The onset of COVID-19 has exposed the inadequacy of the global health infrastructure – China is not an exception. In addition to demographics transition, the authorities have been proactive in revamping healthcare-related policies to ensure a betterment of public health protection in the future, unfolding long-term investment opportunities.

Lately, the mainland authorities released the much-anticipated results for the third round of the Group Purchasing Organisation (GPO) program. A total of 55 drug items was successfully tendered, at an average price cut of 53%¹. In this round, domestic players are set to gain market share within the hospital segment, after the multinational players being less active in submitting tender and a number of them voluntarily losing their bids.

The items tendered include an oral treatment for diabetes, an anti-platelet drug, an anti-inflammatory drug and more. The bid winners are granted with 50-80% share in purchase volume². The duration for the tender lasts from one to three years. The scheme, with a mandate to keep pharmaceutical prices low, carries a mandatory clinical trials to regulate drug quality more systematically.

Betterment of public health

Before regulating drug sales, pharma suppliers had been heavily reliant on individual distributors and hospital networks to secure business orders. Upon the enactment of the centralized purchase program, the drug supply candidates are pooled together and judged strictly on their merits.

But, an essential question from investors is: Has the private medical market improved at the cost of drug makers? As one may recall, around two years ago, the tender system for generic drugs was first launched in Shanghai, followed by ten other mainland cities. The steep price cuts could relieve medical expenditure among the Chinese nationals, but posing a heavy price pressure for generic drug suppliers at the same time.

The looming concerns that the price cut would chip away profitability and future growth then buffetted the share prices of the Chinese drug makers. One of the participating firms was sold off by more than 50%² towards the end of 2018 despite enjoying the visibility in innovative drug development prospect, for instance.

In hindsight, though unable to translate into revenue growth, the bid winners do not only turn in their proposal of price cuts. The bid also means an immediate expansion of market share for each drug nationwide. The sell-off was then proved as an overreaction of the market, without genuinely factoring in the drugmakers’ comprehensive research roadmap and profit profile – especially of the high-margin innovative medical products. Furthermore, the price pressure has not been as severe as feared. For this round, although tendered items are half-priced, the overall impacts would be less than 4% of the 2021 top-line estimates among the bid winners³.

Moreover, the authorities are actively including innovative drugs in the National Reimbursement Drug List, allowing the drug-making industry to ramp sales up in this segment. This is in line with our preference of pharma companies in China – possessing strong innovation capability and rich pipelines, which shall make them fare better against the GPO hurts.

A long-term play

The short-term catalyst for the Chinese healthcare names has been the demand for medical consumables under the COVID-19 hit. The sector’s stock performances were dragged by the March global market rout, but subsequently, they reversed the loss to score a year-to-date gain. Despite a strong rally, our conviction toward China’s medical sector is unshaken, as the long-term growth engine for the industry is intact.

In China, it is estimated that the over-65 population would take up 12%⁴ of the total by 2020 – inevitably increasing the need for improved healthcare and treatment solutions for chronic diseases, including cancers and diabetes, in particular. This should encourage the homegrown development of medical innovation to address a surge in demand.

Secondly, medical spending per capita of the Chinese nationals is only one-fifth of the Americans and lags the world’s average⁵. We believe, in the long run, the gap between China and the developed markets in medical expenditure would narrow. As China advances with rapid urbanization, the new entrants to the middle class are enabled to pursue better healthcare treatment, eventually rewarding the higher quality providers of health-related products and services.

Innovation and quality are the key to unlock the golden door to the true potential of China’s healthcare companies. We suggest that opportunities lie in the leading players that maintain a visible cycle for drug and innovation discovery that spans at least two years. This concludes the case of long-term investment in the sector.

Sources:

1. J.P. Morgan, August 2020
2. Bloomberg
3. Credit Suisse, August 2020
4. Population Pyramid, Statistics Bureaux of various countries, October 2019
5. World Bank and Bernstein

This article originally appeared in the Hong Kong Economic Journal as a bylined article in Traditional Chinese. 

The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable as of the date of presentation, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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