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China biotech keeps long-term shine despite wild swings and sky-high valuations

Hong Kong

THERE seems to be no end to the troubles afflicting Chinese biotechnology stocks. Shares have plunged 32 per cent from a peak as a vaccine scandal shook the entire health-care industry.

Companies have been subject to short-seller attacks and the government's efforts to lower drug prices. Despite the sector's woes, valuations are still at elevated levels compared with global peers.

Yet analysts aren't giving up on one of the most volatile groups in the Chinese market, citing the long-term growth potential of a rapidly developing industry.

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"The business performance of biotech firms is far less volatile than the share prices," said Haitong International Securities analyst Nicolas Wang. "While the market will be more regulated, China has gradually launched supportive policies for the sector, including speeding up new drug approvals. Leading biotech companies are on the right track." Among the top biotech companies trading in Hong Kong and the mainland, Wuxi Biologics Cayman Inc, 3SBio Inc, Shenzhen Kangtai Biological Products Co and GenScript Biotech Corp receive buy ratings from at least 80 per cent of the analysts who cover them, even as they've lost more than 25 per cent since the end of May.

Biotechs started out on a strong note in 2018. Healthcare was the best sector in the CSI 300 index of shares traded in Shanghai and Shenzhen, climbing 26 per cent through the end of May while the entire market fell 5.7 per cent. Investors poured into the US$122 billion drug industry as the government sought to overhaul regulations that had for decades slowed drug approvals and stifled innovation, with the aim of building homegrown champions.

Investors headed for the exits in mid-July after a vaccine scandal sparked a wave of consumer outrage, with biotechs leading the entire healthcare industry lower. The Chinese government cracked down, and last week slapped a 9.1 billion yuan (S$1.8 billion) penalty on Changsheng Bio-technology Co that produced low-quality vaccines for infants and fabricated rabies vaccine data.

The CSI 300 Health Care Index is currently near the lowest level in more than a year. Yet, even after biotech's drop, valuations are still high. The CSI 300 healthcare gauge is trading at 28.5 times reported earnings, 23 per cent higher than an index of global peers.

Analysts aren't worried about such comparisons. "It's not fair to say a fast-growing sector is expensive based on the valuation methods, because in the early development stage of an emerging industry, investors are willing to give high premium to companies that have potential," said Haitong's Mr Wang.

Zhang Jialin, a senior healthcare analyst with ICBC International Research Ltd in Hong Kong, agrees. He said the current three-year average valuation level will be supported by the sector's long-term outlook.

"We think the defensive character of the healthcare sector might be attractive in the turmoil environment," he said. "Pharmas with good drugs will thrive in the long run." Lately, the group has proved more unpredictable than the rest of the market. The historical 120-day volatility of Chinese healthcare companies is far higher that for the overall market.

GenScript has seen the volatility up close. Among the first Chinese developers of so-called CAR-T cancer therapies, GenScript surged 440 per cent last year.

Then, last month, it lost almost half its value after Flaming Research published a bearish report. GenScript denied the allegations in the report. "Prices of the listed healthcare companies are just like riding roller coasters," chief executive officer Frank Zhang said in an interview Wednesday. "Lacking sufficient knowledge on the highly technical sector due to its sophistication, investors, especially retail investors, tend to overreact." He's optimistic the current volatility won't last. BLOOMBERG