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Revisiting China’s healthcare sector

Founding CEO,
Lundgreen’s Capital

China’s healthcare sector was one of the sectors that was significantly reformed last year, which is positive- though lately, it seems to be going through a scandal of its own.

Just within the past 12 months, stocks in the sector have represented swings from losing 25 pct. to gaining 50 pct., which shows how different the investor appetite has been for individual companies, since the reform was announced. One of several elements that still makes the Chinese healthcare sector interesting for investors is that the government is increasing the public spending within the sector.

Even after a tremendous growth in spending during the past years, the public spending still only represents about 6 pct. of the GDP compared to 10 pct. on a global average (17.1 pct. in USA), so China remains behind its peers in developing a sophisticated healthcare sector, and there is no doubt that the growth will simply continue.

Like in any other country, the healthcare market in China is split into service providers (mainly hospitals), distributors, and the pharmaceutical manufacturers. The 2,500-year-old Traditional Chinese Medicine (TCM) sector makes up a bigger chunk of the healthcare market versus what many expect, which makes the whole sector more challenging to analyse compared to the same sector in Western economies. The reality is that TCM is playing a large role in the Chinese healthcare sector, and its market share is even expanding. Hence, we just need to bear in mind that there is such a different component in the Chinese healthcare sector when appraising the market for investment opportunities. Very interesting though, it that one of the stocks that has gone up with 50 pct. the past year is China Traditional Chinese Medicine Holdings Co. Limited, which, as the company name indicates, is active within TCM.

But the past weeks have been dramatic, as the healthcare sector stumbled due to the Changsheng Bio-technology vaccine scandal. The company had fabricated the production and inspection data of its rabies vaccines. It has generated a negative effect in the stock market for the whole pharmaceutical industry. The result has been a sell-off across the board, regardless of whether the company is good or bad, due to the sentiment change among investors.

The event could have quite a significant impact to the industry, and potentially mean that new regulations will be put in place. Mid-term investors could turn cautious towards the pharmaceutical sector, and for a period tend to shift towards the healthcare provider segment, though I expect it to be temporary and not fundamental.

If the Chinese authorities choose to amend the reform by further regulation, then it happens simultaneously, as the new reform is still in-effect. A part of this overall reform plan which I regard as very important, is the so-called “two-invoice system”. It relates to the drug distribution in China, where the reform aims to generate transparency in drug pricing and eliminate excessive profit margins associated with multi-tier distribution models. In the past, medicines go through several distributors before reaching hospitals. Instead of having several levels of distributors, the two-invoice system means that the pharma manufacturer makes-out “invoice one” to the distributor, followed by the distributor’s “invoice two” to the end customer (the hospital). The two-invoice system is expected to be fully implemented among public hospitals across the country by the end of 2018.

The current large changes still make a range of companies very interesting despite the current turmoil. When searching for the gems, it is always worthwhile studying the decisions from China’s Ministry of Human Resources and Social Security (MHRSS). The ministry for example, released the NRD list (National Reimbursement Drug List) which shows all the drugs covered by China’s national insurance plan. The list consists of 51 pct. classical Western chemical / biological drugs and 49 pct. TCM, which once again underlines the uniqueness in the Chinese healthcare market and the importance of TCM.

Naturally, an aging population results in a higher demand for healthcare on a broad base. But in general, the public healthcare service in China is quickly improving, which means that a bigger share of the state budget is allocated to the sector and is undergoing large reforms. In addition, the growing middle class suddenly secures a household income that allows it to pay for better healthcare, thus demanding a healthier living lifestyle.  Now, China is more health-conscious than ever, and despite the recent bumps on the road I remain optimistic for the healthcare and pharma sector as a whole.


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