1、China Healthcare Sector 2019 OutlookChina Healthcare Sector 2019 OutlookChina Healthcare Sector2019 China Healthcare Outlook: Reforms, Reforms & More Reforms!7 January, 2019After the correction in 2H2018, the healthcare sector valuation has reached a three-year low as a result of a series of policie

2、s calling for ASP cuts and consolidation. Given more policy uncertainties ahead in 2019, we strongly recommend investors pick stocks from a bottom-up perspective and embrace earnings visibility. Our top picks are Shanghai Pharm 2607.HK; BUY; CTCM 570.HK; BUY and SinoPharm 1099.HK;BUY.7 January, 2019

3、Healthcare sector correction since 2H2018 due to policy risks. In 1H2018 the healthcare sector was significantly re-rated following strong momentum in 2017. The sector began to correct in June. Apart from macro factors, such as the trade war and RMB depreciation, major de-rating factors in the secto

4、r included 1) the Group Purchasing Organizations (GPO) progress in expanding nationwide and to more drugs accelerated and the ASP cut was much more severe than expected; 2) drug terminal growth pressure from medical insurance cost control; and 3) a rapid increase in the selling expenses of drug comp

5、anies.Medical reform storm to continue in 2019. Looking ahead to 2019, we expect medical reforms to continue to deepen, mainly including a review of upstream drugs and approval reforms, generics consistency evaluation, the GPO, hierarchy diagnosis and treatment, and medical insurance payment reforms

6、. Through these reforms, the authorities key goals are to 1) introduce clinically indispensable drugs to the market as soon as possible to benefit patients; 2) encourage domestic manufacturers to research and develop innovative drugs; 3) call for generics consolidation and ASP cuts (e.g. the GPO) an

7、d improve generics quality (e.g. generics consistency evaluation); 4) cut drug prices to a more affordable level (e.g. tendering price cuts); 5) alleviate the national medical insurance reimbursement fund burden by optimizing insurance coverage and its payment structure; and 6) make good use of limi

8、ted medical resources (e.g. hierarchy diagnosis and treatment).Harry HeAnalyst(852) 3698-6320 HYPERLINK mailto:harryhe.hk Harry HeAnalyst(852) 3698-6320 HYPERLINK mailto:harryhe.hk harryhe.hkWong Chi Man, CFAHead of Research(852) 3698-6317 HYPERLINK mailto:cmwong.hk cmwong.hkLiz LiAnalyst(852) 3698-

9、6297 HYPERLINK mailto:lizli.hk lizli.hk2019 conviction callsOur top 2019 recommendations are companies with high earnings visibility, low exposure to policy risks, especially the GPO, and undemanding valuations, as follows:Shanghai Pharm 2607.HK; Initiate with BUY: Limited exposure to the GPO for it

10、s pharmaceutical manufacturing segment, earnings recovery by its associates and JVs, distribution sector recovery, and high earnings visibility with an attractivevaluation.CTCM 570.HK; BUY: Strong and secure earnings growth of CCMG, Yang Bins stake has been offloaded, not exposed to the GPO, and an

11、appealingvaluation.2SinoPharm 1099.HK; BUY: A leader in the pharmaceutical distribution business, recovery of the distribution business to continue in 2019, limited exposure to the GPO, and rapid development of retail business and medical devices distribution business, with an undemandingvaluation.2

12、The expected 10% medical insurance fund growth rate will provide room for medical insur- ance payment structure changes involving more innovative and clinically indispensable drugs and the removal of supplementary drugs, antibiotics, CTM injec- tions, etc.The State Administration of Mar- ket Supervi

13、sion and Administra- tion was set up in March 2018. Re-structuring of the top-level authorities will promote the healthy long-term development of Chinas pharmaceutical industry.Medical insurance fund raised to keep it at 10% growth in 2019From a macro perspective, medical insurance is the principal

14、payment body in Chinas healthcare industry,accountingfor50%oftotalterminalpayments.Weexpecttheoverallmedicalinsurance funds raised (i.e. medical insurance for urban workers + medical insurance for urban and rural residents and private insurance) to remain at 10% growth (despite a slowdown from 20% i

