2019 Outlook: Embracing a New Competitive Order of 'Must-Have, Also-Need, As-Well-As, and Even-More'

In early 2018, cost containment measures under the medical insurance system fired the “first shot” of healthcare reform, as multiple provinces—including Guangxi, Zhejiang, Sichuan, and Henan—intensively issued notices to expand the scope of diagnosis-related group (DRG)-based payment and fee collection.

On May 31, 2018, the newly established National Healthcare Security Administration was officially inaugurated, consolidating multiple functions including the unified management of medical insurance funds, centralized drug procurement and bidding, and pricing. Its core leadership team was drawn from relevant ministries and commissions such as the Ministry of Finance, the Ministry of Human Resources and Social Security, the National Development and Reform Commission, and the National Health and Family Planning Commission, thereby centralizing previously fragmented responsibilities.

Source: Guotai Junan Securities Research

From the perspective of Guotai Junan’s healthcare team, the mandate for the national medical insurance fund is to seek a triangular balance among economics, sociology, and ethics, thereby resolving the contradiction between limited medical resources and unlimited medical demand.

“The most valuable tragedy lies not between good and evil, but between two dilemmas—Hegel”

Data source: Guotai Junan Securities Research

In 2019, we will also witness a “major year” for policy developments in the pharmaceutical industry, encompassing at least the following aspects:

Data source: Shanghai Sunshine Pharmaceutical Procurement Network, Guotai Junan Securities Research

Data Source: NMPA, Guotai Junan Securities Research

Approximately 23 provinces and municipalities have issued policies related to centralized procurement for drug varieties deemed to have passed the consistency evaluation. Meanwhile, around eight provinces have implemented policies stipulating that procurement of non-evaluated varieties will be suspended if more than three manufacturers of the same generic drug have passed the evaluation.

Data Sources: Ministry of Human Resources and Social Security, National Healthcare Security Administration, Guotai Junan Securities Research

Although the share of health expenditure in GDP is rising globally, China’s health expenditure as a percentage of GDP remains relatively low.

Data sources: OECD, National Bureau of Statistics, National Health Commission, Guotai Junan Securities Research

We often say, “With 7% of the world’s arable land, we feed 22% of the global population.” In regard to China’s healthcare sector, it can be stated that, with health expenditures accounting for 6.4% of GDP, China has achieved universal health insurance coverage for a population exceeding 1.3 billion, established a drug supply system centered on generic medications as the mainstay of diagnosis and treatment, and realized import substitution for more than half of the total volume across most drug categories.

Therefore, the first endogenous driver is the steady growth of future medical demand.

Data Source: CDE, OECE, Guotai Junan Securities Research

The incumbent market, reshuffled by the “consistency evaluation + volume-based procurement” policy for chemical generic drugs, will coexist with the incremental market opened up by high-end generics in both chemical and biological sectors; meanwhile, intellectual curiosity and the drive for survival jointly serve as the subjective initiative propelling this round of industrial upgrading.

The aforementioned drastic changes in the “game rules” may compel domestic pharmaceutical companies to transform their former advantage in low-cost production factors into an advantage in cost innovation. However, the traditional cash-cow businesses of most domestic enterprises—generic drugs and adjuvant medications—are all facing long-term pressure.

We have entered a new competitive order defined by the imperative to “have it all”—excelling simultaneously in R&D strength, regulatory submission capabilities, market access, and sales and promotion. This represents a comprehensive competition of integrated corporate capabilities, as well as an all-out race in product launch speed, indication expansion, and pricing strategy.

A Game for the Few Amidst Concentrated Payer Purchasing Power Determines That We Will Also Welcome a New Era of Blockbuster Products—If You Bloom, the Breeze Will Come.

Even after the patent cliff, generic drugs may still yield excess returns, but this is primarily concentrated in high-end generics.

The core barriers to entry for high-end generic drugs are manifested in three aspects: first, technology, such as dosage form innovation centered on clinical needs and underpinned by technical barriers; second, policy, such as state controls over psychotropic and narcotic drugs; and third, production capacity, where existing capacity gains greater bargaining power amid rising environmental pressures and industry consolidation.

Data source: Guotai Junan Securities Research

Under the policy support of “Priority Review” and “National Reimbursement Drug List (NRDL) Negotiations,” innovative drugs will reach the market and be included in the NRDL at a faster pace.

The gap in the initial launch time between domestic and foreign similar products has narrowed from 10–15 years in the era of small-molecule drugs to four years in the era of immunotherapy.

