Key points of investment

Incident: The company released its 2016 report and 2017 quarterly report. In 2016, it achieved revenue of 1.26 billion yuan (+47%), net profit of 420 million yuan (+67%), net profit of 410 million after deduction (+68%); 2017Q1 achieved operating income of 270 million yuan (+5%), Guimo's net profit of 77.25 million (-1%), and net profit of Fumo after deduction of 76.3 million (-2%); the 2017 interim report is expected to achieve net profit of 20-270 million yuan, an increase of 29-77% over the previous year.

Seasonal factors affected first-quarter results, and the interim results slightly exceeded expectations. Overall, 2017Q1 is slightly lower than expected. It is estimated that it was mainly affected by the Spring Festival and phased adjustments, which led to slow revenue confirmation growth in the first quarter. It is expected to return to normal in the second quarter. The profit growth rate will reach 29-77%, slightly exceeding our expectations. It is estimated that the annual endogenous growth plus Beijing Kexing's investment income is expected to drive net profit growth to 29%. By product, rat nerve growth factor is the company's largest single product. Revenue in 2016 was 800 million, an increase of 19% over the previous year, and gross margin also increased by 0.86 pp. The future increase in rat nerve growth factor mainly comes from terminals. The company only covers more than 700 tertiary hospitals, accounting for only 1/3 of the country's 2,200 hospitals. It is expected that about 100 new hospitals will be developed every year, thus driving the continuous growth of rat nerve growth factor. In 2016, Interferon achieved revenue of 73.61 million, a year-on-year decrease of 18%, and gross margin increased by 1.30 pp. The decline in interferon revenue growth is mainly due to adjustments in the marketing team. With the normalization of marketing promotion and the release of exclusive spray forms, the growth rate of interferon is expected to gradually resume. In 2016, the participating subsidiary (26.91% shareholding ratio), Beijing Kexing achieved a net profit of 82.29 million yuan, contributing 22 million in investment income to the company, mainly because the release of the EV71 vaccine reversed the loss trend.

There is plenty of market space for the blockbuster EV71 vaccine, and the privatization of Kexon Biotech is a probable event. Hand, foot and mouth disease is classified as a legally reported category C infectious disease in China. A total of 13.8 million cases were reported from 2008 to 2015. The average annual incidence rate was 147/100,000, with more than 3,300 deaths, a serious threat to children's health. The EV71 virus (enterovirus type 71) is one of the main causes of hand, foot, and mouth disease. Among patients with hand, foot and mouth disease, the percentage positive for EV71 virus was 44%, and the proportion of severe cases and deaths was as high as 74% and 93%, respectively. Therefore, getting the EV71 vaccine helps control the spread of hand, foot, and mouth disease. The EV71 vaccine of the company's participating subsidiary Kexing Biotech (26.91% shareholding ratio) began to be marketed and sold in May 2016. The CDC recommends getting vaccinated within 6 to 12 months, 2 doses per person, 1 month apart. Based on chickenpox, the condition of hand, foot and mouth disease is more serious, the death toll is higher, and the threat to children is greater. It is estimated that the market demand for the EV71 vaccine is not lower than the chickenpox vaccine. The chickenpox vaccine has been on the market for more than 10 years, with 15 to 20 million copies issued in annual batches. It is estimated that the peak sales of the EV71 vaccine will not be less than 20 million. For example, Kexing Biotech's market share reached 40%, and the peak sales volume was no less than 8 million copies. Referring to the winning bid price of 188 yuan, the peak terminal sales is expected to reach 1.4 billion, and factory sales revenue is expected to exceed 1 billion. Furthermore, the company has submitted Kexon Biotech's privatization plan. If privatization returns smoothly, it may significantly enhance the company's performance.

Profit forecasts and investment recommendations. It is estimated that the 2017-2019 EPS will be 0.82 yuan, 0.98 yuan, and 1.20 yuan respectively. The corresponding PE will be 28 times, 23 times, and 19 times respectively. Considering the high performance growth brought about by the release of the EV71 vaccine and the catalyst for Kexon Biotech's privatization, maintaining the “buy” rating, 40 times PE for 2017 will be given, with a corresponding target price of 32.80 yuan.

Risk warning: EV71 vaccine sales may be lower than expected; risk of privatization of Kexon Biotech may fall short of expectations; risk of rat nerve growth factor sales may fall short of expectations.