15、n previousyearsbecauseofrapidcoverageexpansion)inthenextfewyears.Formedicalinsurance forurbanworkers,fundgrowthwillbedrivenbyanincreaseindisposableincome(accountingfor67ppts) and an increase in the number of workers (accounting for 34ppts). Medical insurance for urban and rural residents, for which

16、7580% of the funding comes from government subsidies, is expectedtocontinuetogrowby89%YoY.Privateinsurancegrowthisexpectedtobe20%YoYp.a. over the next few years.Because of increasing pressure to balance fund growth and increase expenditure, we expect a structural change for drug coverage and payment

17、s for medical insurance. We expect the medical fundtobespentmoreonclinicallyindispensabledrugsthanonsupplementarydrugs.Accordingto IMS data, in 8M2018 the hospital drug sales growth rate was as low as 2.8%, squeezing the bub- bles (i.e. drug use control) for supplementary drugs, antibiotics, CTM inj

18、ections, etc. With limited medical insurance resources, the government intends to provide the best quality pharmaceutical products at the lowest possible prices; that is, the coverage and payment structure of the medical insurance fund is the key. In summary, the expected 10% growth in the medical i

19、nsurance fund willprovideroomforstructuralchangeinthemedicalinsurancepaymentstructure,involvingmore innovativeandclinicallyindispensabledrugsandremovingsupplementarydrugs,antibiotics,CTM injectionsetc.NMPA reforms to secure the execution of 2019 medical reformsIn March 2018, the State Council combin

20、ed 1) the responsibilities of the State Administration for IndustryandCommerce;2)theresponsibilitiesoftheStateAdministrationforQualitySupervision;3)theresponsibilitiesoftheChineseFoodandDrugsAdministration;and4)thepricesupervision, inspection and anti-monopoly law enforcement responsibilities of the

21、 National Development and ReformCommissionunderthenewStateAdministrationofMarketSupervisionandAdministration, which is a direct subordinate of the StateCouncil.Considering the importance of drug supervision, the National Medical Products Administration (NMPA) was set up separately and is administere

22、d directly by the State Administration of Market SupervisionandAdministration.Market.SupervisionoftheNMPAismanagedatdifferentlevelsas follows:The national level NMPA is responsible mainly for product registration and formulation of the regulatory system: it is responsible for formulating the regulat

23、ory system for drugs, medical devices and cosmetics, and for licensing and inspecting the development of drugs, medical devices andcosmetics.The provincial level NMPA is responsible mainly for production supervision: it is responsible for licensing, inspection and enforcement for pharmaceutical, med

24、ical devices and cosmetics production,aswellasdrugwholesalelicensingandretailchainheadquarterslicensing,etc.The municipal and county level NMPA are responsible for product management and supervi- sion: they are responsible for the licensing, inspection and enforcement for drug retailing and medical

25、device operation, as well as the quality inspection and enforcement of cosmetics op- erations, and the use of drugs and medicaldevices.We expect the restructuring of the healthcare industry top-level authorities to facilitate and secure the execution of medical reforms in 2019 and promote the health

26、y long-term development of Chi- naspharmaceuticalindustry.3Chinas healthcare industry has been facing many long-existing problems, and the authorities have initiated a series of reforms since 2015The CDE is now 60 days vs. theU.S. FDAs 30 days for clinical trial application review, a big step for th

27、e Chinese CDEInnovative drugs: reforms, reforms and more reforms!2019 will begin to harvest the benefits of drug review and approval reformsIn past years, Chinas pharmaceutical industry was driven by generic drugs, not innovative drugs. Many obstacles have hindered the healthy development of the pha

28、rmaceutical industry:backlogged drug applications; 2) a much slower new drug launch process compared to that of the U.S.; 3) a lack of innovation capability and motivation for domestic manufacturers; 4) overly duplicated application of generics; and 5) poor quality generics. In 2015, to solve these

