Event:

The Company disclosed its 3Q2016 report, registering operatingrevenue of Rmb593mn (+98.62% YoY) and net profit attributable toshareholders of Rmb86mn (+98.36% YoY) for 1-3Q2016. During3Q2016 alone, its operating revenue and net profit amounted toRmb166mn (+76.60% YoY) and Rmb22mn (+86.47% YoY) respectively.We expect the Company to deliver net profit growth of 90-130% forfull-year 2016.

Comments:

Growth in its own formulation business declined on QoQ basis.During the reporting period, the Company’s operating revenue amountedto Rmb79mn, which points to a QoQ decline in growth (as its 1H2016operating revenue was Rmb208mn). We reckon this was mainly due to1) decreased selling prices for its formulation products due to price cutsin procurement tenders, 2) poor sales of its API and 3) decline in growthof non-antibiotics formulation revenue. Its gross profit margin came in at40.31% for 3Q2016, largely maintaining stable. We expect growth in itsformulation business to pick up as marketing efforts in 1) cities/provincesin whose procurement tenders the Company won bids for during 1H2016and 2) cities/provinces which the Company’s low-price drugs justpenetrated into.

New Summit Biopharm posted steady growth YTD and is expectedto beat its 2016 profit commitment. During the reporting period, NewSummit Biopharm’s operating revenue is forecast to be c. Rmb87mn,largely maintaining stable. We see high probability that it beat 2016Eprofit commitment (Rmb106mn) as it is forecast to have already postednet profit of c. Rmb85mn for 1-3Q2016. In the mid-term, as CFDA hasalready rolled out multiple specific policies for (quality and efficacy)conformity assessment for generic drugs, we expect 2017-18E will bethe time window for exponential growth in demand for clinical research.The Company is thus expected to post rapid growth riding on this policytailwind as it has a powerful pre-clinical research business platform anda growing clinical research business.

The landscape for long term development being formed with theprivate placement completed. On Sep 14, the Company announcedthe completion of its private placement, via which it raised Rmb1,297mnfor 1) the acquisition of 100% stake in New Summit Biopharm, 2) buildinga new drug R&D platform in Optics Valley, Wuhan, and 3) building theCRO business network. We believe that this private placement will laythe cornerstone for the long-term development landscape. Theformulation business will keep growing driven by launch of new productsand growing sales. New Summit Biopharm will bring in a fast-growingCRO business and synergies in R&D with the Company in addition to sharing with the Company the incremental market share that China’s (drug quality/efficacy) conformityassessment generates.

Formulation business expanding amid stability. During the reporting period, the Company obtainedapproval for clinical trial of 6 products and won bids for tenders in extra 9 provinces (including basic andnon-basic drugs). Meanwhile, some of its products are included into the list of low-price drugs for directprocurement. It has completed land slot acquisition and environment assessment for the formulationproject in Shaoxing.

Potential risks: progress in product R&D missing expectation, drug price cuts in procurement tendersand disappointing profit growth of New Summit Biopharm.

Initiate BUY. Growth of the Company’s antibiotics formulation business has stabilized gradually and itsnon- antibiotics formulation as percent of its total businesses has been rising gradually. Its overall grossprofit margin has been on the rise. New Summit Biopharm’s CRO business has kept growing. Weforecast the Company’s 2016-18E EPS to be Rmb0.47/0.77/1.09, apply 55x 2017E PE to the Companyafter looking at comparables’ valuations, set its TP at Rmb42.35 and initiate BUY.