Hutchmed: Progressing, But We Would Like More Clarity On Profit Margins

Investment Thesis

In our last coverage of HUTCHMED (China) Limited (NASDAQ:HCM) on the 7th of May, we concluded that it was not clear when the company would become profitable. As such, we maintained our Hold stance.

Although the share price is up 11.5% for the year, it becomes less attractive if we look at the development of the share price over a 5-year period

With HCM publishing its 2023 interim financial report and a presentation to investors this month, we would like to share our view of the latest development.

2023 Interim Financial Results

The deal HCM made with Takeda (TAK) back in March this year, was an important milestone for the development of making HCM a profitable and sustainable biopharmaceutical company.

TAK agreed to make an upfront payment of $400 million for the license which gives them the right to manufacture and sell HCM’s oncology medicine called Fruquintinib in all markets, except China, Hong Kong, and Macao.

Up to June 2023, HCM has recognized an aggregate of $258.7 million in revenue and expects around $280 million by the end of 2023.

If we exclude this non-operational payment from TAK, we get revenue in FH 2023 from product sales up 16% to $ 101.3 million, plus revenue from R&D services income of $20.4 million. That was up by 62% Y-o-Y.

Expenses were in line with last year, coming in at $364.3 million. Technically, as can be seen above, HCM was profitable in FH 2023 when we consider the payment from TAK.

Their EPS was $ 0.97 per ADS a loss of $0.96 in FH 2022.

There is still a way to go before they can be sustainable and not burn cash. Their goal is to be profitable by 2025.

On the issue of cash, let us look at their balance sheet.

As of 30th of June 2023, HCM had $ 856 million in cash, up from $ 631 million at the end of 2022. Bank borrowings are only $ 40 million.

This strong balance sheet should give them a good runway toward sustainable profitability.

There is good support for the pharmaceutical industry from the authorities in China.

One example of this is their newly built factory where the local authorities have granted HCM a loan at an attractive interest rate of 3.5%. The balance loan on this building is only $ 14 million.

With this new factory up and running, production volume can ramp up to cater to their expected demand. This leads us to HCM’s business development.

Business Development

There is more upside potential from the deal with TAK, as HCM are also eligible to receive up to an additional $730 million in potential payments relating to regulatory, development, and commercial sales milestones, as well as royalties on net sale that TAK gets from Fruquintinib.

Shareholders and investors are looking towards a potential approval from the U.S. Food and Drug Administration. A PDUFA date has been set for the 30th of November 2023. According to HCM, Takeda has already hired sales staff and is preparing for a launch of Fruquintinib in the U.S. once approval is given.

Heart diseases and cancer are the two most common causes of death globally.

The present POTUS claimed in a speech prior to the election that if he was elected, they were going to cure cancer. Politicians often make bold promises, but the whole world has been working on this for many decades without finding a silver bullet.

Much improvement in the field of oncology has taken place and successful treatments are taking place. Nevertheless, this fight against cancer is a marathon, not a sprint.

Looking at colorectal cancer, which Fruquintinib is targeting, the number of patients diagnosed with this disease yearly is large.

This medicine is also targeted towards treating gastric cancer, which is the fifth most diagnosed cancer in the world. Studies are also done on treating other types of cancer such as endometrial cancer, which is a type of cancer that takes place in the uterus.

Risks to the Thesis and Conclusion

Apart from risks associated with obtaining approvals for the drugs in the various markets, one other known risk is diminishing returns on sales of their medicine in China.

In our previous article, we concluded that

The market in China with its 1.4 billion population should be big enough to make money for HCM if the products they want to sell are effective. Their pricing power there might be less attractive than it is in more developed markets”.

Although it is true that the Chinese government is supportive of the industry, as we just stated, it is less clear how profitable it is going to be.

In an article in FT back in January this year, they confirmed our earlier concern about a potential lack of pricing power in China. We are not privy to knowing exactly how the negotiations take place. Manufacturers are said to have to reduce prices by roughly 60%. Since they know that such negotiations will take place, perhaps they start at a higher price than what is normal.

Once production is ramped up and the start-up expenses are accounted for we shall try to calculate CHM’s profit margin. Hopefully, they will give a breakdown of revenue from their various geographical markets.

Approval in the U.S. for Fruquintinib could be a potential catalyst that could send the share price higher.

But for now, we maintain our Hold stance.