Pricing Pressures Lower Profits For Chinese Drug Chain Nepstar, While Healthcare Reform Has Opposite Effect On Hospital Chain Chindex - China Earnings Roundup (Part 1)

Year-end and Q4 earnings results for Chinese healthcare operators and drug stores are shaped by a challenging environment imposed by China's healthcare reform and increasing drug pricing pressure. In 2010, a rising tide of inflation also increased minimum wages and labor costs across the country and impacted companies' bottom lines. Many firms have resorted to business diversification, innovation and enriched pipelines to sustain a strong growth.

In a recurring feature, PharmAsia News ploughs through pharma earnings calls to bring you the latest earnings highlights for Chinese pharmas, key healthcare operators and drug store chains.

Still In Transition, Nepstar Optimistic About Positive Policy Signs

Shenzhen-headquartered China Nepstar Chain Drugstore Ltd. expects to see further profit erosion from the Chinese government's healthcare reform policies aimed at cutting drug prices and reducing healthcare costs. The largest Chinese drug store chain, which is listed on the New York Stock Exchange, is also being hit hard by diversion of customers to community clinics, the company said.

The diversion may be partly due to China healthcare reform; one of the primary goals of the reform is to funnel patients with common diseases from overcrowded top-tier hospitals into community healthcare centers and rural hospitals, freeing up the top hospitals to focus on serious diseases .

"As we look out to the remainder of the year, we are expecting the entire pharmaceutical retail sector to face challenges from ongoing policy uncertainties," Nepstar VP for Investor Relations Lucia Qian told analysts during the company's March 16 earnings call.

Nepstar reported both lower prescription and over-the-counter drug sales in Q4 compared to the same period in 2009, when the H1N1 influenza epidemic bolstered sales. Its store sales declined 1.1%.

Besides government price caps on drugs, Nepstar is also being squeezed by rising costs such as minimum wage levels that have increased throughout regions where Nepstar operates. In 2010, 10 Chinese provinces and cities raised minimum wage levels, and on Nov 20, China's State Council issued 16 new counter-inflation measures, including gradual minimum wage increases.

Searching for a competitive edge to survive the harsh environment, Nepstar is going through a transition process to become a neighborhood one-stop drug and convenience store, and is aggressively pushing its own brands for higher profit margins. The strategy calls for a mix of product offerings that go beyond pharmaceutical products to include nutraceuticals, beverages and stainless steel cookware and kitchen cutlery (Also see "Squeezed by Price Caps And Rising Costs, China's Nepstar Drugstore Chain Pushes Its Own Brands" - Scrip, 25 Nov, 2010.).

Still, the company is also seeing light at the end of tunnel. Two positive policy signs coming from the recently held People's Congress in Beijing could help to increase disposable incomes of citizens that could in turn lead to better positioning for companies like Nepstar.

"First of all, the government is really dedicated to improve the healthcare system in China. And at the same time, the central government is also very concerned about increasing the disposable income of Chinese households," Qian told investors. "There will be an income doubling factor in the coming five to 10 years for Chinese households that actually creates a very good macro potential for the business as a drugstore and a healthcare provider."

The income increase will generate more market opportunities for convenience products, the company anticipates, hoping to turn around the trend that saw it open 31 new stores but close 61 stores in the fourth quarter.

Private Investment In Hospitals Good News For Chindex

American healthcare operator and medical device distributor Chindex International Inc. is scaling up its business model in China, and is especially encouraged by recent Beijing policies that support private investment in healthcare (Also see "China Signals Need For Private Investment To Support Its Healthcare Reforms; Private Insurance Options Likely To Widen" - Scrip, 16 Dec, 2010.).

Relatively new to Chinese patients who are used to seeking care from public hospitals, private healthcare is quickly gaining ground by offering more customized and specialized services. Chinese government and media focus on healthcare reform help increase consumer awareness about the varying quality of healthcare available from public and private options.

In addition, the combination of an aging population, an increasingly industrialized society and affordability for private care has offered an unprecedented window of opportunity for an accelerated rollout and scaling up of the Chindex business model, CEO Roberta Lipson told investors during the company's March 16 earnings call. As China's middle class continues to grow and becomes more accustomed to premium care from private hospitals and clinics, Chindex sees more inroads into more Chinese cities.

"We continue to aggressively pursue a national build out that will bring the United Family Healthcare brand to more and more cities in China," Lipson said. "Our development team is always looking for new site locations, as well as having consistent interactions with local authorities to ensure the right relationships are in place to build new hospitals."

Expanding beyond stronghold megacities such as Beijing, Shanghai and the Southern city of Guangzhou, Chindex is expanding to second-tier urban areas such as Tianjin. The company has begun construction of a new 25-bed facility in the port city, 69 miles from Beijing. To be completed in 2011, the new project will be a launch pad to more tier-2 Chinese cities (Also see "Riding High And Scaling Up, Chindex Readies Business Model Rollout In China" - Scrip, 12 Nov, 2010.)

For existing facilities, Chindex is focusing on bolstering efficiency, and adding new service offerings such as a special cancer treatment center located in Beijing staffed with counseling specialists. Chindex also plans to open an off-site dental clinic in Shanghai and to expand out-patient services in Pudong.

Friendly Environment For Private Healthcare Investment

On top of these macro factors, recent policies encouraging private investment in hospitals, issued last December, will gradually loosen restrictions on foreign ownership of hospitals, and eventually allow wholly foreign-owned hospitals and clinics.

Importantly, the reforms also would allow private hospitals to participate in government-run insurance programs, potentially opening the market to new patients (Also see "In Major Policy Turnaround, Chinese Premier's Office Lifts Restrictions On Foreign Investment In Hospitals" - Scrip, 7 Dec, 2010.).

Another positive sign, Lipson said, is that the government has delegated some of the approval processes to local governments, which could shorten approval times as Chindex moves deeper into tier-2 cities and deals increasingly with local authorities.

Moreover, the Beijing municipal authority issued a new regulation to allow Chinese doctors to register their licenses to practice at up to two sites instead of one hospital at a time. The measure will expand the talent pool for Chindex's Beijing facility. The company expects other cities to follow the policy lead soon.

The government hopes that allowing doctors to practice at multiple locations will contribute to standardization of care and implementation of best practices.

For the fourth quarter, Chindex, which is listed on NASDAQ, reported quarterly revenue up 7.5% compared to the previous year.

Looking ahead, Chindex has now completed the spin out of its medical device distribution arm, combining it in a joint venture with Shanghai Fosun Pharmaceutical Group Co. Ltd., which is contributing three of its medical device companies. Chindex will own 49% of the JV, and future results will be deconsolidated from Chindex's financial statements.

- Brian Yang ([email protected])