Cutting mid-term ROIC by 5pptWe believe quality-consistency evaluations will affect the progress of Er-Kang's starchcapsules in capturing share from traditional gelatin capsules. The auxiliary materials andtechnologies used to make preparations, including the type of capsule used, can impactwhether a pharmaceutical preparation is able to pass quality-consistency evaluations. With this in mind, we think drug makers may avoid switching to this new product,instead preferring to conservatively stick with the gelatin capsules that have been inwidespread use for over 50 years. We therefore estimate that replacement of gelatincapsules with Er-Kang's starch capsules may lose momentum in China, which leads usto cut our mid-term ROIC by 5ppt and lower our PT to Rmb17.84. Controlling shareholder to trim stake by up to 9.66% of outstanding sharesOn 7 December, the company announced that Mr. Fangwen Shuai (its controllingshareholder and effective controller) and Ms. Zaiyun Cao, who acts in concert with Mr. Shuai, plan to trim their stake in the company by no more than 9.66% of totaloutstanding shares, bringing their combined stake to 36.83%, with the action to becompleted within six months of 12 December. We remain optimistic on long-term potential of starch capsulesEr-kang's starch capsule series posted revenue of Rmb683m in H116, up 161.09%YoY. We are positive on the use of starch capsules in the pharmaceutical and foodsectors, given starch capsules' advantages over gelatin capsules (better safety andstability) and our view that replacement of gelatin capsules with starch capsules is along-term trend. Moreover, Er-Kang is the world's only company to have successfullycommercialised starch capsules, and we expect the company will leverage its starchcapsules to gradually expand into the downstream capsule drug preparation market. Valuation: Lowering PT to Rmb17.84; maintain Buy ratingWe are lowering our DCF-derived PT by 9.1% to Rmb17.84 (WACC 7.9%), implying35x 2017E PE, while our Buy rating remains unchanged.

Shijiazhuang orders drugmakers to halt or limit production to curb air pollution. The Shijiazhuang municipal government has unveiled an emergency plan to addresspersistent smog. The plan mandates a complete citywide production halt for sevenmajor industries (steel, cement, coking, casting, glass, ceramics, calcium/magnesium)from 17 Nov 2016 to 31 Dec 2016, although production lines engaged in critical tasks(residential heating, ensuring basic living conditions, etc.) are exempt. Meanwhile,industries such as pharmaceutical manufacturing, chemicals, packaging/printing, andfurniture will be managed based on a checklist system; in principle, all productionprocesses involving volatile organic compounds will be completely halted, but in specialcases where a total shutdown is not feasible, production may be scaled back withapproval from the municipal government. Based on our checks with Yiling, thecompany is currently subject to the production halt but is in talks with the citygovernment to resume production. Ample finished goods inventory. Yiling is a modern Chinese medicine producer whose EU/US-certified chemical drugproduction lines meet zero-emission standards. The company also demonstratedcompliance with standards during environmental checks just carried out in November. Looking at Shijiazhuang's pollution control efforts in past years, the city has oftenplaced limits on supply of power and heating during the heating season. In addition,Yiling's past annual reports indicate that it generally keeps at least 3 months of finishedgoods inventory on hand (not including inventory held in distribution channels). Weview the impact of production halts on the company as limited for now, and we arecontinuing to closely monitor the results of Yiling's talks with the government. Growth set to accelerate for 3 major prescription cardiovascular drugs. Yiling generates over 90% of its revenue from exclusive orally-administered Chinesedrugs, and it has been effective in maintaining tender prices. Yiling's major products(Shensong Yangxin/Qili Qiangxin/Lianhua Qingwen capsules) are likely to see rapidrevenue growth as more tenders take place given benign competition and upside forhospital coverage. Valuation: Maintain Rmb23.32 price target, Buy rating. Our Rmb23.32 price target is based on DCF and assumes an 8.1% WACC. Wemaintain our Buy rating.

