Tong Ren Tang

Yunnan Baiyao: An Oriental Mystery in the Limelight Part 2

► From 2009 to 2019, Yunnan Baiyao started to harvest the brand value. ► With the dividend payout ratio growing to 40% in 2019 and even higher in the future, this time-honored brand seeks diverse business opportunities. This is the second chapter of EqualOcean’s ‘two-parter’ about Yunnan Baiyao. Before you start reading this article, please check out the first article. From a fundamental perspective, this time-honored pharmaceutical brand’s history in the 21st century can be divided into four phases, as indicated by the ROE (return on equity) paths and related constituent indicators. 2009-2013: the brand value effect While the world economy was suffering amid the 2008 global market slump triggered by the financial crisis in the US, this traditional Chinese medicine showed a very resilient quality, with an up-swinging ROE, driven by growing net profitability. Compared to the other two relatively stable influencers, the equity multiplier and asset turnover ratio, the net margin increased from 8.49% to 14.68%. This was a remarkable achievement, arising directly out of the massive marketing and sales strategy in the previous stage.  As the public perceived the brand in a better light, a more reliable profile was established. Yunnan Baiyao, after several years of marketing investment and product innovation, reached a new level in the brand qualifying landscape.  2013-2019: a shock is met with in the health-care reform process An increase in equity multipliers partly drove a general drop in Yunnan Baiyao’s ROE during this period. It was also partly due to a slowed asset turnover.  In July 2016, this state-owned pharmaceutical giant initiated a ‘mixed ownership reform,’ with the idea that private investors would further drive both endogenous and extensive growth. This grand project was fueled by debts and was completed in December 2019, showing a slight increase in leverage. As the pharmaceutical giant gradually moved to a mature phase at a historical crossroads to change growth gears, it also faced an industry-wide shock. The same year saw the inception of the ownership reform, the Chinese government-initiated healthcare reform intending to lower the drug price at the consumer end. The ‘two-invoice policy’ (‘两票制’) came out first in 2016 and nation-wide spread in 2017, followed by ‘procurement of drugs with target quantity policy’ (‘带量采货’) in 2018. It was good news for the public patients, but a disruptor, or a shock, to the pharmaceuticals – especially those players in the drug distribution (or circulation) businesses.  The Chinese medicine brand, whose largest revenue source is drug distribution, has experienced a severe impact on assets turnover, reflecting its inventory turnover and its accounts receivable turnover. Compared to other medicine distributors, the White Drug-maker has been disadvantageous in inventory turnover cycles, due to a comparatively high volume of goods at stock over total assets. But on the relative weights against downstream distribution channels, the national-protected brand had an overwhelming advantage with a receivable turnover of 22.68x during the last six years, considering other giant drug circulators China National Medicine (600511:SH) and Jointown Pharmaceutical (600998:SH) at an average of 6.9x and 5.15x, respectively. According to Warren Buffet’s Moat Theory, this Chinese ‘Time-honored Brand’ has an unbeatable advantage, a kind of rarity and exclusivity crowned by the government, and well-established reputation and recognition in the market. Indeed, if considering the life cycle of an authentic brand, ‘Yunnan Baiyao’ has not yet touched the ceiling. Exploring new ways to drive value in modern times  An over 150-bagger like Yunnan Baiyao sounds like the stuff of legend. Many world-class research institutions and investment funds see Yunnan Baiyao as one of their heavyweights. As of April 30, 2020, MSCI China All Shares Health Care Index held it at a weight of 2.35%, a top 9 position in the index’s portfolio. Its relevant ETF fund, KURE, kept a 2.51% position in Yunnan Baiyao. See more EqualOcean analysis here about the performance of China healthcare indexes and ETFs. Now, as the four-year-long mixed-ownership reform comes to an end, this TCM will find itself in the healthcare market in a new position. What moves will it make? Will the market continue buying its brand as always? Its 2019 financial report, released in March this year, announced a significant update in its dividend payout policy. The newly privately-owned Shenzhen-listed company plans to pay a CNY 3.8 billion cash dividend to its shareholders, and no lower than 40% dividend ratio in the coming three years. More specifically, shareholders will receive CNY 30 as the cash dividend for every ten shares held. Compared to the CNY 4.18 billion net profit in 2019, this plan implies a 91.83% payout ratio.  There is no doubt this decision has aroused the market to ask more questions. Many cannot help wondering the future path of this China-representative pharmaceutical. In a financial analysis, a high dividend payout ratio has several implications. First, the cash dividend is a strong sign of the company’s abundant liquidity, which is consistent with Yunnan Baiyao’s net profit in 2019.  A second supportive justification is about taxation. In China, the personal tax rate for dividends and capital gains is 20%, while the corporate tax rate for net profit is generally 25%. So in this context, the company would like to pay dividends in cash, not only avoiding the 5% more tax rates but also fulfilling the management’s mission to maximize shareholder value.  