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Author

段煉先生(Leon Duan)
分析師

本科畢業於山東大學理科,碩士畢業於香港中文大學理學院及香港城市大學商學院,擅長從行業前景及公司基本面進行分析,主要負責醫藥及環保板塊的研究。

Bachelor Degree in Shandong University of Science, and Master Degrees in Chinese University of Hong Kong Faculty of Science and City University of Hong Kong College of Business. Currently cover Pharmaceuticals and Environmental Protection sectors, good at combining analysis with industry prospects and company fundamentals.


Phone: 852 2277 6515  
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FRONTAGE (1521.HK) - Covering both China and the US markets, Professional Advantages of "Two Countries, One System"

Monday, February 17, 2020 Views616
FRONTAGE(1521)
Recommendation on  17 February 2020
Recommendation Accumulate
Price on Recommendation Date $4.340
Target Price $5.000

The market for CRO is growing rapidly

The global pharmaceutical CRO market size in 2018 was US$55.2 billion and is expected to increase to US$91.4 billion in 2023, with a compound annual growth rate of 10.6%. Market penetration of outsourcing services for global R&D expenditure by a total of 33.7% in 2014 sustained growth to 37.7% in 2018, it is expected to increase to 49.3% in 2023.

Business covers China and the US, taking advantages of "Two Countries, One System"

The company is a fast-growing CRO that provides integrated, science-driven research, analysis, and development services throughout the pharmaceutical discovery and development process to assist pharmaceutical companies in achieving drug development goals. The company has business in both China and the United States, and can effectively capture the growth opportunities in both markets. The company implements the "Two Countries, One System" approach to ensure that customers enjoy the same quality standards, operating procedures and systems in both markets. At the same time, the company can also provide customers with detailed and experienced interpretation of drug development regulations and requirements in both countries. The company serves customers` drug discovery and development goals by sharing technical expertise and personnel in two countries and leveraging familiarity with the two regulatory systems.

Endogenous growth and extensional expansion work together to maintain stable growth

The company continues to expand their production capacity with operation of several laboratories. The company also expand its business and production capacity through acquisitions. Through the upgrade initiatives, the company hopes to use BRI and RMI to expand its Canadian and North American West Coast businesses, establish DMPK centers across North America and China, and expand its CMC service capabilities in China through controlling most of the shares of Frontage Suzhou. And through the new laboratory in Shanghai Zhangjiang Science and Technology Park to establish a Chinese DMPK team and business line, expand production capacity, seize market opportunities, and continue to promote business growth in China and the United States.

Complementary to the parent company's strengths to further enhance synergies in the future

Hangzhou Tigermed (stock code: 300347) is a CRO that focuses on providing professional services for the whole process of clinical trials for the development of new drugs. The business division of Tigermed Group and the company is clear and synergistic. The company has established a cooperative relationship with Tigermed Group. Benefiting from the synergy with Tigermed Group, the company is able to provide Chinese customers with comprehensive clinical trial support solutions from Phase I to Phase IV, and Tigermed Group customers also have access to the company's services, especially bioanalysis services.

Initial coverage with “Accumulate” investment rating

We forecast that the company's FY19/FY20/FY21 income will be US$ 113/150/188 million, representing an increase of 35.96%/32.85%/25.01% YoY; net profit attributable to shareholders will be US$ 21.37/28.37/35.55 million; corresponding EPS will be US$ 0.01/0.02/0.02. We get target price of HKD 5.00. The corresponds to FY19/FY20/FY21 48.00x/36.17x/28.86x PE, which has an increase of +15.20% compared to the current price (HKD 4.34 as of February 11, 2020), giving an “Accumulate” rating.

Industry Analysis

Global pharmaceutical market grows rapidly

The global pharmaceutical market can be divided into two segments, the chemical drug market and the biologics market. According to Frost & Sullivan 's statistics, the scale of the global pharmaceutical market in 2018 is US$1,270 billion, which is expected to increase to US$1,600 billion in 2023, with a CAGR of 4.7%. Among them, the expected annual compound annual growth rate of biologics market will reach 9.0% from 2018 to 2023, and up to US$402.1 billion in 2023, growing faster than the overall pharmaceutical market. According to 2018 market size, the United States, China and Japan are the three largest pharmaceutical markets in the world, accounting for the global market of 38.7%, 18.3% and 7.5%, respectively.