29、prob- lems, the State Council issued the document “Opinions on Reforming the Reviewing and Ap- proval system of Drugs and Medical Devices”, putting forward an enormous number of measures, including 1) expanding the personnel of the Center for Drug Evaluation (CDE); 2) calling for clinical trial data

30、 reviews; 3) stimulating priority review of drugs and applications for green pathways; 4) pushing generics consistency evaluation; 5) launching the Marketing Author- ization Holder (MAH); 6) joining the International Council for Harmonization (ICH); and 7) reform- ing the chemical drugs registration

31、 and classification. So far, the new drug registration and clas- sification system has been introduced, and the backlogged drug applications have been alleviat- ed. We expect the drug review and approval reforms to bring about structural development op- portunities in many subdivisions of the health

32、care sector in 2019. With the completion of the drug review and approval reforms, the launch process for innovative drugs will be condensed, and clinically indispensable drugs will have a faster marketing channel to patients inChina.Domestic manufacturers will be forced to innovate in 2019The author

33、ities have put forward many specific measures for speeding up bringing foreign inno- vative drugs into China. First, in July 2018, the National Medical Products Administration (NMPA) published “Adjustment of the Procedures for Review and Approval of Drug Clinical Tri- als”, which states that “if an

34、applicant does not receive a negative or doubtful opinion from the CDE within 60 days from the date of acceptance and payment of the application, it may carry on clinical trials in accordance with the submitted trial design”. Although the 60-day review period is still longer than the U.S. FDAs pract

35、ice of 30 days, we believe the Chinese CDE has made a big step compared with the past, when manufacturers had to wait sometimes for over a year to get clinical trial approval (i.e. manufacturers had to get a “YES” from the CDE, while now, as long as CDE does not say “NO” within 60 days, they can sta

36、rt clinical trials). Second, for clinically urgent drugs, as long as human race trials can demonstrate bioequivalence in different human races, foreign clinical trial data can be accepted by the CDE. We believe supporting foreign innovative drugs will put pressure on domestic manufacturers and push

37、them to put more effort into innova- tion (we have seen that in recent years in some specific areas, such as PD-1 or CAR-T, some Chinese pharmaceutical manufacturers have reached tier-1 level worldwide). Of course, one thing we need to point out is that supporting innovative drugs alone is not enoug

38、h; supplemen- tary policies which reduce the unreasonable profits of generics (such as the GPO, tender price cuts, and national oncology drug price negotiations) are also critical for pushing domestic inno- vations.Consistency evaluation and the GPO are the two important keys for the healthy develop

39、ment of generic drugs over the next fewyearsGenerics: landscape about to undergo restructuringChinas generics face three major problemsThe healthy development of generics is crucial for the pharmaceutical industry to substitute origi- nal drugs to reduce the burden on the medical fund and secure the

40、 overall drug supply. Howev- er, there are three major obstacles hindering the development of generics: 1) overly duplicated applications for low value-added generics, especially in the anti-virus and metabolic area; 2) in- consistency of quality and efficiency of generics compared with the original

41、 drugs because many small manufacturers have limited R&D capability, and dont have the expertise to set up research projects based on sufficient due diligence (i.e. they just struggle to survive at first by producing generics); and 3) the relatively high profit margin of generics reduced the incenti

42、ve for manufac- turers to research and develop innovative drugs.So the governments targets are clear: 1) to consolidate the generics industry to avoid inefficient and duplicated competition; 2) to call for a generics ASP cut and lower the profitability of gener- ics to motivate manufacturers to focu

43、s on innovative drugs; and 3) to secure the quality of gener- ics. Generics consistency evaluation is put forward under these circumstances to comply with target 3 via streamlining the safety and efficiency of generics with original drugs. Together with stringent regulation of clinical trail data ch

44、ecks and generics quality, safety and efficiency can be secured to the highest level.Generics consistency evaluation progress slowAs at end-September 2018, the CDE had accepted up to 350 applications for consistency evalu- ation, involving 151 drugs. Starting from July 2017, manufacturers began to a

45、pply one after an- other, 16 applications a month on average. The progress has accelerated since May 2018 (Figure 1 below), indicating that more and more manufacturers realize the importance of con- sistency evaluation, and the CDEs review progress began toaccelerate.Because of a limited number of q