Third, consecutive high ratio dividends can help shareholders gain stable cash inflows, reducing volatility. Thus, a possible intention in making this move could be that Yunnan Baiyao wants to attract higher-value investors who mostly like to hold equities for the long term. Doing an unexpected stunt in the form of a nearly 92% payout may quickly filter out those speculators that have been destroying their market value. Last but not least, the idea to keep value investors or get rid of speculators, through the increase in higher payout ratio, is an extended strategy for its future path after the ownership reform. Transformed into a privately-owned company, it will no longer be backed by state power and will face fiercer competition with domestic and foreign challenges.  Market expansion and business diversification Through all these years, it has transformed from a drugmaker into a cosmetic goods provider, from a national brand to a globally recognized and unique name. Where else should it go to explore more possibilities, or open up a new market? It has not touched upon its highest ceiling yet. One noteworthy thing is that TCM has a logic that is very different from other pharmaceuticals. It is not like typical generic medicine manufacturing, or advanced biotechnology. As clearly pointed out in its 2019 financial report, the most prominent core competency comes from its brand, ‘Yunnan Baiyao.’ Thus it makes sense for a drug maker suddenly to orient to consumer goods business, since the first engagement with the cosmetic goods market found it confronting a market dominated by foreign brands, back then in 2001. It has now become a nationally recognized brand, based on a ‘healthcare +’ cosmetic manufacturing model, providing a diverse product portfolio from pharmaceutical skincare goods in China’s New Retail industry. Indeed, compared to those biotech pharmaceuticals, its R&D investment is not aimed at the most cutting-edge technologies, nor tackling rare and significant diseases, but at serving up its consumer-focused products. After sluggish investment in its R&D area in 2016 and 2017, it started an acceleration phase, with CNY 110.3 million in 2018 and CNY 173.9 million in 2019.  As for the near future, it is getting more prepared than ever before with a new profile – a wholly-listed company under mixed ownership. Agility in strategy with flexible tactics is the new growth driver. According to its 2019 report, since the four-year reform, the company has become the only healthcare platform with acquisitions and resource integration. The last few years saw Yunnan Baiyao make efforts to make breakthroughs. It built a biotech-based healthcare platform, with a heavy anchor in post-development commercialization. The engagement in the industrial hemp segment may well lever its advantages in resource provenance. Even more, this ‘old name’ plans to construct an SaaS cloud platform with interconnections with hospitals, pharmacies, drug makers and B-clients, to escalate the healthcare IT service. Directing a nationally-honored brand is a privilege. But as time goes by, it can be confining, and something of a burden when one is seeking new growth engines. After stepping out of its comfort zone, this pharmaceutical company may yet try out new businesses, faced with opportunities that show themselves from inside a more uncertain future nowadays.

Yunnan Baiyao: An Oriental Mystery in the Limelight Part 1

► Traditional chinese medicine provider Yunnan Baiyao is an 100-bagger stock. ► From an ROE perspective, the TCM is staged into four phases with analysis into a period from 2000 to 2009. This is the first chapter of EqualOcean’s ‘two-parter’ about Yunnan Baiyao. Click here to read the following article. Peter Lynch suggests investors seek ‘ten-bagger’ stocks from daily life, from the supermarket near your neighborhood, from the posters in the public parks. Indeed, to achieve a 10x growth for a company,  one great dynamic comes from a sprawling consumer market coverage, or simply market popularity. Yunnan Baiyao (云南白药), a Kunming-based TCM company, is the first-ever ten-bagger at A-share market – or, showing even more ambition, 150-bagger in the 23 years since its first listing. More than a pharmaceutical brand, it has entered into cosmetics, providing toothpaste, facial masks, etc. that nearly every Chinese consumer is well familiar with. However, even though the zigzag path over two decades has not all been very smooth, the long-term upward trend can indicate its fundamental value or the core competency in the TCM industry. Very different from western medication, Chinese medicine views a person as ‘one skin’ – the human body is interconnected to mobilize blood flow. Traditional Chinese medicine enjoys a history of over 3,500 years, traceable to the Yellow Emperor and Shennong, who are jointly considered as the originators of Chinese medicinal theories. As a branch of Chinese medical practices, this herbal medicine stream has been popular within the Sinosphere and built quite a large fan base in the western world, carrying with it the inherent Chinese ancient binary wisdom embodied in ‘yin’ and ‘yang.’ As this concept acquires more acceptance in the west, a pretty sophisticated Chinese medicine market has arisen, with a comprehensive classification of medicine products and mature distribution networks from herbal provenance to the end consumer and an industrial landscape with qualified brand players: Yunnan Baiyao, Tong Ren Tang (600085:SH) and Tasly (600535:SH). In China’s A-share market, there are 65 TCM enterprises according to the SES Industry Classification, among them 49 oral medicine makers like Tasly, 12 injection medicine providers such as Buchang Pharma (603858:SH) and four brand-name drug companies – Yunnan Baiyao, Tong Ren Tang, Pientzehuang (600436:SH) and Guang Yu Yuan (600771:SH). A Chinese time-honored brand  As one of the flagships in the TCM pharmaceutical world, Yunnan Baiyao has been selling a brand, a historical brand whose value appreciates as time goes by.  