The latest drug price cuts on the mainland had been expected by many observers, but the share prices of pharmaceutical companies in Hong Kong took a tumble nevertheless. But, some analysts feel that fears of a margin squeeze have been overdone.

The National Development and Reform Commission (NDRC), China regulatory agency, announced on August 5 that the prices for 82 different types of endocrine and neurological chemical drugs will be slashed by an average of 14 percent starting September 1. 

The last such move was in March, when the NDRC slashed the maximum retail prices of some antibiotics and circulatory system drugs by an average of 21 percent. That price cut, according to the NDRC, could save patients on the mainland up to 10 billion yuan a year. 

The moves have come at a time when consumer prices in the country are surging and illness is becoming increasingly expensive, fuelling public grievances. 

According to figures from the Ministry of Health, the average drug costs per inpatient were 6,193.9 yuan ($970) in 2010, up 9 percent from 2009, whereas outpatients spent an average of 166.8 yuan on drugs, an increase of 9.7 percent year-on-year. And cost inflation is even graver on the retail side with drug makers' input costs such as the prices of raw herbal medicines and chemical materials expanding and labor costs rising. 

"The drug prices are being cut as part of the fight against inflation," Linus Yip, a strategist with First Shanghai Securities, said in an interview with China Daily in July. 

Overall inflation on the mainland accelerated to its fastest pace in three years in July, with the consumer price index, the main gauge of inflation, hitting 6.5 percent. 

"The government is set to come out with more such moves," Yip added. 

But despite the fact that the market knew another round of price cuts were on their way, the share prices of many mainland pharmaceutical companies took a nosedive after the latest move, continuing a trend of declining stock prices since the March move. 

August 5-19 saw the share prices of Sinopharm Group Co and Shanghai Pharmaceuticals Holding Co Ltd, the country's top two pharmaceutical companies and both of which boast annual sales value of more than 10 billion yuan, plunge 17.58 percent and 17.87 percent respectively to HK$17.06 and HK$2.39. 

Meanwhile, Sinopharm has fallen almost 40 percent since March, while Shanghai Pharmaceuticals has slipped 20 percent. China Shineway Pharmaceutical Group Ltd, China's largest manufacturer of traditional Chinese medicines injection and soft capsules, has meanwhile lost half of its market capitalization since March and is currently valued at HK$8.32 billion, making it the worst performer on the MSCI ACWI/Health Care Index. China Pharmaceutical Group Ltd, another heavyweight company which recorded revenue of HK$7.77 billion for 2010, has slid 30 percent since March to close at HK$3.17 on August 19. The company bought back a total of 8.74 million worth of shares in June. 

"The price caps are worrying investors," Wu Bin, an analyst at BOCOM International, told China Daily. 

According to Wu, healthcare stocks have been weighed down in part by investors' fear that the prices caps are squeezing company margins - in part through the expectations of further price controls. 

In a note issued on August 8, analysts at SWS Research played down the possibility of another round of price cuts occurring by the end of this year, but said that one to two rounds of cuts are highly likely in 2012, targeting drugs for tumors, digestive and respiratory diseases in particular. 

"Drug price cuts have become a regular measure and will continue in the future, however most healthcare companies will be able to adapt through product structure adjustments and expense controls," SWS analyst Shi Ming said in the research note. "We remain optimistic on China's healthcare industry outlook." 

Likewise, BOCOM International's Wu doesn't see the price cuts of having a considerable bearing on company bottom lines. 

"The impact on margins will be minimal," he said. 

One important factor is that the existing prices of many of the drugs targeted for price cuts are well below the central government-imposed retail price caps, Wu suggested. 

The ceiling drug prices set by the NDRC have only helped bridge the gap between the maximum retail prices and tender prices. According to an estimate by Goldman Sachs analysts, the latest price cuts will still leave the maximum retail prices about 33 percent higher on average than the tender prices. 

Back in June, Credit Suisse analysts issued a research report, in which they called the price-cut concerns "overdone". The research house argued that price-controls are not an unusual phenomenon in the pharmaceutical industry, while unmet medical demand, an aging population and a changing disease profile will continue to underpin the fast expansion of the industry on the mainland. 

The analysts noted that in the 10 years between 2000 and 2010, during which the central government imposed more than 27 rounds of price-control initiatives with an average 20 percent cut in prices each time, the overall hospital drug sales price index on the mainland dropped by a compound annual rate of just 3 percent. 

In contrast, hospital drugs sales in terms of volume grew by a whopping 24.7 percent annually during this period. 

Official data shows that the gross margin of China's drug manufacturing sector as a whole has historically remained stable at no less than 30 percent despite the multiple rounds of price cuts. 

But some will surely feel more of the pain. Compared with drug manufacturers, distributors or those with a fair share of the distribution business will likely emerge as the least scathed from the price-control initiatives, according to BOCOM International's Wu. 

Wu referred in particular to Sinopharm, China's largest drug distributor which enjoys a 12 percent market share, and Shanghai Pharmaceuticals, the country's second-largest drug distributor which is spending $80 million to build a nationwide drug distribution network.