46、ualified clinical trial centers (only 100 hospitals are qualified perform clinical trial phase I), the progress of the Bioequivalence (BE) test for the “289 Essen- tial Drug List (EDL)” drugs has been seriously delayed. According to Centre for Drug Evaluation (CDE), as at end-September 2018, only 18

47、 drugs had completed the consistency evaluation vs. the target of 289 drugs completed by end-2018. Slow progress in consistency evaluation may hinder the progress of the GPO expanding to moredrugs.Figure 1: CDE consistency evaluation applications59625962433618191913860504030201002018.1 2018.2 2018.3

48、 2018.4 2018.5 2018.6 2018.7 2018.8 2018.9CDE application numbersSource: CDE, CGIS researchGenerics: top level support for generics developmentOn April 3, 2018, the State Council announced “Opinions on Reforming and Perfecting the Policy of Supply Guarantee and Use of Generic Pharmaceuticals”. It cl

49、early stated support for the whole supply chain of chemical generics in four majorways:Generics R&D (supporting the R&D of generics of clinical indispensable drugs with definite curativeeffects);Improving generics efficiency and accelerating the consistency evaluationprocess;Terminals support (gener

50、ics that pass the consistency evaluation will be included in the pro- curement list in a timely manner, and they will be recommended as substitutes for original drugs via doctors medication education and clearly stated in drug labels, drugs procurement support, medical reimbursement list support, me

51、dication recommendations, etc.). Some provinces have published detailed policies to push generics consistency evaluation imple- mentation. Sichuan, Hubei, Guangxi, Shaanxi etc. have claimed to have categorized gener- ics that passed the evaluation in the same quality classification as the original d

52、rugs. Shang- hai announced that generics passing the evaluation will go direct to the online procurement process rather than tendering. We believe these local policies will secure the implementa- tion of the consistency policy and stimulate manufacturers motivation to choose premium candidates to pa

53、ss the consistency evaluation, eventually benefiting patients and medical funds with cheaper alternatives that are equivalent to the original drugs;andTax reductions of up to 15% for genericsmanufacturers.Overall, we believe this Opinion will stimulate the development of domestic generics as substi-

54、 tutes for original/imported drugs, securing good generics for patients.The essence of the GPO is calling for ASP cuts andgener- icsconsolidationThe Group Purchasing Organization (GPO)Our understanding of the GPO is that its basic mission is to bring about price reductions for generics and consolida

55、tion (as an ideal supplement, the chemical consistency evalua- tion will secure overall generics quality, while the GPO will cut ASPs). In the past, Chinese pharmaceutical companies had relative high profitability for their generic drugs, which was considered unhealthy, as this hindered their motiva

56、tion to conduct R&D on innova- tive drugs. The GPOs drastic ASP cut can be seen as a way to squeeze the profitability of generics to a normal level, thus forcing manufactures to consolidate and undertake inno- vative R&D. More importantly, the sharp ASP cut for generics can give the medical insur- a

57、nce fund more room to include clinically indispensable and newly launched innovative drugs (oncology targeted drugs, PD-1/PD-L1 etc.), essentially benefiting patients. With the announcement of the first round preliminary tender prices in December 2018, which were much lower than expected, we are con

58、cerned that the GPO may expand nationwide faster than we previously expected in 3 to 5 years, which may trigger volatility in the share pric- es of generics manufacturers in 2019.The fifth meeting of the Central Committee for deepening reform on November 14, 2018 ad- dressed the purposes of the GPO,

59、 which are to explore and improve the group purchasing mechanism and market-driven pricing mechanism, reduce the financial burden for medication expenditure for patients, standardize the drug distribution system, and enhance awareness of drug safety. The overall concepts of “national organization, a

60、lliance procurement and platform operation” must be followed. The government and the market should work hand in hand to en- sure drug quality and supply stability.Following the fifth meeting of the Central Committee for deepening reform (Nov 14), the 11 city GPO document was released, with 31 final