Yunnan Baiyao, or Yunnan White Drug, is a kind of hemostatic, anti-inflammatory medicine mainly comprised of tienqi ginseng (Panax pseudo-ginseng). The inventor of Baiyao, Dr. Qu Huanzhang, donated loads of this drug during the Taierzhuang Battle (‘台儿庄战役’), an anti-Japanese campaign during the second world war, saving hundreds of soldiers’ lives. Dr. Qu was subjected to house arrest after refusing to give up Baiyao’s formula. Several years afterward, the patriotic doctor died in anger; his medicine was protected as a national strategic resource and played an important role in the resistance war against the American army in Korea. There are over 10 thousand Chinese medicines, but only two are listed as national-level super-confidential formulas: Yunnan Baiyao and Pientzehuang. Undoubtedly, this kind of absolute exclusivity has laid a solid foundation for this particular White Drug’s market value, adding an additional flavor of mystery. Not confined to just this advantageous source of profit, this Kunming-based medicine maker eyes even further goals than working with this single formula. It has developed many other businesses and formed four primary revenue sources along its value chain. Year after year, what has been getting more valuable, along with its increasing revenues and market expansion, is its brand value.  BrandZ™’s 2019 Most Valuable Chinese Brands Top 100 ranks Yunnan Baiyao 45th, the top name in the healthcare industry, at a brand value of USD 2.88 billion. Interbrand, an international consultancy, published ‘2019 Best Chinese Brands,’ giving White Drug an estimated CNY 7.43 billion (USD 1.05 billion) brand value at 34th, still number one in healthcare. In the same year, given a brand value of CNY 25.5 billion (USD 3.59 billion), it ranked 66th on the 2019 Hurun Brand List. As of May 15, the market valued this Chinese TCM representative at CNY 112.283 billion (USD 15.81 billion). Despite being similarly under the protection of a national umbrella, the other leading brand, Pientzehaung, has not enjoyed such a global reputation. It was also ranked on the 2019 Hurun Brand list (Healthcare), with a brand value of CNY 14.5 billion (USD 2.04 billion), after Yunnan Baiyao. What makes the White Drug stand out among its peers is not only paper protection but also its internal operation and business strategies – two other factors that together form the value proposition. More practical than just a concept From a fundamental perspective, this time-honored pharmaceutical brand’s history in the 21st century can be divided into four phases, as indicated by the ROE (return on equity) paths and related constituent indicators. 2000 – 2005: the foundation  Into the new century, this TCM showed an upward trend in operation efficiency and profitability. During these six years, its ROE ratio increased to 30.82%, nearly 2.4 times the initial 12.84% in 2000. This surprising performance came from higher profitability – net margins and asset turnover – a more efficient production process and better management.  The last year of the 20th century witnessed this Chinese medicine company take a new CEO on board, Mr. Wang Minghui, who implemented an internal entrepreneurial sales mechanism – a ‘knockout or bonus’ incentive and promoted a more aggressive marketing strategy. A direct result is an obvious decrease in the administration and selling expenses, from 18.42% and 16.74% in 1999 to 12.78% and 5.04% in 2006. The other credible change during this time lies in asset utilization. After its production department adopted an ‘internal order system’  – an order-oriented ERP system – this company had seen a prominent advantage in its inventory turnover among its peers. From 2001 to 2005, it had an average inventory turnover of 3.8x (from 3.09x to 4.11x), compared to Pientzehuang’s 1.0x (from 0.84x to 1.92x) and Tong Ren Tang’s 1.21 (from 1.35x to 1.09x) during the same time. Moreover, from the perspective of the net operation cycle, it also showed high efficiency in capital turnover, indicating its relatively stronger power over its upstream suppliers and downstream distributors. It had an operation cycle of 104.74 days, almost half of Pienzehuang’s 187.85 days in 2005 or one-third of Tong Ren Tang’s 330.73 days, according to the Wind. 2005- 2009: the sprint These three years saw a continued downward correction in ROE and ROIC. The apparent divergence between these two ratios shows a growing equity multiplier – a rate reflecting the status of debts relative to the equity.  This sudden change can be traced back to its new business strategy in 2000, the initial year when this herbal medical-centered pharmaceutical brand started to enter cosmetics. Following that, in 2001 and 2003, the ambitious medical player launched Baiyao bandage and Baiyao toothpaste. Its bandages highlighted Baiyao’s hemostatic function, aggressively challenging Johnson & Johnson Band-Aid’s 50% market share. Its toothpaste showed no weakness either, with an additional feature of anti-inflammation, at a retail price of CNY 20, 33.3% higher than the price of foreign peers. As a new entrant just into this new market, Yunnan Baiyao sought fast and effective moves. It cannibalized its profits to expand sales, resulting in an increased amount payable to downstream distributors and higher selling expenses afterward. The marketing strategy for these two cosmetic products further cemented the prestigious status of the brand. Along with a sprawling sales network in capital cities, the year of 2007 saw an explosive boost in sales of Baiyao toothpaste. And more than that. It invested in advertising promotions, establishing a lively and modern image, and cultivating a large pool of young consumers. (To be continued in the second part of Yunnan Baiyao analysis here)