Starpharm - A turnaround pharma stock

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13 Sep 2013 11:05 - 13 Sep 2013 11:23 #16150 by MRK
A few years ago when Star was about to launch Yanning Capsules, relatively big international funds such as Populus pushed up the share price to acquire stakes, at much higher price than IPO of 0.35 SGD (as it has always being rather illiquid) - only to dump all at as low as 0.02 SGD in late 2011 - as the company's high hopes did not materialise as soon as expected.

One needs more patience with pharmaceutical companies, this fund did not have it. If you look at their overall track record, they have made some very good but also several not so good and some outright bad investments over time, so I do not think they did much homework or had particular insight, just pure greed and desire to beat the crowds should Star come up with something unique. Their focus has traditionally being on Thai stock exchange, and their investments in China have not turned out remarkable, mostly because of lack of understanding the complex nature of China-related companies. Doing business in China is different from Thailand.

The previous chairlady and CEO of Star Pharma did not have the required industry connections to succeed at commercialisation of R&D efforts. Many other Chinese pharma companies have meanwhile proceeded to focus on TCM drugs, some of them listed in Hong Kong and being much bigger than Star which is also having hard times because of the overall S-chips crisis and market perception. Being located in peripheral Hainan (and up until recently having headquarters in Haikou, a considerable distance from the manufacturing location itself) also created some inefficiencies.

Star Pharma still has 234.125 m shares in issue, same as right after IPO. It had convertible instrument programme that was terminated early (original conversion price was 0.60 SGD) and investors were paid back original amounts. This was a fantastic achievement from such a microcap company which managed to carry on basic production and has now under new ownership/management reduced practically all the debt it incurred during early redemption of convertible securities. It has been producing relatively low key pharmaceuticals at acceptable profit under difficult operating environment as prices have been set by central government agencies. Despite this, the cash flow has been used to pay off debt - but nothing has been left over for dividends recently, earlier there were 2 rounds of dividends (1.3 and 1.0 SG cents). No share dilution ever occurred. A very strong point. The company does not have the usual S-chip problems but its ranking has nevertheless suffered recently on the Singapore Corporate Governance Index, mostly because of unclear signals of turnaround. The management is very careful not to articulate something they might not be able to fully deliver.

New management acquired shares from previous management. They are clearly determined to make things more positive for Star but it will not happen overnight. It is difficult for outsiders to evaluate at what stage the new product launches actually are, and what is their ultimate potential if any. Without new catalysts, the share price will not exceed 0.10 SGD.

Given this, it is only natural that the value of the company equity has been hard to evaluate in recent years, and as most investors have been overlooking the company, the S-chip problem together with institutional selldown have caused the equity to be valued at very low level. Any potential turnaround together with buying interest, like the one we saw in late July, will certainly lift the price, but not much over 0.10-0.12 SGD until the new drugs from the new management roll out. The new management will first want to make the company debt-free and reorganise some operations so that new products can be launched smoothly. I did visit the company when it was run by previous management, and production facilities seemed of quite high standard.

I estimate every new successful product will lift its market value so that the share price increases by 0.10-0.15 SGD per product over 1.5-2.5 years time frame. We must bear in mind that such a small company has limited R&D capabilities and is currently entirely dependent upon the collaboration with (and partial ownership of) the research institute related to Beijing University. Investors in pharma stocks often overlook the time needed to come up with new products especially in a country like China. 7 years from IPO is a normal time frame. These types of companies are not well suited for public ownership, as price can fluctuate a lot, and the fact is usually they are even not offered via public placements. Therefore, Star is a relatively unique company within the reach of anyone investing in Singapore listed public companies.

Key turnaround indicators to look at will be management's attitude towards investor relations and possible roadshows in 2014. Right now they are not promising anything giving interested people time to accumulate at below 0.10 SGD per share. This will work out P/E around 10 for current operations once all debt is paid off and low margins remain because of the industry situation. I assume RMB 100 m normalised annual sales with net profit of RMB 10 m/SGD 2 m. Star is currently too small to start mass production of anything new, it will likely be outsourced. As such, we can estimate any new product will generate another RMB 100 to 150 m annual sales with net profit of about 25% of that. Historically, Star has shown quite good profit margin also on earlier products, only recent times have been hard as no new successful launches and lot of R&D expense.

I doubt its price can ever exceed more than 10-20 times from now, but a few times, even 3-4-5-6 times is by all means possible. It is one of the most promising ignored S-chips out there, albeit carries more risks than some, but has far better risk-reward ratio/profile than textile industry S-chips for instance, as it could potentially have quite high value added products with limited competition. China is still a huge market and one day pharma prices will be rised to offset inflationary pressures. New top management is much more familiar with the sales channels and momentum needed to raise its profile, and I think they do have the access to Beijing University's knowhow to try to commercialise at least 1 or 2 new products now, for starters.

The new management is keeping low profile until (if ever) it is time to celebrate. Until then, accumulate a small holding into your S-chip growth portfolio, perhaps not more than 0.50-1.00 % though. Downside is limited to 0.04-0.05 SGD currently, upside first 0.08-0.10, perhaps into 0.12, then next threshold 0.15-0.20 with first signs of successful turnaround. It is likely in making. Getting back to IPO price will be a challenge though.
Last edit: 13 Sep 2013 11:23 by MRK.
The following user(s) said Thank You: Masterinvestor

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13 Sep 2013 11:14 #16151 by Oceangrace
Thanks for the detailed analysis :) I am still holding on.

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13 Sep 2013 14:34 #16154 by gangho
Oceangrace,

It looks bullish today. Will the big boys chase it up like what happened to Anchun earlier?? Let's watch closely :)

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13 Sep 2013 15:02 #16156 by Oceangrace
The big boys r not in yet, price inching with very little vol. What will happen if they r in? Our guesses.... good luck Gangho!

gangho wrote: Oceangrace,

It looks bullish today. Will the big boys chase it up like what happened to Anchun earlier?? Let's watch closely :)

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13 Sep 2013 16:57 #16160 by h0ly0wl

Oceangrace wrote: The big boys r not in yet, price inching with very little vol. What will happen if they r in? Our guesses.... good luck Gangho!

gangho wrote: Oceangrace,

It looks bullish today. Will the big boys chase it up like what happened to Anchun earlier?? Let's watch closely :)



big boys in = HUAT AH!!!

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13 Sep 2013 17:53 #16164 by Oceangrace
HolyOwl, when the big boys know this is a gem, sky will be its limit. Lets have the virtue of patience and wait for this shooting star to perform...

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