Investment Highlights:

The year of 2017 is crucial for the Company, which has been firmlyventuring into innovative drugs and preparation export. TheCompany was a heparin producer at the very beginning and has beenupgrading its operation by firmly venturing into the fields of innovativedrugs and preparation export. Starting from 2017, it is expected tolaunch sildenafil, hyaluronic acid etc. gradually, see gradual growth insales volume of dalteparin heparin and nadroparin and proceed withoverseas clinical trials for its innovative drugs and preparation smoothly.As such, the year of 2017 will be a crucial time window for the Companyand also a prime time for investors to allocate to it as a long-terminvestment choice.

The cost for heparin raw material will inevitably rise as the rise inheparin price will last for 2-3 years. The heparin sodium price hasalready started rising, to Rmb14k-15k/100mn units YTD fromRmb9k-10k/100mn units at the beginning of 2016. Seen from history, anup-trend or a down-trend for heparin prices usually lasts for 2-3 years.On the cost end, the price for hog casings has already risen noticeablyso that the hot casing cost for 100mn units of heparin is estimated atRmb18k assuming 1) hot casing price of Rmb22/piece, 2) 100mn unitsof heparin sodium can be exacted from every 1,500 pieces of hogcasing and 3) labour cost and equipment depreciation totalingRmb1,500.

The rise in heparin sodium price will be passed onto the API pricewith the concentration ratio for the heparin field rising. Manyill-performing small API producers in China have been forced to exit thesector after APIs prices have been on the decline for years. This,coupled with stepped-up regulatory efforts in cracking down onenvironmental pollution, has driven up the concentration ratio of theheparin sodium field. Seen from statistics by China Customs, China hasalready taken up over 50% of the global market (by output of heparinraw material). Out of all Chinese producers, the top 10 players take upover 80% of China’s heparin sodium export. In addition, a stablerelationship has been forged between raw material producers andheparin producers. As such, when the cost for heparin sodium goes up,heparin preparation producers have to leave rational profit margin withheparin sodium producers.

The huge inventory of low-price heparin sodium will boost theCompany’s net profit remarkably during 2017-18E. The Companydisclosed in its 2016 interim report that it had an inventory of APIs worthRmb656mn that it had stocked at low prices. We expect most of itsinventory is heparin sodium, whose average cost is estimated to bebelow Rmb11k/100mn units (Rmb3k-4k lower than the current ASP).We expect this Company to use this low-price inventory over next 2-3 years, boosting its net profit during 2017-18E by c. Rmb38mn-Rmb57mn.

Stable price regime for Wanmishu and gradual increase in sales volume of dalteparin andnadroparin. With a stable price regime, Wanmaishu (Low Molecular Weight Heparins Calcium Injectionor LMWHCI) is expected to sustain a growth of c. 25% on continuous growth in its demand andbetter-positioned brand image. The Company has won bids in 16 province/municipalities for dalteparinand tenders for nadroparin have already kicked off. We expect the Company’s revenue from heparinpreparation to grow by 28%/32%/35% respectively during 2016-18.

To step into harvest time for exports of innovative drug and preparations during 2018-19E as theCompany has started the cooperation with D.Med and NantPharma. The Company has been usingexternal resources amid its transformation to overtake its peers by making presence in exports ofinnovative drug and preparations. Currently, it has completed the Phase I of the clinical trial foralong-acting insulin (modified exenatide) and is expected to start the Phase II of the clinical trial in 2017.Its clinical trials for Dalteparin BE in the US and heparin preparation in the EU are expected to be carriedout gradually and completed in 2018E. These products, once commercially launched, will bring sizeableupside for the Company’s topline growth.

Potential risks: weaker than expected efforts in maintaining decent product prices, intensifyingcompetition across the sector and disappointing progress in new product R&D.

Earnings forecast, valuation and investment rating. We believe that the heparin price hike will keepboosting the Company’s profit over next 2-3 years considering the Company’s balanced presence in thefield of herapin product and ongoing growth of its heparin preparation business. The Company has joinedhands with overseas pharmaceutical giants to make exposure to innovative drug and preparation exportbusiness. We forecast its 2016-18E EPS estimates to be Rmb0.20/0.30/0.40.Based on the sector’saverage PEG ratio of ~1.35x as well as estimated net profit CAGR of ~34% for Changshan over the nextthree years apply 45x 2017E PE to it, arrive at a TP of Rmb13.50 and initiate BUY.