Data Source: Yaozhi, Guotai Junan Securities Research

The sales share of targeted oncology drugs (including biologics and small-molecule chemicals) in domestic sample hospitals has been rising year by year, with major domestically produced products poised for rapid growth.

Data Sources: Frost & Sullivan, Company Announcements, Guotai Junan Securities Research

However, the innovative drug sector is a brutal battlefield. The healthcare team at Guotai Junan Securities judges that the future test for innovative pharmaceutical companies will be their “four-in-one” comprehensive competitive capabilities: R&D capability, clinical and regulatory affairs capability, academic promotion and sales capability, and market access capability.

Source: Guotai Junan Securities Research

Beyond the two heavyweight segments of innovative drugs and generic drugs, the Guotai Junan pharmaceutical team also provided a detailed analysis in its outlook on areas such as vaccines, traditional Chinese medicine (TCM), blood products, and active pharmaceutical ingredients (APIs) within pharmaceutical manufacturing. Here, we will elaborate on vaccines, which have attracted considerable public attention.

Currently, the global vaccine market is experiencing steady growth, driven by increasing demand for vaccination, support from governments and international organizations, and the development and launch of new vaccines, all of which continue to propel the expansion of the global vaccine industry.

Compared with developed countries, most commonly used vaccines in China are previous-generation products, and the pace of introducing and launching new vaccines lags behind the international market.

However, driven by the accelerated approval of novel vaccines and the maturation of R&D efforts among domestic enterprises leading to increased market uptake of major new vaccine products, along with the development of the adult vaccine market, growing public awareness of vaccination, and improved affordability, China’s Class II vaccine market is expected to sustain rapid growth.

Data Sources: CIC, Frost & Sullivan, Guotai Junan Securities Research

Amid healthcare reforms, the National Medical Products Administration (NMPA) has accelerated the vaccine approval process, leading to the successive market launch of multiple imported and domestically developed new products, with EV71 and HPV vaccines seeing rapid volume growth. Currently, several promising novel vaccines in China have completed R&D and entered late-stage clinical trials, signaling that domestic vaccine manufacturers will enter a period of significant product launches in the coming years.

For Class II vaccines, which are widely recognized by parents, their preventive nature is nearly a rigid demand. They continuously benefit from the market trend of consumption upgrading. With short and flexible bidding cycles, they are not subject to medical insurance cost controls, face minimal pressure for price reductions, achieve rapid volume growth, and demonstrate significant earnings elasticity.

Data sources: Company financial reports, National Institutes for Food and Drug Control (NIFDC), Guotai Junan Securities Research

Having discussed pharmaceuticals, let us now turn our attention to the medical device industry.

The medical device industry is highly heterogeneous and can be subdivided into medical equipment, high-value consumables, and in vitro diagnostics (IVD). The hospital equipment market exhibits strong performance, primarily driven by increased demand for primary-care facilities under the tiered diagnosis and treatment system, coupled with accelerated import substitution as leading domestic manufacturers penetrate the high-end segment.

As the tiered diagnosis and treatment system continues to advance, primary healthcare institutions—particularly county-level hospitals—are entering a period of rapid development, which is expected to drive market expansion for the medical device industry serving these facilities.

Data source: Health Statistics Yearbook, Guotai Junan Securities Research

Investment in innovative drug stocks follows three stages: value discovery, event-driven catalysts, and earnings realization. After the value discovery phase driven by top-level policies from the General Office of the CPC Central Committee and the General Office of the State Council in October 2017, the sector entered an event-driven phase in 2018 with progress in regulatory submissions and approvals. It is expected to enter the earnings realization phase in 2019 as newly approved drugs undergo intensive commercialization. Companies with genuine R&D progress are likely to see their valuations recover. Hengrui Medicine is our top pick.

The companies undergoing transformation are all former leaders in their respective niche segments. They have already laid out their subsequent product pipelines and possess the material foundation and most of the capabilities required for transformation, but require a 1–2 year validation period. Examples include Huadong Medicine, Livzon Group, Lepu Medical, and Shanghai Pharmaceuticals.

Data Source: Guotai Junan Securities Research

Manufacturing and service sectors with consumer attributes, being less correlated with policy, are expected to see their “certainty” premium further reinforced as long as their performance meets or exceeds expectations. Examples include Wolwo Bio-Pharmaceutical, Changchun High-Tech, Aier Eye Hospital Group, Topchoice Medical, and Yuwell Medical.