Aoxing Pharmaceutical(ticker AXN) is one of those Chinese drug companies that wanted a US stock market listing. Such listings are a smart move if a thriving foreign company wants to raise capital here or expand operations beyond its home country. Either option will now face an uphill climb after some December news items about the company.
At first glance, Aoxing's profit margin of 22.83% and operating margin of 35.8% should indicate health. These measures don't square with the company's five-year average ROA of -18.68% and five-year average ROE of -50.75%. Aoxing's 2015 financial results show a sudden reversal of fortune after net losses in 2013 and 2014. Significantly higher gross revenue helped in 2015, in spite of persistently rising total liabilities and several negative changes in operating cash flows. Aoxing's SEC 10-Q filing dated November 13, 2015notes in its MD+A how a shift in sales strategy from a third-party agent network to direct sales drove revenue growth. The strategy's reliance on independent direct sales will face challenges as China's drug distribution market changes.
Reviewing English-language reports on China's drug market reveals reasons to be concerned about any young Chinese drug company's ability to grow. AT Kearney's "China's Pharmaceutical Distribution: Poised for Change"reveals a fragmented distribution market and poor supply chain visibility.The US FDA's country director for China testified in 2014about how hard US drug regulators are working to ensure Chinese drug exports meet US standards. Aoxing's future success in distribution will depend very much on securing healthy relationships with the three or four Chinese companies that will likely absorb much of the country's drug distribution network during consolidation.
Pharmaceutical companies with strong IP portfolios can tolerate high debt/equity leverage because their drug patents are supposed to be money makers. Aoxing's leverage will test US markets' tolerance if the company cannot sustain its net income improvement into 2016. The market is already showing its concern as the price of AXN fell from US$2.20 on June 8 to $0.92 on December 24. The company cannot blame this share price disappointment entirely on China's currency devaluation. Investors have a right to wonder how Aoxing responds to its US legal critics and China's changing drug distribution landscape.