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China pharmaceuticals feel bite of healthcare reforms

By Donny Kwok and Tan Ee Lyn

HONG KONG (Reuters) - A renewed push by the central government to expand healthcare reforms and restrict costs for end users is putting pressure on margins for a growing number of Chinese drugmakers.

Five Chinese drugmakers including United Laboratories International Holdings Ltd have issued profit warnings in recent weeks, citing price pressures and government policies. They are due to report earnings in March.

Chief among the government's reforms is the expansion of the essential drugs list (EDL) to more than 800 products from 307, Health Minister Chen Zhu was reported by Chinese media as saying in early February.

It is the first expansion since the EDL was established in 2009 and heralds further price cuts on more expensive drugs available from hospitals. Prices of drugs on the list are state-controlled and kept very low, in line with Beijing's policy to reduce healthcare costs for end users.

"This is particularly challenging for manufacturers, given that drugs sold through hospitals provide higher margins and profit contribution," said Jason Mann, head of Barclays Capital's China healthcare & pharmaceuticals unit.

The move also appears to be aimed at tackling over-liberal prescription of antibiotics to treat a broad range of medical conditions, a practice resonant in many parts of Asia, is fuelling a rise in drug resistance.

"It appears the government is determined to control the use of antibiotics, and we expect the strict restrictions to continue in 2012 and demand for bulk medicines and finished products to remain weak," said SWS Research analyst Ming Shi in a report.

"We remain pessimistic on the outlook for the antibiotics sector in 2012," said Shi. SWS, which downgraded United Laboratories to underperform from neutral, forecast a 57.4 percent decline in 2011 net profit for the antibiotics maker.

CONSOLIDATION

As the country's biggest buyer, the government is using centralized drug tenders, a bulk-buying policy that forces down prices and which can oust uncompetitive players and encourage consolidation in the sector. Hospitals previously procured their own drug supplies and drug sales were a major source of income for hospitals, which received no state funding.

"Strategic events such as M&As and global collaboration should be a major theme in 2012 for China's healthcare sector," said Derrick Sun at BNP Paribas in a research note.

Bigger players such as Yunnan Baiyao Group Co Ltd, Sinopharm Group Co Ltd and Sichuan Pharmaceutical Holdings Group Ltd are expected to survive and even thrive at the expense of smaller rivals.

"The big players (pharmaceutical companies) will be able to weather the current storm, Said Mann. "Actually this heavy margin and pricing pressure is good because it forces a consolidation."

China's prescription drug market, set to be the world's second-largest by 2020, is estimated to be worth more than $110 billion by 2015, from $50 billion in 2010.

The market's massive potential has attracted western drugmakers such as AstraZeneca Plc, Pfizer Inc, Abbott Laboratories and Novartis AG. These global giants have to set up huge R&D centers to take advantage of China's lower costs and large pool of scientists to develop products aimed at Asian markets and largely geared towards higher-end products unaffected by the EDL.

Given their leading roles in their sub-sectors, some analysts favor distributors such as Sinopharm Group Co Ltd and device makers such as Shandong Weigao Group Medical Polymer Co Ltd over drugmakers, which face policy risks and continued margin pressure.

"Being the only state-owned nationwide distributor, (Sinopharm) does have clear advantages in terms of financing, local government support and power over policy influences. Distributors in general have relatively low exposure to pricing policies," Sun said.

BNP forecast Sinopharm to deliver a net profit of 1.55 billion yuan for 2011, a rise of 27.8 percent from 2010.

Mann said: "We see the balance shifting in favor of lower prices in the near term, and more policy headwinds. Ultimately, we are quite bullish and see great structural potential. (China's pharma sector) is still fairly underdeveloped and growing rapidly but has much room to expand."

(Reporting by Tan Ee Lyn and Donny Kwok; Editing by Chris Lewis)

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