CSKI: A Chinese antidote for a sick portfolio

It seems as if China Sky One Medical, Inc. (CSKI:NASDAQ) has the antidote for a sick portfolio. This Chinese phamacuetical manufacturer and distributor is up 100% since Nov. 2 and it is likely to continue making investors well. Through 9-months in 2009, revenues have increased an average of 32% quarter-over-quarter and are on trajectory to eclipse 2008 revenues by over 70%. This is 22% above the company's guidance for 2009. At a consistant 30% net profit margin, projected 2009 earnings of $2.85 are a 52% increase yoy. No wonder its 60 day price chart is near vertical, jumping form $11 to $23.50, up 10% on Christmas Eve alone. Trading at 12-13 times earnings, this forcasts a conservative $37, and potentially $45/share price tag.

Optimism for these projections in not unfounded. The recently released edition of National Basic Medical Insurance. Industrial Injury Insurance and Maternity Insurance Medicine Directory that specifies which drugs are reimbursable under China's national medical program contains 30 drugs from CSKI's portfolio. Nine of the drugs (4 Western and 5 Traditional Chinese Medicines) are in category A which means reimbursement is 100%. These drugs accounted for 17% of CSKI's revenues for the 9-months of 2009. The other 21 drugs in category B can be reimbursed up to 90% of costs under China's health care regulations. In addition to these select medications, CSKI has over 100 licensed products and 47 new products in the pipeline at various stages of application readiness. Also CSKI has been granted exclusive geographical research rights for stem cell research. Because China does not suffer the same moral restrictions for stem cell research that are found in the US, this grant may be the most significant determination of future growth for CSKI. Presently, CSKI's AIDS, Pregnancy, and Cancer screening tests represent only 9% of revenues but its developmental, gold colloid ELISA technology for quick disease screening may prove extremely profitable.

Fundamentally, CSKI is incredible. The company has no debt, so all liquidy ratios are healthy (Quick Ratio-4; Current Ratio-10; Cash Ratio-6.4). Its $56 million war chest is 41% of total assest. Chinese pharmaceutical companies do not invest heavily in R&D because ingredients in their pharmaceutical products are generic whether Western or TCM (Traditional Chinese Medicine). CSKI is an exception spending 8% (2008) of revenues on R&D. This is in-addition to capital expenditures for physical plant expansion for product development. All of which were financed from operating cash flow.

With an ROE of 30%, with no debt, a wide moat evidenced by an ROIC of 53%, P/CF of 9.8, Insider ownership limited to 37% and Institutional ownership limited to 8%, and a float of only 10.3 million shares, what is not to love about this stock. And did I mention that this stock is so thinly traded that its short ratio of 10 could cause massive upward movement in the event of a short squeeze.

Unfortunately, this stock has come too far too fast and Wall Street always punishes the last man in. There are also some realities of the Chinese national health care system that are not obvious by this stock's move.

1) Only 300 million of China's 1.5 billion population are included in the nation's healthcare program and no pharmaceutical company in China commands more than 1% of the Chinese pharmacuetical market so revenues are limited despite governmental listings.

2) Healthcare account reimbursement is limited to the total amount available in individual accounts that are defined by individual and employer contributions based on salary and subject to drugs included in the national health care directory, so OTC alternatives that are not necessarily reimbursed are more frequently sought to preserve these accounts for more ctritical illness usesage.

3) Retail pharmacies are embyrionic in China and most critical drugs are dispensed by government hospitals while non-emergency drugs are purchased TCM drugs as Over-the-Counter (OTC) based on cultural beliefs and competition in the OTC markets is intense.

4) All Western drugs are generic in China so propriatary patents are non-existent and patents and trademarks are limited to packaging or package artwork. Of CSKI's patents only 1 is for proprietary content, all others are for packaging and artwork.

5) Because 80% of drug purchases are through government hospital pharmacies, the process of "tendering", or mass presentation of drugs requires that successful pharmacuetical contracts meet extremely competitive pricing and meet other subjective requirements of governmental officials. This limits margins and makes contracts subject to official whim and political favoritism.

6) CSKI's portfolio of drugs is limited to generic Western drugs of which all Chinese pharmacuetical companies have the same access. CSKI's OTC TCM drug portfolio is dominated by dermal patches, topical creams, and nasal/oral sprays and subject to massive competition.

7) Four CSKI's customers represent 40% of revenues.

I typically trade on fundamentals and this company is fundamentally strong with a 5 star rating, but its stock performance has been to so phenomenal that I need a pull back in order to pull the trigger. Changes in technical behavior may indicate a better entry level. If this stock forms a nice cup and handle with a dip in the $16-18/share price range, I think it will achieve the price targets indicated above.