China graft probes a tough tonic as pharma margins bounce

By Adam Jourdan

SHANGHAI, June 11 (Reuters) - Sales growth is picking up speed at Chinese drugs firms, and margins are widening, in a sign that the world's second-largest pharmaceuticals market may be rebounding from a crackdown on corruption and high prices.

A Reuters' analysis of more than five dozen Chinese healthcare companies shows sales growth bounced to 15.6 percent in January-March after falling steadily from around 30 percent in 2011. There was also stronger growth in margins and profits.

Faster growth in China is good news for local and global firms chasing a medicine bill estimated by IMS Health (NYSE: IMS - news) to hit $185 billion by 2018, but who have taken a hit from a series of bribery probes that led to a $500 million fine against British drugmaker GlaxoSmithKline PLC (Other OTC: GLAXF - news) last year.

"Sales departments did slow down activities in China and have taken their time to adapt their sales efforts," said Anand Tharmaratnam, head of Asia Pacific for drug development firm Quintiles Transnational Holdings Inc. "But there are 1.4 billion people here. They're going to fall ill and that's not going to change," he told Reuters at the firm's new regional headquarters in Shanghai.

Industry executives said firms had adapted their operations to the greater levels of scrutiny on marketing and sales since the corruption probes; others said spending on wining and dining had fallen, helping trim costs and boost margins.

The data - a swing from a similar analysis a year ago which showed a squeeze on margins and profits - offers a rare window into potentially improving prospects for global Big Pharma in China, few of which break out local sales.

"I'd say overall things have stabilized over the last 6-9 months in every dimension, and I'm personally cautiously optimistic in terms of what we can see happening now in China," GSK CEO Andrew Witty said in May.

WINING AND DINING

Beijing is helping firms through tax breaks and preferential pricing on drugs amid a push to more widely encourage healthcare innovation and research. Firms are also shedding staff and less profitable products to cut costs.

"A combination of these is helping firms improve margins," said Guillaume Demarne, a Shanghai-based business manager at a firm helping healthcare companies to enter the Chinese market.

The Reuters' analysis showed margins widened to 6.9 percent in the first quarter after falling to 5.3 percent in 2014. Profit growth, which stagnated in 2012 and 2013, started to bounce last year and sped to 26 percent at the start of 2015.

A Shanghai-based compliance expert who works with drug firms said the corruption crackdown had reduced "wining and dining" between firms and local partners or regulators, hampering business in the short-term, but now helping trim costs.

"With the anti-corruption drive you've seen lower costs of entertaining, and this has helped some firms streamline their business," another industry insider said. Both asked not to be named as they are not permitted to speak with the media.

Investigations into healthcare have by no means ceased; China launched probes into two healthcare officials last month and sources told Reuters earlier this year that regulators had quietly started to probe the medical devices sector.

A Deutsche Bank (Xetra: 514000 - news) report said 83 percent of industry executives expect drug sales growth at hospitals, the dominant sales channel for medicine in China, to accelerate this year.

WINNERS AND LOSERS

Longer-term, analysts said growth in the market was likely to cool amid a wider economic slowdown, but the prospect of rising healthcare demands from China's ageing population was too enticing for global firms and investors to ignore.

This has driven up Chinese healthcare stocks to record highs. The CSI300 Health Care Index of Shanghai and Shenzhen-listed firms is up 63 percent this year, beating the wider index's 50 percent gain.

Broader healthcare reforms are likely to benefit firms with exclusive drugs, medicines on China's essential drug list (EDL), and strong R&D pipelines, analysts said. Retail drug sales will also benefit from a drive by Beijing to push medicine sales away from hospitals.

Goldman Sachs (NYSE: GS-PB - news) had buy ratings on Lijun International , WuXi PharmaTech, China Medical Systems , Fosun Pharmaceutical and CSPC Pharmaceutical among others.

"Medical reforms like the separation of drugs from medical treatment will move drug sales more into private drug stores rather than in-house hospital pharmacies," said Frank Zhao, chief financial officer at China Jo-Jo Drugstores Inc (NasdaqCM: CJJD - news) .

"This should propel growth of retail sales." (Additional reporting by Ben Hirschler in LONDON; Editing by Ian Geoghegan)