Event
Excluding the fair value gain of derivative financial instruments and amortised interest expense arising from its convertible bonds, China Animal Healthcare’s (CAH) adjusted net profit rose by 54.5% YoY to RMB59.0m in 2Q11, well within our expectation. We see a strong second half that will put CAH on track to meet our full-year forecast (1H11’s core earnings already achieved about 43% of FY11 estimate). Maintain BUY.
Our View
Not surprisingly, sales of biological drugs picked up significantly in 2Q11 after a muted start in the first quarter. Revenue contribution from these drugs amounted to RMB84.1m (+256.1% QoQ and +187.5% YoY). CAH’s animal foot and mouth disease (FMD) vaccine also made a maiden contribution of RMB4.9m in turnover during the period.
Gross margin for the biological drug segment, however, contracted by 7.1ppt to 67.1% in 1H11. This was partly due to two key reasons: (1) lower ASPs for the blue ear vaccines sold to new provincial veterinary stations, which allowed CAH to penetrate these new markets, and (2) usual start-up costs as production of the FMD vaccines has yet to achieve economies of scale. Nevertheless, we expect gross margin to improve sequentially as the group ramps up its utilisation rate.
While CAH’s traditional powdered and injection drugs should continue to do reasonably well along with rising poultry and pork prices, we opined that its newly-launched animal FMD vaccine is likely to provide the next growth catalyst as it gains market acceptance. Longer term, management also intends to explore other sales avenues such as exporting the animal FMD vaccines to overseas markets either through joint ventures or OEM arrangements.
Action & Recommendation
We roll forward our valuation basis to FY12 adjusted EPS and peg at a lower 11x PER (below the stock’s historical average of 12.4x since listing). Reiterate BUY with a new target price of $0.37.
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