We initiate coverage on China CRO/CDMO sector with a positive view, based on strong demand in innovative drug R&D in China and potential market share gain in the global market for domestic CRO/CDMO companies.
- Robust R&D spending in China and worldwide. We expect both global and China R&D spending to grow strongly, led by 1) a more conducive regulatory environment with increase in FDA and NMPA drug approvals, 2) a shift by pharmaceutical companies towards externalized R&D models with around half of pipelines externally sourced, 3) a robust biotech funding environment for biotech companies, and 4) a smaller percentage of drug sales exposed to patent expirations. Frost & Sullivan (F&S) forecasts the global R&D expenditure to increase from US$174.0bn in 2018 to US$216.8bn in 2023E, representing a 4.5% CAGR. The increase in R&D expenditures has laid a foundation for the continuous growth of the global pharmaceutical R&D outsourcing services industry.
- Increasing penetration of R&D outsourcing. Given the lengthy and costly drug development process and growing number of small-sized pharmaceutical companies, we expect a larger proportion of R&D spending will be outsourced. Outsourcing industry is consolidating because pharmaceutical companies and biotech companies are outsourcing more work to fewer, more capable service providers by building long-term partnership with vendors. Thus, large CRO/CDMO companies have been actively expanding their business width through M&As in order to provide one-stop shop services for customers.
- China-based CRO/CDMO companies to gain market share. We believe China-based CRO/CDMO companies will continue to expand service width through M&As and expand footprints to overseas markets. China-based CRO/CDMO companies have strong competition advantages over overseas peers, given their improving technology, abundant talent pool and sufficient capital funding. We expect China-based CRO/CDMO companies to play more important roles in global markets. With expanding service capabilities and increasing market share from overseas markets, we believe China-based CRO/CDMO companies will see significant improvement in output per capital.
- Our top picks in China CRO/CDMO sector are Tigermed (300347 CH), WuXi AppTec (603259 CH) and WuXi Biologics (2269 HK), given their comprehensive service capabilities, strong market positioning in China and early moves in globalization.
