九州通(600998)

RMB100bn sales target in 2019; 3 key drivers

Management is targeting RMB100bn sales in 2019, suggesting CAGR16-19E of18%. Major drivers include geographical expansion, increasing product offeringand deeper penetration of hospital channels. First, the company expanded itslogistics network coverage to 30 provinces in China, noting 5 distribution centersin construction and typically smaller base for newer regions. Second, productsinitiated over recent years continue to ramp up, while the company developsnew offerings in high-margin segments such as medical devices and nutritionsupplements. Lastly, as the company started its direct sales business in 2009,there is plenty of room for sales channel expansion. Going forward, managementreaffirms 2H17 to outperform 1H17 per historical trends, and that over RMB73bnsales can be achieved in FY17.

Dynamics of DS and IDS under two invoice implementation

Indirect sales (IDS) remains high at 44% of total sales as of now, down 1% from45% in 2016. However, management also expects IDS to stay at 35% by 2019,as a two invoice policy is unlikely to be strictly implemented in rural areas, drugstores and device/consumables. For 1H17, robust growth was attributed partiallyto JT's ability to take market share due to the following two changes under thetwo invoices: 1) JT was able to get more contracts directly from manufacturers,bypassing JT's previous upstream distributors as those distributors exited the IDSbusiness; 2) JT was able to assume more contracts directly from more drug stores,as JT's previous downstream distributors exited market.

Approximately RMB10bn additional working capital required

On liquidity, the working capital to revenue ratio currently stands at 6:1, and isexpected to go up with higher hospital concentration. As there is a RMB40bnrevenue gap between the 2019 target and revenue in 2016, management budgetsRMB10bn in capital requirements and plans to tackle liquidity pressure by raisingRMB3.6bn equity, while additional debt can go up to RMB7.2bn. Cost of debt willlikely be around 4-5%.

Maintaining price target of RMB27.3; risks

We keep our PT of RMB27.3, based on 33x 2018E EPS of RMB0.83. Webelieve 33x is justified due to its growth profile and improving product mix, andJointown's Chinese peers are trading at 30x 2018E EPS with 18% growth in 2018(vs. the 26% we model for Jointown). Key risks include policy headwinds and aslower-than-expected ramp-up of new businesses.