A champion for each corner
Initiate with two Outperforms: Prefer Mindray
We initiate coverage on the Chinese medical sector with Outperform ratings on
Shandong Weigao and Mindray. We regard both as compelling growth stories:
Weigao in medical consumables and Mindray in medical equipment. YTD, Weigao
has outperformed Mindray by 38% and up to 1Q09 has shown no noticeable
slowing in sales. Mindray, on the other hand, recently downgraded its EPS
guidance due to a slowdown in equipment sales. The market has efficiently
derated Mindray’s PER and now we believe the stock offers an attractive entry
point for an expected rebound in growth in FY10.
Growth driver #1: Riding China’s healthcare spending
We forecast China’s healthcare spending will grow at above-GDP levels for the
next decade. In our overview inside, we examine China’s healthcare subsectors
and conclude that medical devices and consumables will grow at the highest
pace. Weigao and Mindray are the leaders in these respective subsectors.
Pharmaceuticals look likely to lag in our opinion.
Growth driver #2: Leveraging ‘The China discount’ globally
Weigao and Mindray each currently has a low single-digit share of their
respective global markets. We think that the combination of the ‘China discount’
with quality that has only recently reached global standards will lead to a multiyear
growth surge. The fiscal pressures facing global hospitals will likely only
intensify their interest in the lower-priced Chinese alternatives.
Mindray: A tough FY09 provides an opportunity
Mindray recently lowered its guidance for FY09 EPS growth from 20% to 10% –
a bitter pill for a company that had developed a reputation for operational
excellence and sustained growth. We view the slowdown as temporary and as
the price of venturing into the riskier developed markets. We argue inside that
Mindray’s competitive advantages are compelling and its global strategy is the
right one. The recent concerns over growth offer an opportunity to buy.
Shandong Weigao: Pricey and worth it
Weigao has outperformed and now trades at a lofty 20x FY10E PER. Weigao is
a pure China play (for the moment), and as such we view it as behind Mindray in
development. Ironically, however, that has shielded Weigao this year from the
tumult of overseas markets, and the company should post 26% EPS growth. We
foresee strong optionality value on top of its strong organic growth trajectory.

China medical overview
In this overview of the China medical sector, we focus on key changes occurring at the
margin and the impact these changes will have on various subsectors within Healthcare. Our
conclusion is that medical equipment and disposables offer the best reward/risk profile to
investors. Clinics and Insurance are interesting, but there are few viable investment vehicles.
We believe the environment for Pharmaceuticals will be challenging.
Our main arguments
Spending is too low and has to rise. Healthcare spending in China as a percentage of GDP
is the lowest of the BRIC nations. That is starting to change. Healthcare spending lagged
GDP growth by an average of 1.3% during the past four years, but we expect it to outpace
that growth by 4% over the next four (Figures 2–3).
Spending is shifting from the individual and direct government grants to social
insurance schemes. To support this thesis, we look in depth at how the medical insurance
safety net is structured and where the holes are in the net.
Private health insurance is still too small to be relevant to overall spending. Although
growth will be high, it is a rounding error on overall spending (Figure 6).
Rural spending will outpace urban spending. This means more clinics and more
equipment and disposables to fill those clinics.
Hospital profitability is made up entirely of pharmaceutical sales and government
subsidies. Profits from pharma sales may decline rapidly, putting more emphasis on services
using equipment and disposables (Figures 11–12).
Spending may shift away from pharmaceuticals. Right now such spending is overinflated,
plagued by over-prescribing. Spending will likely shift more to training, doctors pay,
disposables and equipment.
Smaller clinics are the only profitable sector of the entire healthcare provider spectrum.
They should continue to proliferate and represent higher incremental spending on equipment
in particular (Figures 13–4).
The hardware is at a more-advanced stage than the software (as is often the case in
China). There are hundreds of new hospitals and relatively decent penetration of equipment,
but procedures, training and standards all lag.
Corruption is a serious problem in China’s healthcare industry. In particular, overprescribing
of drugs is widespread in order to boost profits. Equipment and disposables are
not immune, but there are much-fewer structural incentives to corruption in these sub-sectors.
In the pages that follow, we provide supporting data from the field for each of those points.
Based on such data, the conclusion is clear: The best investment plays in the China medical
sector is through disposables and equipment companies. Private clinics should also be a
good opportunity, but investment vehicles are sparse. Pharmaceuticals will face strong
headwinds, and we have not identified any compelling investment opportunities at this time.
Private insurance should post strong growth, but the overall numbers are so small
(particularly in relation to life and P&C) that they do not represent a viable investment
opportunity for the public markets.