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Prescription to Chinese Pharma Industry Stock Market Profits

Stock-Markets / China Stocks Jun 24, 2009 - 10:18 AM GMT

By: Uncommon_Wisdom

Stock-Markets

Best Financial Markets Analysis ArticleTony Sagami writes: I was raised in a small, rural farming community in western Washington, and my parents knew most of the people in town on a first-name basis. It was a slice of Mayberry RFD heaven.

The policemen in my town routinely gave me a ride home, if they saw me walking home from baseball or basketball practice. The firemen would let my friends and me sit on the fire engines and ring the siren. We could stop by the barber shop and get a piece of free penny candy even if we didn’t get a haircut.


I could also count on my neighbors to call my parents if they ever saw me misbehave. My father often had his belt in hand waiting for me even before I got home!

Despite those tattle-tale neighbors, it was that sense of community that made Fife, Washington, such a wonderful place to grow up. When Hilary Clinton said “it takes a village,” I always thought she was talking about my hometown.

One of the people that my mother knew by first name was the local pharmacist, and he was kind enough to personally drop off medications on his way home. For my sun-up-to-sun-down working farming parents, that extra service was a generous luxury that you just can’t find anymore.

Sadly, the independent mom-and-pop pharmacies that took care of my parents have been replaced by the behemoth pharmacy departments at Walgreens, CVS, Rite Aid and Wal-Mart.

China’s Pharma Industry

The pharmacy business in China today is a lot like it was in my hometown when I was a child. In China, no company controls more than 1 percent of the entire pharmacy industry. In the business world, they call that a highly fragmented industry.

Not for long. Just as it happened in the United States, the pharmacy business is in the process of slowly changing from mom-and-pop operations to big, bulk-buying corporate giants. Getting in on the ground floor of that Chinese pharmaceutical groundswell of change could make you a bundle of money.

In China, that change is being brought on by China Nepstar Chain Drugstore (NPD), the largest drugstore chain in China with 2,700 outlets. Established in 1995, the green Nepstar store is becoming a familiar sight in many urban neighborhoods across China.

Nepstar, China's largest drugstore chain, is poised to rake in serious profits  from the country's aging population.
Nepstar, China’s largest drugstore chain, is poised to rake in serious profits from the country’s aging population.

Being the biggest has some significant advantages. It is the only retailer to have successfully negotiated discount purchasing agreements with drug manufacturers and has aggressively introduced private label products (with jumbo profit margins) into its stores.

Much like American drug stores, Nepstar sells a lot more than just prescription drugs. In fact, only 21.5 percent of 2008 sales were pharmaceutical drugs while over-the-counter drugs (36.1 percent of sales) and nutritional supplements (20 percent) are even bigger sellers.

The Unstoppable Demographic Wave

Traditional Chinese medicine — herbs, acupuncture, cupping, and acupressure massage — is still very popular in China and I’ve even tried it out for myself to see what it’s all about.

The Chinese doctor I visited spent a lot of time feeling the pulse in my wrist, peering into my eyes, and asked an unusual number of questions about my sex life.

My prescription? A bunch of dried herbs, roots, and mystery animal parts were ground up into powdered tea that tasted AWFUL, and I was instructed not to eat so fast.

While traditional Chinese medicine is still widely practiced, western medicine is gaining popularity as millions of Chinese move from the poor, rural interior to prosperous urban cities on the east coast. It is in China’s modern cities that western medicine is rapidly gaining popularity.

American media has followed U.S. baby boomers for decades, and the next big step for baby boomers is going to be retirement. There are approximately 40 million of those aging baby boomers. While that sounds like a huge number of people, it is nothing compared to the number of soon-to-be seniors in China.

China has 160 million citizens over the age of 60, which is about 12 percent of its population, and that ratio is expected to rise until it hits about 25 percent by 2050. You can bet those aging Chinese will need lots of prescription drugs.

On top of the growing demographic bulge, China’s fast-growing middle class has the money to spend on better health care. China currently has 20 percent of the world’s population, but it buys only 1.5 percent of the global drug market.

That percentage is going to do nothing but increase. Plain and simple, Nepstar is sitting pretty.

Growth with a Capital “G”

When Nepstar went public in October 2007, it had 1,800 stores in 62 cities in China. At the end of 2008, that number grew to 2,709 stores in 76 cities and is the largest drug store in China.

Along with that store growth, sales have been exploding too. In the most recent quarter, Nepstar reported a 25.2 percent increase in revenue to $96 million from the same period in 2007.

That’s impressive, but it is especially impressive considering that only 30 percent of China’s population is covered by health insurance. That is going to change quickly, however, because the Chinese government recently announced a sweeping reform of its health care system. The goal is to provide basic health care to 90 percent of Chinese by 2011 and comprehensive coverage by 2020.

Per-capita drug spending in China is forecast to grow at roughly 18 percent over the next five years.

That increased health coverage means that Nepstar’s growth is about to jump from the speed of sound to the speed of light.

Beware of Fakes

I absolutely love my visits to China, but I get tired of the constant bombardment of sales pitches from the street peddlers selling faux Rolexes and fake Louis Vuitton bags.

Plain and simple, China has a huge counterfeit problem. I’m sure that Rolex and Louis Vuitton aren’t happy at the lost revenues from counterfeits; nobody has ever died from using a knockoff watch or handbag. That isn’t true of knockoff drugs.

A little understood key advantage for Nepstar is consumer confidence. The drugs you buy from a mom-and-pop store could be fake … and fatal.

A recent investigation in the city of Nanjing found that 22 out of 32 drug stores were selling counterfeit drugs, and the International Policy Network estimates that between 200,000 and 300,000 people die from counterfeit medicine in China each year!

Chinese consumers, however, can buy with complete confidence from Nepstar, and that confidence is one of the most powerful fuels behind Nepstar’s growth.

Impressive Balance Sheet

Nepstar has $274 million in cash, another $1 million in marketable securities, and ZERO long-term debt.

Nepstar’s stock is on sale too. After rising above $20 shortly after its IPO, Nepstar has dropped to the $5 area.

That 75 percent haircut doesn’t guarantee that Nepstar won’t fall any more, but it has been building what looks like very strong support above the $4 range, which tells me that the downside risk is very limited.

Regards,

Tony

This investment news is brought to you by Uncommon Wisdom. Uncommon Wisdom is a free daily investment newsletter from Weiss Research analysts offering the latest investing news and financial insights for the stock market, precious metals, natural resources, Asian and South American markets. From time to time, the authors of Uncommon Wisdom also cover other topics they feel can contribute to making you healthy, wealthy and wise. To view archives or subscribe, visit http://www.uncommonwisdomdaily.com.

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