Further price increases for key products e-jiao bars/e-jiao syrup/Taohuaji The company announced ex-factory price increases of 14%/28%/25% for e-jiao bars,e-jiao syrup and Taohuaji, with corresponding adjustments to the retail prices. Theadjusted retail prices for the three products are Rmb1,350/250g, Rmb467/48 sticks andRmb300/225g, respectively. This is the first price hike in a year for the e-jiao series. After the price hike, we expect the company to boost sales by stepping up its supportfor dealers and retail sales promotions. Gross margin could rise 2ppts, but we expect selling expenses to rise as well The latest price hike may further increase pressure on the sales volume of e-jiao bars,which posted flat revenue and a decline in sales volume in Q1-Q316 due to sharp priceincreases in 2014/15. Therefore, we do not expect the price hike to lead to anysignificant improvement in revenue/profit for e-jiao bars. For e-jiao syrup and Taohuaji,as the price hike comes at an opportune time when the end-market demand for thesetwo products is growing rapidly, their revenues and profits are likely to improvesignificantly if the company complements the price hike with retail sales promotions. We estimate that the price hike is likely to boost 2017 gross margin by about 2ppts(assuming a 10% increase in the donkey hide price). In our base case, the price hike islikely to add Rmb290m to the company's gross profit, but we expect selling expensesto increase concurrently. Overseas hide sourcing strategy starting to pay off China's donkey inventory has trended lower in recent years on high feed prices and alack of efficient breeding technology. This has driven up the price of donkey hide fromRmb48/kg in 2011 to Rmb373/kg in 2015. On the one hand, the company is buildingupstream facilities to gain more control over donkey hide sourcing. On the other hand,it is buying donkey hides from overseas. Foreign markets currently account for over30% of its donkey hide purchases. Sourcing donkey hides from overseas has alsoreduced the pressure to buy them in the domestic market. The price of donkey hideshas risen much more slowly, at c10% YTD. Moreover, donkey hide inventory hasincreased substantially, which is likely to underpin the company's earnings growth inthe next three years. Valuation: Rmb66.71 PT, Buy Our DCF-based PT of Rmb66.71 assumes 7.1% WACC.

Q: How did the results compare vs expectations? A: Q1-Q316 revenue was Rmb1.24bn (+8.4% YoY) and net profit attributable to the parent was Rmb305m (+37.8% YoY). In Q316, because the consolidation of Xianqiang Pharmaceutical was complete and no longer had an impact, revenue rose 8.5% YoYand NP attributable to the parent rose only 13% YoY. Q1-Q316 revenue and NP were in line with our expectations, as they equal 78% of our full-year estimates. Q: What were the most noteworthy areas in the results? A: Q1-Q316 R&D spending grew 79% YoY to Rmb127m, or 15% of revenue, a leading percentage among pharmaceutical companies. Most of the spending went to new product R&D projects. The company is in cooperation with WuXi AppTec to develop new products, which should further expand its product pipeline. Q: Has the company's outlook/guidance changed? A: We expect the company to maintain steady earnings growth from Q416 to 2017. The company guided that 2016 full-year net profit growth would be in the range of 20-40%, implying net profit of Rmb356-415m. Q: How would we expect investors to react? A: We expect a neutral response from investors to the in-line earnings.

Q316 destocking continued while manufacturing revenue continued to decline Tasly's Q1-Q316 revenue was Rmb9.6bn, with pharmaceutical manufacturing revenuedown 14.46% YoY to Rmb4bn and pharmaceutical distribution revenue up 19.13%YoY to Rmb5.6bn. Net profit attributable to the parent fell 17.7% YoY to Rmb1.0bn.Q316 manufacturing revenue was Rmb1.4bn, down 13% YoY, a larger decline than inQ216. Q316 distribution revenue was Rmb1.8bn, up 17% YoY. The main reasons forthe lower-than-expected manufacturing revenue are strict control of receivables andclearing of channel inventory. The parent's receivables continued to fall, downRmb140m from end-Q216. Q1-Q316 net cash generated from operating activities roseRmb419m from the same period last year, up 138% YoY. Good sales growth in the end-market IMS sample hospital data show that the main products continued to grow in the endmarket.In January-August, Dantonic/Yangxue Qingnao grew 8.0%/8.5%, whileSalvianolate/Puyouke grew 2.9x/5.4x. In our view, with end-market demand for Tasly'smain products maintaining strong growth, the company's manufacturing revenue islikely to recover next year after the completion of destocking. Dantonic phase III results a milestone for Tasly and the TCM sector We think the results of Dantonic's phase III US clinical trial will be available soon, andwe believe the market has not fully priced in this expectation. Given the encouragingphase II data, we believe there is a high likelihood that the phase III results will bepositive, which could lead to: 1) the launch of Dantonic in the US and other developedmarkets; 2) partnerships with multinational corporations; 3) expansion of indications forDantonic; and 4) the beginning of a new era for TCM modernisation. Valuation: Price target of Rmb59.58, implying 34x 2017E PE We value Tasly's existing business at Rmb48.61 per share based on DCF (WACC 6.4%).We value the Dantonic angina indication in the overseas market at Rmb10.97 pershare. We derive our price target of Rmb59.58 using sum-of-the-parts, implying 34x2017E PE. We maintain our Buy rating.