Total research and development (“R&D”) spending in the global pharmaceutical industry was US$174.0 billion in 2018 and is expected to grow at a CAGR of 4.5% during the period from 2018 to 2023, reaching US$216.8 billion in 2023. In 2018 R&D spending represented 13.7% of the total size of the global pharmaceutical market by revenue, the US and China accounting for 15% and 7.5%, respectively. But the R&D spending by Chinese pharmaceutical companies is not limited to China. An increasingnumber of Chinese headquartered pharmaceutical companies also spend a significant amount of their R&D budget to support applications in other jurisdictions, and in particular in the United States for IND and ANDA applications. Additionally, according to Frost & Sullivan estimates, the annual growth rate of China pharmaceutical market for R&D spending is 23.1% from 2018 to 2023, which will be much higher than the United States of 4% and the world average of 4.5%.

Comparison of pharmaceutical markets in China and the US

The United States is the world's largest pharmaceutical market. In 2018, the size of the market was US$490.8 billion, representing 38.7% of the entire global pharmaceutical market and a margin of more than 20% in terms of market share over China, the second largest pharmaceutical market globally. The size of the pharmaceutical market in the United States increased from US$385.5 billion in 2014 to US$490.8 billion in 2018 and is expected to grow to US$634.2 billion in 2023, representing a CAGR of 5.3% during the period of 2018 to 2023. The growth of this market is primarily driven by increases in both public and private spending on healthcare as new and more effective treatments for diseases become available. China is the second largest pharmaceutical market in the world, after the United States. The size of China's pharmaceutical market increased from US$182.2 billion in 2014 to US$231.6 billion in 2018 and is expected to grow to US$322.1 billion in 2023, representing a CAGR of 6.8% during this period. The growth is mainly driven by an ageing population and corresponding increase in the prevalence of chronic diseases, as well as favourable policies from the government of the PRC, aimed at developing the market for quality drugs and biologics in China and an increase in disposable income and improving insurance coverage.

Compared to the chemical drug market, there is expected faster rate of growth in the biologics market in the US. The size of the market for biologics in the United States was US$104.0 billion in 2018 and is projected to grow to US$164.1 billion in 2023, which would represent a projected 9.6% CAGR from 2018 to 2023, compared to a projected 4.0% CAGR for chemical drugs over the same period. The size of the market for patented drugs in the United States was US$379.7 billion in 2018 and is projected to grow to US$502.5 billion in 2023, which would represent 79.2% of the total pharmaceutical market in the United States in 2023. Relatively, policies in China are expected to continue to focus on encouraging the development of innovative patented drugs over the next five years from 2018 to 2023, which in turn is expected to lead to increased investment in patented drugs, whose market size is expected to grow at a CAGR of 7.5% during the same period to reach US$184.4 billion in 2023.

U.S. pharmaceutical companies lead the world

Magazine "Pharmaceutical Manager" (Pharm Exec) in US published 2019 annual sales of prescription drugs based on "global pharmaceutical companies 50 " (Pharm Exec's Top 50 Companies 2019). Pfizer still ranks first in sales of prescription drugs in the United States, while Roche and Novartis in Switzerland rank second and third. In terms of R&D expenditure, Roche of Switzerland still ranked first, and Johnson & Johnson of the United States and Novartis of Switzerland ranked second and third. This year for the first time two Chinese pharmaceutical companies into the global pharmaceutical companies 50 strong list of orders, including Sino Pharma (ranked 42), subsidiary of Chia Tai Group headquartered in Hong Kong, the and Jiangsu Hengrui Medicine (ranked 47).

The market for pharmaceutical contract research organisations is growing rapidly

The complete process of drug development is generally categorized into four stages: discovery, preclinical testing and development, clinical development (e.g. phase I-III clinical studies) and post approval clinical studies (e.g. phase IV clinical studies). The type of, and objectives of, the research, analytical and development services offered byContract Research Organisations (CROs) through the drug development process depends on the phase of development.

