Capital + brand to drive healthy expansion of healthcare service business

We project that Jinling's healthcare service segment will see 40% revenue growth inthe next three years, backed by its "capital + brand" model, under which the companyprovides capital and Nanjing Drum Tower Hospital provides brand expertise. Jinling isshifting towards healthcare services, which we estimate will contribute 35% of its grossprofit in 2016. Suqian Hospital, which came under the company's control in 2004, hada net profit CAGR of 33% in 2004-14. We expect the company to replicate the "capital+ brand" model in its other hospitals to allow the business to expand rapidly, andhealthcare services to replace drug manufacturing as its main driver of earnings growth.

Chemical drugs to maintain steady growth

The company's businesses are divided into four segments: TCM, chemical drugs,healthcare services, and others. The chemical drug segment, which mainly involves thedistribution of products, has seen its revenue growth negatively affected, as fallinggrowth in upstream drug manufacturing hurts the pharma distribution sector. Weexpect revenue growth in the chemical drug segment to be in line with the average forthe pharma distribution sector, at c10% in 2016-17.

TCM injections to resume slow growth

The Mailuoning injection, Jinling's core TCM offering, was again included on theNational Essential Drug List (NEDL) in 2013. Mailuoning prices have fallen in tandemwith sales due to drug tenders and pressure arising from recent regulations on TCMinjection safety. With the end of this round of tendering, we forecast Mailuoning willmaintain c5% revenue growth in the next three years, and TCM injections willcontribute 20% of total gross profit in 2016.

Valuation: Initiating coverage with Rmb15.65 price target and Buy rating

Our price target of Rmb15.65 is derived using a DCF-based methodology (WACC8.1%) and implies 28x 2016E PE. The stock is trading at 22x 2016E PE, in line with itshistorical average but below the average of the pharmaceutical industry. We areinitiating with a Buy rating, as we believe the solid growth potential of Jinling'shealthcare service segment has not been fully priced in.