The average price of human serum albumin has been raised since April. In line with our expectations, human albumin is the company's main revenue growth engine, and price changes have had a huge impact on its profits. The company raised prices for all dealers by 5% starting in April, in line with our expectations of an average price increase of 3% for the full year of 2016.

In the short term, policy risks are basically manageable

Since management adopted a low price strategy, the price given to downstream dealers is far lower than the tender price, so we believe Xing Kerong's current product portfolio is less affected by the bid price reduction. At the same time, we think Xing Kerong is actually more like a manufacturer (supplier) in the current product value chain, so the two-ticket system reform has less impact on the company. Furthermore, with regard to the consistent evaluation that the company is currently facing, we believe that the range of drugs involved in the company's products is small, so its impact is also basically manageable.

Affected by the decline in sales volume, adjusting the 2016-18 profit forecast to -9%/-10%/-8% RMB exchange rate fluctuations is another factor that will have a huge impact on the company's future profits. We slightly raised the 2016 RMB to USD forecast from 6.7 to 1.5% to 6.6. We expect the exchange rate to remain stable in 2017/18. At the same time, our forecast for the growth of human albumin imports in 2016 was lowered by 6%, mainly because the production capacity of the old Octapharma plant was close to the upper limit since 2015. The adjusted net profit was -9%/-10%/-8% compared to the previous forecast. The decline was mainly due to the lower sales forecast. Meanwhile, we expect costs to remain stable in the short term.

Valuation and risk

We lowered the target price to HK$1.0 accordingly, taking the average of the two valuation methods, which is equivalent to 11.0 times the predicted price-earnings ratio for 2016, or 0.6 times the dynamic price-earnings ratio. The current valuation of Xinkerong Pharmaceutical is equivalent to 6.9 times the predicted price-earnings ratio for 2016, while the H-share interbank average is a price-earnings ratio of 16 times or a dynamic price-earnings ratio of 0.8 times. We think the current valuation is attractive. Risk warning: 1) concentration risk; 2) exchange rate risk; 3) future bargaining power with suppliers may decrease; 4) authorization risk; 5) short operating history.