The size of the global pharmaceutical CRO market was US$55.2 billion in 2018 and is expected to grow to US$91.4 billion in 2023, representing a projected CAGR of 10.6%. The proportion of outsourcing services spending of the total spending on both outsourcing and in-house services, or `rate of penetration`, of the total global R&D expenditure by outsourcing services has continued to grow from 33.7% in 2014 to 37.7% in 2018 and is expected to grow to 49.3% in 2023. Among them, the size of the pharmaceutical CRO market in the United States increased from US$18.7 billion in 2014 to US$27.0 billion in 2018 and is expected to grow to US$41.1 billion in 2023, representing a projected CAGR of 8.8% over the period 2018 to 2023. The size of the pharmaceutical CRO market in China increased from US$2.1 billion in 2014 to US$5.5 billion in 2018 and is expected to grow to US$19.1 billion in 2023, representing a projected CAGR of 28.3% over the period 2018 to 2023.

Company Analysis

Company Introduction

The company is a fast-growing CRO providing integrated, scientifically-driven research, analytical and development services throughout the drug discovery and development process to enable pharmaceutical companies to achieve their drug development goals. The services of the company provide in the United States include DMPK, safety and toxicology, and CMC, in each case, throughout the drug discovery and development process. The bioanalytical services, which are the largest source of the revenue of the company (contributing 48.23%, 50.57% and 53.18% of revenue for the years ended December 31, 2016, 2017 and 2018, respectively), are offered throughout the drug discovery and development process in both the United States and in China. The company also provides bioequivalence and related services in China. Certain of our services are also offered to agrochemical companies.

In the United States, the company is recognised as a leader in the CRO industry. For example, in 1H2019, the company was awarded the CRO leadership award by “Life Science Leader” (a United States business journal targeted at life science executives) based on research conducted by “Nice Insight” (a leading United States market intelligence institution specialising in life sciences). The company has won this award many times since 2014, which reflects its leading position in quality system, technical capabilities, regulatory compliance and customer satisfaction. The company also won the 2019 China Top 20 CRO at the 2019 China Pharmaceutical Industry Development Conference, and the company's facilities have successfully passed multiple inspections by FDA, NMPA and other regulatory agencies. In 1H 2019, the company also successfully passed multiple inspections by the US Department of Agriculture, the US Environmental Protection Agency, and the Chinese State Drug Administration, indicating that the company continues to meet or exceed the strict standards implemented by the industry.

The company positions themselves as a value-add partner with a focus on solving their customers` most significant and complex drug discovery and development challenges. Their scientific knowledge base, technical expertise and reputation for high quality services have been integral to the ability to enter into strong long-term strategic relationships and partnerships with our key customers. The customers include Janssen, BeiGene, Blueprint, Fresenius Kabi, Celgene, Rhodes and Duke in the United States and Yangzijiang Pharma, Hisun Pharma, Luye Pharma, Simcere Pharma and Chia Tai Tianqing in China.

The Company's controlling shareholder, Hong Kong Tigermed Co, Limited is a wholly owned subsidiary of Hangzhou Tigermed. Therefore, Hong Kong Tigermed and Tigermed, as a group, are the controlling shareholders of the company. The Listing will constitute a spin-off of the assets and businesses held by the company from Tigermed, a company listed on the ChiNext market of the Shenzhen Stock Exchange with stock code 300347. Tigermed Group is a global CRO headquartered in Hangzhou. China and is principally engaged in the provision of clinical trial services to meet the needs of pharmaceutical companies. The Tigermed Group has a leading reputation in late phase (Phases II-IV) clinical trials in China and other countries in the Asia Pacific region. Through more than 30 subsidiaries (including our Group), Tigermed and its subsidiaries have in excess of 3,000 employees globally. Moreover, in the United States, the Tigermed Group has no presence other than through its interest in our Company and its majority ownership of Tigermed-BDM Inc. (which is a joint venture between us and the Tigermed Group). In China, our Group's business is to provide bioanalytical services and bioequivalence services. The Tigermed Group does not offer these bioanalytical andbioequivalence services in China.

