The investment case for Zhejiang Huahai, based within the province of Zhejiang, is that it is cheap based on current valuations, has good fundamentals and is a fairly decent business. The company was founded in 1989 and now employs over 9,000 people. It operates more than 40 subsidiaries and units across China, the US and Germany.
The brand is recognised globally, as it was the first Chinese pharmaceutical company to pass the US Food and Drug Administration (FDA) certification for finished pharmaceutical products, and has established an international platform to increase global trade for active pharmaceutical ingredients, which aids in its mission of enabling public access to cost-effective medicinal and healthcare products. This implies that Zhejiang Huahai has a larger presence along the pharmaceutical value chain, and its operating segments are cohesive with one another for business growth.
A supporting case for Zhejiang Huahai is its multi-level R&D institutions, a national enterprise technology centre recognised by the Chinese ministry, and a national postdoctoral scientific research station. Given that the pharmaceutical industry relies on patents for profit generation and innovation, the company’s competitive advantage is likely to be more protected and secure. An example of this is the company’s R&D centre at Linhai, which develops formulation processes with proprietary intellectual property rights.
Zhejiang Huahai’s import and export segment covers five main business scopes: active pharmaceutical ingredients (API), pharmaceutical excipients, cosmetics raw materials, animal health and food supplements and additives. The broad range of sectors covered by the import and export business provides a solid foundation for expanding into diverse industries to drive revenue and income.
See also: Retiring The Edge Singapore’s global portfolio
The company’s contract manufacturer organisation (CMO) process includes process and formula development, medicines for clinical trials, production of APIs, either for chemical or biological medicines, formulated products and packaging. To ensure repeat contracts, the company has adopted an approach called “total quality management”, where it manages each step in the product life cycle. To date, its products have been officially certified by various national and regional organisations, including China, the US, the European Union, Japan and the World Health Organization. This reflects that the CMO process is of a high standard, which aids in revenue and earnings generation for the company.
Financials-wise, Zhejiang Huahai has shown consistent growth in its revenue, net income, and operating cash flow, with the exception of one year. The company’s strong margins reflect its competitive advantage in the industry. Its net income, operating cash flow and free cash flow margins are 10%, 23.3% and 5.1%, respectively. Profits-wise, the company’s return on equity and return on assets are 13.5% and 6%, respectively, representing good profitability.
In terms of financial health, the company has good solvency, with a current ratio of 1.4 times. Although its net debt-to-equity ratio is 72%, its interest coverage ratio of 4.8 times is more than enough to ensure its solvency is not an issue. Further, the company’s average credit rating is investment grade with minimal default risk probability and its Altman Z-score of 3.15 times, which is above the benchmark of three times, represents a low probability of the company defaulting.
See also: Traders’ fear of missing out on stock gains outweighs tariff concerns
In terms of relative valuation, Zhejiang Huahai trades at a discount for all its valuation ratios compared to global peers. The company trades at an 18%, 8%, 19%, 1% and 14% discount for its forward P/E, EV/Ebitda, EV/Ebit, EV/Revenue and P/B ratios, respectively. Also, Zhejiang Huahai is currently trading at the lower range of its two-year historical range for all the previous ratios, reflecting that it is cheap at current valuations. The company is consistent with its dividends — it has paid annual dividends over the past 10 years with the exception of one year. The current dividend yield is 1.3% and it is forecast that it will maintain its dividend for the next payable period.
Sentiment-wise, there are eight “buy” calls, no “hold” calls and one “sell” call for Zhejiang Huahai from analysts with an average target price of 30% above its current trading price of RMB15.60 ($2.90). Based on our in-house valuations (see Charts 1a and 1b), we think the fair value for the company is RMB18.40.
Disclaimer: This article is for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy or sell stocks, including the stocks mentioned herein. This article does not take into account an investor’s particular financial situation, investment objectives, investment horizon, risk profile, risk tolerance and preferences. Any personal investments should be done at the investor's own discretion and/or after consulting licensed investment professionals, at their own risk.
