Incident: The company announced that in the first three quarters, it achieved revenue of RMB 40.209 million, or -53.48%; net profit after deduction of RMB 2,913 million, or -83.17%; net profit after deducting non-return income - RMB 2,663 million, year-on-year, -116.35%; net operating cash flow - RMB 28.2 million, or -291.37% year-on-year.
The decline in the company's revenue continues to narrow, and the successful reversal of losses in Q3 results indicates a clear inflection point in performance. The company achieved revenue of 40.21 million yuan in the first three quarters, including 17.54 million yuan for clinical research and 17.41 million yuan for pre-clinical research. That is, the company's Q3 clinical research business reached nearly 7 million yuan, better than 10.88 million yuan in the first half of the year. As clinical trial data standards become clear and order prices rise, we think the CRO industry is gradually picking up. Looking at the revenue side, the company's revenue growth rates for the Q1, Q2, and Q3 quarters in 2016 were -64.36%, -60.75%, and -31.77%, respectively, and the decline continued to narrow. Looking at the profit side, the company reversed losses in the third quarter to achieve net profit of 4.59 million yuan, after deducting net profit of 106,000 yuan. There are obvious signs of an inflection point in performance.
The registration system for clinical trial institutions is ready to be introduced, production capacity bottlenecks in the CRO industry are expected to be alleviated, and policy catalysts are highly certain. Currently, there is a serious shortage of clinical resources in the CRO industry. The main reason is: 1) Inventory: Clinical trial approvals that have quadrupled since October 2015 are rushing to pharmaceutical companies; 2) Increment: Chemical oral formulations requiring generic drug consistency evaluation involve 3,000 varieties and 60,000 approvals. Judging from the current reference preparation filing situation, BE clinical trial demand is very strong; 3) Clinical resource bottlenecks: Currently, there are 475 clinical drug testing institutions that have been certified by the General Administration, and are concentrated in Class III A hospitals, which are far from meeting the needs of the industry. At the same time, after verifying clinical trial data, tertiary hospitals are less motivated, and under the current clinical trial institution certification management method, it is impossible to effectively release the clinical trial resource production capacity of hospitals below the top three, which have strong motivation, and the certification of clinical trial institutions using a filing system is imminent. On September 14, for the first time, the CFDA made a detailed interpretation of policies relating to the consistent evaluation of the quality and efficacy of generic drugs. Among them, it clearly explained the shortage of resources for clinical trials: the General Administration has already communicated with the State Health Planning Commission to consider adjusting the qualification certification to filing management, has drafted a notice, and is currently seeking opinions from relevant departments. We believe that industry policy catalysts are highly deterministic, and that after implementing filing management, the conflict over tight clinical trial resources can be mitigated.
Profit forecasts and investment recommendations. We expect the company's revenue and net profit to grow at a compound rate of 77% and 81% in 2016-2018. We believe that the CRO industry is undergoing positive changes. The inflection point in the industry is clear, the low point in the company's performance has passed, and at the same time, the company still has international expectations. Considering the company's high growth performance and small market value premium, we maintain our “buy” rating.
Risk warning: There is a risk that the company's performance will fall short of expectations due to inadequate implementation of policies such as the liberalization of certification of clinical trial institutions and consistent evaluation work; the risk that industry regulations will exceed expectations, that the CRO industry or company will be subject to administrative penalties, etc., or cause the company's valuation to decline.
