaxel and camrelizumab.

Jiangsu Hengrui spent CNY 14.55 million in R&D for docetaxel, an anti-cancer chemotherapy drug, before taking it to the United States in 2017. By 2018, sales from this drug grew by 23% and made up 11% of total revenues.

In 2019, camrelizumab, which is used to treat classical Hodgkin’s lymphoma, received its first global approval. This drug can be combined with apatinib, another cancer tablet distributed by the company, to treat lung cancer and gastric cancer. This combination therapy drives demand forecasts for camrelizumab, pushing sales estimates to rise to CNY 2.45 billion in 2021.

Jiangsu Hengrui also has its own drug engineering technology research center and its own post-doctoral research station. Moreover, aside from their research centers in their home country, they have research and development centers and branches across different locations such as the United States, Europe, and Japan.

Furthermore, the company has expanded to now have over 21 subsidiaries, which helps to improve the company’s current pipeline. Jiangsu Hengrui invests in and acquires other pharmaceutical companies to ensure its growth. These acquisitions broaden the company’s reach and make more innovations possible.

Given the company’s R&D focus and leading position in the industry, one can expect high returns. However, as-reported metrics make it seem that Jiangsu Hengrui’s R&D investments have not been paying off, with as-reported ROAs ranging only from 9% to 18% levels in the past sixteen years.

However, Uniform Accounting reveals that Uniform returns have been consistently more robust than what the market thinks. This is evident with Uniform ROA actually being at 31% instead in 2015, which is double the as-reported numbers.

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

We have highlighted how Jiangsu Hengrui 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 necessary adjustments are made, we can see that Jiangsu Hengrui isn’t actually performing poorly, as shown by as-reported metrics. In fact, its current Uniform returns are 2x stronger than what is reported.

Jiangsu Hengrui’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 reveal.

Jiangsu Hengrui’s Uniform ROA has been higher than its as-reported ROA in the past sixteen years. For example, when Uniform ROA peaked at 36% in 2008, as-reported ROA was only 18%.

The company’s Uniform ROA for the past sixteen years has ranged from 21% to 36%, while as-reported ROA has ranged only from 9% to 18% in the same timeframe.

Specifically, Uniform ROA peaked from 21% in 2004 to 36% in 2008, before declining to 26% to 32% levels for the years 2009 to 2017. It then further contracted to a low of 22% in 2018, before rebounding to 32% in 2019.

Jiangsu Hengrui’s Uniform earnings margins are generally 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, with peaks and troughs lining up historically with that of Uniform ROA.

From 13% in 2004, Uniform margins rose to 24% in 2008, before declining to 19% to 20% levels from 2009 to 2010. It then gradually increased to a peak of 33% in 2019.

Meanwhile, Uniform turns have been consistently higher than as-reported metrics, ranging at 0.7x to 1.1x levels in the past nine years.

SUMMARY and Jiangsu Hengrui Medicine Co., Ltd. Tearsheet

As the Uniform Accounting tearsheet for Jiangsu Hengrui Medicine Co., Ltd. (600276:CHN) highlights, the Uniform P/E trades at 51.4x, which is above the global corporate average of 25.2x and its own historical average of 38.4x.

High P/Es require high EPS growth to sustain them. That said, in the case of Jiangsu Hengrui, the company has recently shown a 38% 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 Chinese Accounting Standards (CAS) earnings and convert them to Uniform earnings forecasts. When we do this, Jiangsu Hengrui’s sell-side analyst-driven forecast is a 2% EPS decline in 2020 and a 26% EPS 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 Jiangsu Hengrui’s CNY 105 stock price. These are often referred to as market embedded expectations.

Jiangsu Hengrui is currently being valued as if Uniform earnings were to grow 22% annually over the next three years. What sell-side analysts expect for Jiangsu Hengrui’s earnings growth is below what the current stock market valuation requires in 2020 but above this requirement in 2021.

Furthermore, the company’s earning power is 5x above the long-run corporate average. Also, cash flows and cash on hand are almost 8x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.

To conclude, Jiangsu Hengrui’s Uniform earnings growth is in line with its peer averages but the company is trading above its average peer valuations.

About the Philippine Market 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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