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China Drug-Buying Overhaul Triggers a Flood of Profit Warnings

Chinese Drugmakers Warn on Profits as Government Overhaul Bites

(Bloomberg) -- China’s drive to cut health-care costs is taking a toll on the profits of its drugmakers.

Nearly 70% of the 65 pharmaceutical manufacturers listed in China have flagged they’re likely to report slower profit growth for the first half of this year. That’s the most since 2016, data compiled by Bloomberg show. While some haven’t given reasons for the expected weakness, others have pinned it on Beijing’s zeal in slashing drug prices and curtailing the use of medicines with unclear efficacy.

China is focused on overhauling its health-care system to better meet the expectations of its rising middle class. Part of that has been a drive to reduce the cost of drugs in what is the world’s second-biggest pharmaceutical market by making companies bid for the right to supply 25 off-patent medicines to 11 cities. The new bidding process -- which China is looking at extending nationwide -- has cut prices on some drugs by as much as 96%.

China Drug-Buying Overhaul Triggers a Flood of Profit Warnings

“With last year’s purchases now showing impact across the sector, expanding the program will add further pricing pressure on the companies,” said Wang Ruizhe, a Shanghai-based analyst at Capital Securities Corp.

The MSCI China Health Care Index advanced 2.5% on Thursday, closing at its highest level since May 7.

While the government and the patients have emerged as clear winners of this watershed regulatory reform -- the state-run health insurance fund has saved 5.8 billion yuan ($844 million) in procurement costs -- it has roiled drugmakers’ shares and balance sheets.
The worst hit have been generic drugmakers and suppliers of key pharmaceutical ingredients. The 25 medicines that were part of the pilot plan last year ranged from lipid-lowering tablets to those indicated for treating cancer, hepatitis and neurological disorders.

Sichuan Kelun Pharmaceutical Co., which won the contract to supply an antidepressant drug under the bulk purchase program, says its first-half earnings may slide by up to 10% from a year ago on declining revenue from one of its units and rising drug research expenses. Hunan Er-Kang Pharmaceutical Co. said in a July 12 filing that its profit could drop by 43% from a year ago, citing changing demand amid the government’s health-care reforms as one of the reasons.

Hybio Pharmaceutical Co. expects its profit to slip by as much as 65% as the government squeezes its medical insurance spending and competition intensifies amid policy changes such as the drug procurement program, it said in a filing.

What Bloomberg Intelligence Says:

“We believe high margins aren’t sustainable for generic drugs in China. The government will continue to put pressure on drug prices to curb escalating health-care costs amid an aging population.”

--Nikkie Lu, industrial and medical analyst
Click here to read the note

While this new purchase plan caused a lot uncertainty for companies, it is not the only source of pain.

The nation’s health regulator is also asking hospitals to tighten use of the so-called “adjuvant drugs” that are supposed to enhance the therapeutic effect of another medicine or treatment. Many of these drugs have made it to the state reimbursement list but have questionable clinical efficacy, forcing a rethink within the government on whether it should spend this money instead on more novel and effective treatments.

‘Procurement Patterns’

Hong Kong-listed Sihuan Pharmaceutical Holdings Group Ltd. said in a July 19 filing that it could even report a net loss for the first six months on an expected impairment due to “possible impact on prescription and procurement patterns” as the government tightens use of adjuvant drugs.

Staidson Beijing Biopharmaceuticals Co. said on July 12 that its profit could fall 65% on declining sales of its nerve injury-drug as the government curbs the use of these drugs while it ramps up research spending.

There are some silver linings. The bulk buying plan, while being extended to more cities, will stay contained to the original list of 25 drugs, sparking a relief rally earlier this month. Also, authorities will pick up to three winners instead of one, relaxing the previous winner-takes-all approach and softening the blow.

The reforms “won’t necessarily plunge companies into losses, but making generics will no longer be as profitable as it used to be,” Capital Securities’ Wang said.

Uneven Pain

In addition, the pain of these regulatory reforms is unevenly distributed. The impact will depend on the extent of price cuts a drugmaker faces, and the share of discounted drugs in its total sales.

Zhejiang Jingxin Pharmaceutical Co., for instance, expects to escape unscathed with an earnings growth that matches last year’s. It won contracts to supply three generic drugs under the bulk purchase program -- with one medicine that’s just 4% of what the foreign maker was charging.

The crisis, however, has put the Chinese drugmakers at crossroads, leaving them to choose between two difficult alternatives.

“Price cuts for generic drugs will be a long-term trend,” said Zhang Jialin, analyst with ICBC International in Hong Kong. “Companies will either have to pivot to drug innovation or cut costs for survival.”

©2019 Bloomberg L.P.

With assistance from Bloomberg