Shijiazhuang orders drugmakers to halt or limit production to curb air pollution.
   
The Shijiazhuang municipal government has unveiled an emergency plan to addresspersistent smog. The plan mandates a complete citywide production halt for sevenmajor industries (steel, cement, coking, casting, glass, ceramics, calcium/magnesium)from 17 Nov 2016 to 31 Dec 2016, although production lines engaged in critical tasks(residential heating, ensuring basic living conditions, etc.) are exempt. Meanwhile,industries such as pharmaceutical manufacturing, chemicals, packaging/printing, andfurniture will be managed based on a checklist system; in principle, all productionprocesses involving volatile organic compounds will be completely halted, but in specialcases where a total shutdown is not feasible, production may be scaled back withapproval from the municipal government. Based on our checks with Yiling, thecompany is currently subject to the production halt but is in talks with the citygovernment to resume production.
   
Ample finished goods inventory.
   
Yiling is a modern Chinese medicine producer whose EU/US-certified chemical drugproduction lines meet zero-emission standards. The company also demonstratedcompliance with standards during environmental checks just carried out in November.
   
Looking at Shijiazhuang's pollution control efforts in past years, the city has oftenplaced limits on supply of power and heating during the heating season. In addition,Yiling's past annual reports indicate that it generally keeps at least 3 months of finishedgoods inventory on hand (not including inventory held in distribution channels). Weview the impact of production halts on the company as limited for now, and we arecontinuing to closely monitor the results of Yiling's talks with the government.
   
Growth set to accelerate for 3 major prescription cardiovascular drugs.
   
Yiling generates over 90% of its revenue from exclusive orally-administered Chinesedrugs, and it has been effective in maintaining tender prices. Yiling's major products(Shensong Yangxin/Qili Qiangxin/Lianhua Qingwen capsules) are likely to see rapidrevenue growth as more tenders take place given benign competition and upside forhospital coverage.
   
Valuation: Maintain Rmb23.32 price target, Buy rating.
   
Our Rmb23.32 price target is based on DCF and assumes an 8.1% WACC. Wemaintain our Buy rating.