Pharm/Biotech (NEUTRAL):Selective approach still valid amid sector reratings

2016. 1. 6 Pharm/Biotech (NEUTRAL) Selective approach still valid amid sector reratings ● We believe the pharmaceutical and biotechnology sectors will keep re-rating in 2016 and the combined operating profit of the ten companies under our coverage will slightly top consensus. ● We believe a selective approach is still valid, given that anticipation re-rating has been mostly priced in. That said, Korea’s pharmaceutical/biotechnology sector should continue garnering attention this year considering the Korean government is encouraging a focus on R&D and that there are still a number of firms boasting competitive pipelines with potential for out-licensing deals with global players. ● We keep both sectors at NEUTRAL, with SK Chemicals, Chong Kun Dang Pharmaceutical, and Donga ST as our top picks. WHAT’S THE STORY? Maintain NEUTRAL and selective approach: Korea’s pharmaceutical and biotechnology sectors should keep re-rating this year considering the government is encouraging sector firms to focus on R&D and that there are still a number of firms that boast competitive pipelines with potential for out-licensing deals with global players. Excluding Hanmi Pharmaceutical—the only company that inked large-scale out-licensing deals in 2015—Korea’s pharmaceutical and health care sector indexes outperformed the Kospi by a respective 45.2% and 116.8% in 2015, implying that a sector re-rating has been mostly priced in. Thus, we still believe a selective approach for the sector is valid. Focus on players with competitive pipelines: Spurred by Hanmi’s multiple, large-scale out-licensing deals in 2015, domestic pharmaceutical/biotech firms are increasingly seeking to expand R&D and penetrate overseas markets to grow. In our view, chances of Korean firms signing out-licensing deals for their pipeline drugs with global firms have increased, given the latter’s pursuit of higher R&D efficiency. Against this backdrop, we advise focusing investment targets on firms boasting solid R&D pipelines and stable cash flows from established operations. SK Chemicals, Chong Kun Dang, and Donga ST are top picks: SK Chemicals should have a full vaccine lineup in 2017—the company obtained Ministry of Food and Drug Safety approval for its quadrivalent flu vaccine (Korea’s first cell-cultured flu one) in December and should receive approval for its 13-valent pneumococcal conjugate vaccine in 1H16 and its shingles vaccine in 2H16. Chong Kun Dang Pharmaceutical has several drugs in its pipeline boasting new mechanisms of action and potential to beat rivals in terms of stability and performances that should interest global firms. For Donga ST, results for US phase II clinical trials for its botanical diabetic neuropathy treatment DA-9801 should be released in 1Q16 and ease concerns over the drug’s commercial success. 4Q preview—profits to edge forecast as sales growth stays solid: We believe combined 4Q operating profit of the 10 pharmaceutical/biotechnology firms under our coverage rose 56.8% y-y but fell 34.3% q-q—topping consensus by 7.5%—as sales growth likely stayed solid for a second straight quarter after stalling in 2Q due to MERS fears. We attribute the y-y jump to strong performances at Celltrion, SK Chemicals, and Medytox, and the q-q drop to Hanmi’s high base from upfront payments for out-licensing deals and seasonally weak vaccine sales. We assume Hanmi will book massive upfront payments from out-licensing deals with Sanofi and Janssen in 1Q. Sector Update Pharmaceuticals 2016. 1. 6 2 Pharmaceutical and biotechnology sectors at NEUTRAL; selective approach still valid SK Chemicals, CKD Pharmaceutical, and Donga ST are top picks Factoring in new pipelines, valuation basis change 4Q15 preview: Growth keeps pace q-q; operating profit edges concensus Related companies SK Chemicals Chong Kun Dang Pharmaceutical Donga ST Hanmi Pharmaceutical Contents Pharmaceuticals 2016. 1. 6 3 Pharmaceutical and biotechnology sectors at NEUTRAL; selective approach still valid We keep the pharmaceutical and biotechnology sectors at NEUTRAL. We maintain our view that the two sectors are rerating—spurred by Hanmi’s massive out-licensing contracts—as there are still a number of companies that boast competitive pipelines with potential for out-licensing deals with global pharmaceutical firms and that the Korean government has encouraged the sector to focus on R&D. We keep the pharmaceutical sector at NEUTRAL as share prices have already priced in related expectations. Samsung pharmaceutical universe: Valuation summary (KRW) Target Rating Current Upside P/B P/E (Samsung) P/E (Consensus) price price(%)2015E (x)2015E (x)2016E (x)2015E (x)2016E (x)Hanmi Pharmaceutical 810,000 HOLD 776,000 4.4 18.8 n/a13.1 69.5 57.5 Yuhan 300,000 HOLD 281,000 6.8 2.1 20.9 19.9 26.4 25.1 Green Cross 250,000 BUY 223,500 11.9 2.8 24.5 33.0 24.1 30.7 LG Life Sciences 66,000 HOL