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This Supersafe, Long-Term China Play Just Keeps Getting BetterBy Larsen Kusick, analyst, Phase 1 InvestorMonday, April 11, 2011 After decades of neglect, China is ramping up its health care system at hyperspeed.
The Chinese government is spending about $125 billion to build infrastructure and provide health coverage to the nation's 1.3 billion citizens. This includes plans to build about 2,000 large provincial hospitals and 20,000 smaller "township" hospitals over the next decade or so.
This is a perfect market for the world's biggest drugmakers. Lots of people. Lots of demand. And growing income to pay for it.
Pfizer, for example, just added 1,000 sales representatives during 2010, covering a total of 220 cities in China. During the company's most recent conference call, CEO Ian Reed said Pfizer plans on eventually growing to 4,000 reps. He added, "The pent-up demand in China is absolutely enormous for quality health care."
Analysts at research firm Cowen estimate China's per capita annual spending on pharmaceuticals is around $20 vs. $800 in the U.S. and over $400 in Europe. There's no doubt spending will soar off these rock-bottom levels...
China is No. 1 in the world in terms of people with diabetes. And despite population-control efforts like the one-child policy, China still ranks No. 2 in the world in births, which is the biggest driver for vaccine sales. Yet drug sales for anything besides communicable diseases (like the flu) are still miniscule compared to developed nations.
Nevertheless, China has gone from No. 9 in pharmaceutical sales back in 2004 to No. 3 currently (behind the U.S. and Japan).
Besides this enormous growth, the best part is the little details...
For one, Big Pharma can collect higher revenues from its most lucrative drugs. You see, upper- and middle-class Chinese people are hypersensitive to quality issues. Since China has been one of the world's great manufacturers of low-quality goods (ranging from cars to golf clubs), many Chinese are happy to pay up for brand names. Unlike in the U.S., they're reluctant to switch to generic drugs.
For example, AstraZeneca's blockbuster drug Losec – used to treat ulcers and acid reflux disease – lost its patent protection back in 2001. Yet sales in China are still growing at a 15% rate even though cheaper generic versions are available.
Even better, customers are willing to pay more than double for brand name drugs. In some cases in China, drugmakers are able to sell their products for eight times the price of generics.
There's also the lower costs for sales reps. These reps keep contact with doctors, touting the effectiveness of their employers' drugs. According to Merck, the average sales representative in China costs about one-fifth as much as in the U.S.
In short, China offers an attractive, early-stage market for big drugmakers to push their products. Pfizer (PFE) remains the biggest brand in the highly fragmented Chinese market. But AstraZeneca (AZN), Sanofi-Aventis (SNY), and Novo-Nordisk (NVO) all have significant operations in China as well.
But for now, total China revenues are still tiny compared to sales in developed nations. Analysts estimate Pfizer and AstraZeneca got about 3% of their sales from China in 2010. Novo-Nordisk is the only company with a higher percentage, but that's because it has focused solely on becoming the top seller of insulin to China's big diabetes market.
In other words, China is still in the early stages of developing its health care market. That means a 20% annual growth rate in drug sales could last for well over a decade.
That's not going to double any Big Pharma company's revenues overnight. But you can get paid while you wait. Pfizer pays a 4% dividend. Sanofi pays 4.4%. AstraZeneca pays 5%.
Yields are so high because the market is focused on the stagnant growth in developed nations and is selling these stocks cheaper on a price-to-book measure than it has in more than 10 years.
But as drug sales in China continue to grow at double-digit rates, China will become a hugely profitable place to do business for these companies. You can expect the market to get excited about these stocks again. In the meantime, sit back and collect your dividends.
Good investing,
Larsen
Further Reading:
When Larsen visited China last summer, he was shocked at the poor conditions of the hospitals. The doctors were top-notch, the equipment was up to date... but after seeing it for himself, Larsen says there's "a lot of room for growth."
As the Chinese government pushes billions of dollars into the health care system, there's a lot of room for growth for American investors, too. Read more here: After a Decade of Neglect, This China Sector Is Ramping Up.
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