Business Introduction

The company is a fast-growing CRO providing integrated, scientifically-driven research, analytical and development services throughout the drug discovery and development process to enable pharmaceutical companies to achieve their drug development goals. The company benefit greatly from having operations in both the United States and China and are well placed to capture growth opportunities in both markets. The company implements the "Two Countries, one system" approach, which is also an important part of the company's commitment to high quality standards. The company serves customers` discovery and development goals by sharing technical expertise and personnel in two countries and using its knowledge of the two regulatory systems to stimulate the company's strengths in both markets. The company can support Chinese companies entering the US market through the use of Abbreviated New Drug Application regulatory submissions Chinese and US research data, and to seek support through conformity assessment and bioequivalence certification to enter the Chinese market and international companies that has been approved by Chinese market and Chinese companies that have approved by the United States and elsewhere.

The company offer services primarily through the wholly owned subsidiary in the United States, Frontage Labs, and the wholly owned subsidiary in China, Frontage Shanghai. and also adopted through the acquisition of Concord in April 2018 to provide safety and toxicology services.

As of 30 June, 2019, the company has four facilities in the United States, including (i) two facilities located in Exton, PA; (ii) a facility located in Concord, Ohio , and (iii) one in New Jersey For Princeton facilities, the company also has four facilities in China, including (i) two facilities in Shanghai; (ii) one facility in Zhengzhou, Henan Province, and (iii) one facility in Suzhou, Jiangsu Province.

Investment Highlights

Business covering China and the US markets, taking advantages of "Two Countries, One System"

The company is a fast-growing CROs that provides integrated, science-driven research, analysis, and development services throughout the pharmaceutical discovery and development process to assist pharmaceutical companies in achieving drug development goals. The company has business in both China and the United States, and can effectively capture the growth opportunities in both markets.

In 2001, the founder, Dr. Song Li, set up a testing laboratory in Thorofare, New Jersey, dedicated to building a customer-first organization to help pharmaceutical companies overcome their complex drug development challenges through outsourcing solutions. In 2004, Frontage Labs was incorporated in Pennsylvania and established laboratory facilities. Since 2004, Dr. Song Li has led Frontage Labs to rapidly expand the scope and scope of the services it provides.

In China, with the chance of success in recent years, CROs increased opportunities for outsourcing opportunities, the income of the company in China has increased from US$7.18 million to US$28.45 million in 2018. The market for pharmaceutical CROs in China has achieved significant growth over the past five years, with a large portion of the market focused on the development of generic drugs. Under the Consistency Evaluation Opinion, all oral solid dosage drugs on the National Essential Drug List approved before 2007, were required to complete the consistency evaluation by the end of 2018. Failure to complete the consistency evaluation would have precluded a drug from reregistration. This policy, combined with enhanced regulatory standards on supporting data for these studies which were introduced at approximately the same time and subsequently, has led to a significant increase in demand for high quality bioequivalence and bioanalytical CRO services due to the historical lack of existing bioequivalence data and capabilities of conducting bioequivalence studies in house. For the long-term impact, the Consistency Evaluation Opinion is lead to a potential decrease in the number of pharmaceutical companies involved in the development of generic drugs operating in China and also increase levels of expenditure on research and development by pharmaceutical companies. Moreover, an additional growth driver has been direct support of the Chinese government for drug innovation that has resulted in an increased demand for CRO services. These policies include China's Twelfth Five Year Plan for Pharmaceutical Industry in 2012 and the Notice on Construction of Pharmaceutical and Biological Contract Research Organization (CRO) Service and Contract Manufacturing Organization (CMO) Platform in 2018.

The company has implemented "Two Countries, One System" to ensure that customers in both China and the United States enjoy the same quality standards, operating procedures and systems, while also providing a detailed interpretation and experienced clients on drug development and regulatory requirements of the two countries. The company serves customers` drug discovery and development goals by sharing technical expertise and personnel in two countries and leveraging familiarity with the two regulatory systems.

