Saturday, February 18, 2006

Efficient traditional chinese medicine

Tong Ren Tang Technologies ("TRT") [8069 HK] is a researcher, manufacturer and distributor of traditional Chinese medicine in mainland China. It was founded over 300 years ago. TRT was established during in the reign of the last Qing Dynasty in China. It is listed on the Hong Kong Stock Exchange and it closed at HK $17.00 per share today.

Its price recently look a hit when there was a 8.5% decline in its 3Q05 profit. There are also fears that as a result of the mature growth of its flagship drugs, TRT will experience slower earnings growth.

Key ratios:
P/E: 15.7
Div yield: 2.6%
P/B: 4
Current ratio: 1.9

A succinct breakdown of the merits and risks of TRT is set out below:

Strong brand name with experience history. Verified with Chinese counterparts that TRT has one of the strongest brand name in traditional Chinese medicine in China.
Experienced management that has delivered results.
Management is of the view that 3Q05 results were only a blip and full year target of double digit earnings growth is still on track. Hence, TRT may be undemanding on a PEG basis.
New plant in HK likely to be completed in middle of 2006 which will increase its overseas reach. Expect to penetrate Taiwan market.
Established distribution network.

As a result of relatively poorer intellectual property rights in China, other manufacturers may replicate its mature products.
There is stiff competition from lower priced generics.
Continued expenditure in R&D to produce new drugs to replace older ones.

A variant of the discount cash flow was applied to the historical cash flows of TRT. It is noted that whilst income grew steadily along with top line growth over the last five years, TRT had periods of high capital expenditure too; particularly in 2002 and 2004 which led to a hit on its free cash flow. As a result, it is probably unreasonable to do a straight line projection growth of free cash flow. However, in an attempt to put a finger down on its intrinsic value, it is assumed that TRT's owner earnings for 2004 is able to grow at a growth rate of 3% for 10 years. A relatively growth rate of 3% was selected in an attempt to smooth out its historical fluctuations. No terminal growth rate was assigned.

The above assumptions lead to a fair price which is close to the current market price. There appear to be no margin of safety at current quoted prices. Well, considering that TRT is considered a "blue chip" garnering a large number of coverage by analysts, it should be no surprise if the market is efficient with this one!



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