Q3revenue missed due to business environment/channel inventory
9M16revenue decreased 42% YoY to Rmb1.09bn, mainly as Jiangxi Jointown was nolonger included in Jiangzhong’s financial statements. Excluding this, Jiangzhong’s drugmanufacturing revenue fell 8.89% YoY, with OTC drug/dietary supplement revenuedown 4.3%/27.98% YoY to Rmb920m/168m, respectively. Net profit (excluding oneoffs)increased 22.78% YoY. Due to the environment in the drug distribution sectorand Jiangzhong’s proactive control of channel inventory, Q3revenue shrank c43%QoQ, less than we expected. We continue to believe Jiangzhong’s OTC drug business ismaturing and its dietary supplement segment is still in a transforming and expandingstage.
Radix pseudostellariae prices rose, expense ratio continued to fall
Radix pseudostellariae output fell due to weather and prices increased more than 50%YoY, which we estimate pushed down Jiangzhong’s OTC drug gross margin to 72.8%in Q3from 76.84% in H116. Jiangzhong continued to follow a precision channelcontrol strategy to manage advertising expenses and strictly appraise output-to-inputratios, which effectively reduced expense ratios, with Q3selling and administrativeexpense ratio down by 11.4ppts QoQ. The strategy enabled Jiangzhong to generatestrong cash flow, and the company’s 9M16net cash flow from operations rose 34%YoY to Rmb582m, much higher than net profit.
Q416and 2017outlook
Jiangzhong enjoys visible brand advantages in the OTC market, especiallygastrointestinal OTC drugs. With steady demand, we estimate digestive and stomachtablets and lactobacillin tablets, Jiangzhong’s main products, will maintain 5-10% salesvolume growth. Lower output could cause radix pseudostellariae prices to remain highin 2016. However, we do not think this will continue to push down Jiangzhong’s grossmargin if the main producing regions do not experience adverse weather conditionsagain, as radix pseudostellariea is an annual plant. In addition, decreasing expenseratios are likely to offset weaker gross margins.
Valuation: Maintain Rmb44.56price target, Buy rating
Our DCF-based price target is Rmb44.56(6.7% WACC). We maintain our Buy rating.