Endogenous growth and extensional expansion work together to maintain stable growth

The company continues to expand their production capacity with operation of Shanghai Zhangjiang Hi-Tech Park of about 42,000 square feet of new bioanalytical laboratory; expansion of laboratory area of approximately 10,000 square feet in the United States 700 Pennsylvania Drive, Exton, PA and put into operation on December 2019; leases 71,000 square feet of new facilities in the United States Exton, PA, which will be used to expand the CMC and bioanalysis businesses after the renovation. The company also approved and purchased the expansion of existing business and production capacity: in October 2019, the company increased Fonda Suzhou stake from 49.04% to 75%, the main business includes analytical testing services, stability studies, preparation process development and clinical use of drugs production and expand the chemical, manufacturing and control capabilities and business in China; in November 2019, the company acquired RMI 100% stake, which is mainly engaged in the pharmaceutical and biotechnology to provide quantitative and qualitative drug metabolism surgery services company; in December , the company acquired a 100% stake of BRI. BRI has been more than 20 years since the establishment in Vancouver, Canada. The company hopes to use this to expand its business base to Canada and the west coast of North America, so that it can more conveniently provide customers with drug metabolism and pharmacokinetics as well as biological analysis services.

Through the above-mentioned business line new or upgrade initiatives, the company hopes to use BRI and RMI to expand its Canadian and North American West Coast businesses, establish DMPK centers across North America and China, and expand its CMC service capabilities in China through most of the shares of Fonda Suzhou. And business, and through the new laboratory in Shanghai Zhangjiang Science and Technology Park to establish a Chinese DMPK team and business line, expand production capacity, seize market opportunities, and continue to promote business growth in China and the United States.

Complementary to the parent company's strengths to further enhance synergies in the future

Hangzhou Tigermed (stock code: 300347) is a CRO that focuses on providing professional services for the whole process of clinical trials for the development of new drugs. It mainly provides professional services for the whole process of clinical research of innovative medicines, medical devices and biotechnology-related products for domestic and foreign pharmaceutical and medical device innovation companies, aiming to reduce the risk of R&D, shorten the R&D cycle, save R&D expenses for customers, promote the marketization process of products, and enable patients to use newer and better medicine and medical treatment as soon as possible. The business division of Tiger Group and the company is clear and synergistic. The company has established a cooperative relationship with Tiger Group. Benefiting from the synergy with Tiger Group, the company is able to provide Chinese customers with comprehensive clinical trial support solutions from Phase I to Phase IV, and Tiger Group customers also have access to the company's services, especially bioanalysis services.

Financial Analysis

The revenue of the company increased by 70.87% from US$48.64 million in 2016 to US$83.11 million in 2018, among which the operations in China increasing significantly from US$7.18 million in 2016 to US$28.45 million in 2018. However, the revenue from bioequivalence services in China decreased slightly from US$9.59 million in 2017 to US$9.49 million in 2018 due in part to the transfer of our interest in in our subsidiaries, Suzhou Frontage and Shanghai Frontage in April 2018, which offset the growth in our bioequivalence revenue in China in 2018 from existing and new customers. The revenue from the US operations increased from US$41.47 million in 2016 to US$54.66 million in 2018 due to consistent growth in our revenue from bioanalytical services as well as due to the contribution of Concord to the newly created safety and toxiology business segment and DMPK services in 2018. In 2018, the gross profit margin of excluded and included Concord were 45.42% and 40.78%, repectively, as Concord has reduced the overall gross profit margin. The company will continue to integrate Concord with therest of the business and to take steps to improve the gross profit margin of Concord.

We forecast that the company's FY19/FY20/FY21 income will be US$ 113/150/188 million, representing an increase of 35.96%/32.85%/25.01% YoY; gross profit will be US$ 46.78/62.77/79.25 million, net profit attributable to shareholders will be US$ 21.37/28.37/35.55 million; corresponding EPS will be US$ 0.01/0.02/0.02. We get target price of HKD 5.00. The corresponds to FY19/FY20/FY21 48.00x/36.17x/28.86x PE, which has an increase of +15.20% compared to the current price (HKD 4.34 as of February 11, 2020), giving an “Accumulate” rating.

Risk

R&D investment in pharma industry fails expectations; Production capacity increases fail expectations; Industry policy risk.

Financials

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