The largest producer of Vitamin C series (VC) in the world. According to our industry survey, annual global VC demand is around 120,000 ton; annual VC supply is around 200,000 ton. The company’s VC production capacity is 40,000 ton/year, ranked NO.1 in the world (35% global market share), mainly exporting to USA (ASLAND, VOPAK, DNP), Japan (CHOR), Australia (REDOX), India (SHIVAM), through international distributors like UNIVER, HELM, FUSO.

Five China producers dominate global VC supply and price. CSPC(石药集团)has production capacity of 40,000 ton; Shandong Luwei Pharma(山东鲁维制药)has production capacity of 30,000 ton; Northeast Pharma(东北制药)has production capacity of 25,000 ton; North China Pharma(华北制药)has production capacity of 20,000 ton; Aland (Jiangsu) Nutraceutical(江山制药)has production capacity of 20,000 ton.

Overcapacity led to operating loss for the Company. Due to cyclical overcapacity, ASP of VC dropped from over USD10.0/KG in 2009 to USD3.4/KG at present, leading to 1-3Q segment operating loss of HK$106 mn for the Company. Please refer to following figures for VC price and gross margin of the Company in 2009-2013. VC price (RMB/KG): 2009: RMB70/KG, 2010: RMB62/KG; 2011: RMB30/KG; 2012: RMB25/KG; 2013: RMB21/KG. VC series gross margin: 2009: 64%; 2010: 48%; 2011: 19%; 2012: 10%. 2013: 5% (our estimate).

Shrinking production capacity; VC price to recover to USD4.5/KG in 2015. With overcapacity lingering and competition intensified, most China VC producers are loss-making. Many producers suspend or limit their production. Given shrinking capacity, we expect VC price to recover to USD4.5/KG in 2015, which should help the Company to make an operating profit of HK$63 mn..

Maintain Buy, with target price of HK$6.8. We expect total revenue to grow at CAGR of 14% in 2013-15, with EPS to grow at CAGR of 30% in 2013-15. The counter is trading at 0.8x 2013-15 PEG, which does not fully factor in the growth potential of NBP and VC series, in our view. Maintain“Buy”, with target price of HK$6.8, equal to 0.85 x 2013-15 PEG.

Risks: centralized bidding system may continue to cut drug prices. State-run, nonprofit healthcare institutions in China procure most of the drugs through a bidding process centralized at provincial level. This may cut drug prices and lead to earnings volatilities for drug producers.

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