Results largely in line with expectations 9M16 revenue was Rmb21.42bn (+8.85% YoY) and net profit attributable to theparent was Rmb720m (+25.91% YoY), or Rmb580m (+3.94% YoY) excluding oneoffs.9M16 net profit equalled 78% of our full-year net profit forecast, largely in linewith our expectations. Waiting for completion of stake transfer after getting administrative approval Shanghai Shyndec Pharmaceutical, the counterpart of the company's assetrestructuring deal, has obtained approval from the Ministry of Commerce, marking thecompletion of the administrative approval process, which is a prerequisite for majorasset restructuring. We estimate the subsequent stake transfer and change in companyregistration will take more than a month. At that point, Guoda Drugstore, the largestretail pharmacy chain in China, will be officially consolidated. Performance of Guoda Drugstore after restructuring bears watching As a leading pharmaceutical distributor in Guangdong and Guangxi, we believe aclearer business structure after the transfer of the controlling stake in thepharmaceutical manufacturing segment and the inclusion of the Guoda Drugstore retailbusiness will help improve the company's operating efficiency, create economies ofscale and boost its gross margin, likely resulting in faster pharmaceutical distributionrevenue growth. In addition, we believe Guoda would benefit from the separation ofthe clinic from the pharmacy and higher industry concentration, and we expectprofitability to improve. Valuation: Maintain price target of Rmb82.38, Buy rating We maintain our DCF-based price target of Rmb82.38 (WACC 7.1%) and Buy rating.

Q3revenue missed due to business environment/channel inventory 9M16revenue decreased 42% YoY to Rmb1.09bn, mainly as Jiangxi Jointown was nolonger included in Jiangzhong’s financial statements. Excluding this, Jiangzhong’s drugmanufacturing revenue fell 8.89% YoY, with OTC drug/dietary supplement revenuedown 4.3%/27.98% YoY to Rmb920m/168m, respectively. Net profit (excluding oneoffs)increased 22.78% YoY. Due to the environment in the drug distribution sectorand Jiangzhong’s proactive control of channel inventory, Q3revenue shrank c43%QoQ, less than we expected. We continue to believe Jiangzhong’s OTC drug business ismaturing and its dietary supplement segment is still in a transforming and expandingstage. Radix pseudostellariae prices rose, expense ratio continued to fall Radix pseudostellariae output fell due to weather and prices increased more than 50%YoY, which we estimate pushed down Jiangzhong’s OTC drug gross margin to 72.8%in Q3from 76.84% in H116. Jiangzhong continued to follow a precision channelcontrol strategy to manage advertising expenses and strictly appraise output-to-inputratios, which effectively reduced expense ratios, with Q3selling and administrativeexpense ratio down by 11.4ppts QoQ. The strategy enabled Jiangzhong to generatestrong cash flow, and the company’s 9M16net cash flow from operations rose 34%YoY to Rmb582m, much higher than net profit. Q416and 2017outlook Jiangzhong enjoys visible brand advantages in the OTC market, especiallygastrointestinal OTC drugs. With steady demand, we estimate digestive and stomachtablets and lactobacillin tablets, Jiangzhong’s main products, will maintain 5-10% salesvolume growth. Lower output could cause radix pseudostellariae prices to remain highin 2016. However, we do not think this will continue to push down Jiangzhong’s grossmargin if the main producing regions do not experience adverse weather conditionsagain, as radix pseudostellariea is an annual plant. In addition, decreasing expenseratios are likely to offset weaker gross margins. Valuation: Maintain Rmb44.56price target, Buy rating Our DCF-based price target is Rmb44.56(6.7% WACC). We maintain our Buy rating.

Earnings in line 9M16 revenue was Rmb45.2bn, up 24.08% YoY, with net profit attributable to theparent of Rmb460m, up 21.86% YoY. This included Q3 revenue of Rmb15.4bn andnet profit of Rmb150m, in line with our expectation. Net operating cash flow jumped40% YoY in 9M16, mainly due to: 1) an increase in cash collected on sales; and2) issuance of bills and securities backed by the company's accounts receivable assets. Steady growth in core segments Proprietary Chinese medicines (PCM) and Western drugs posted revenue of Rmb38bnin 9M16, up 20.4% YoY. Traditional Chinese crude drugs and prepared drug slicesbrought in revenue of Rmb1.5bn, up 10% YoY, and medical devices and birth controlproducts recorded revenue of Rmb3.3bn, up 47.3% YoY, with both segmentsmaintaining robust growth. Food, health products and cosmetics grew 93% comparedto 9M15. Two-invoice system to boost Jointown's proportion of direct hospital sales Policies such as the two-invoice system and the business tax-for-VAT switchover areeroding the competitiveness of smaller companies and accelerating development oflarger players such as Jointown. The company has advantages in terms of logistics andwarehousing, and if the two-invoice system is rolled out on a large scale, the companywould likely consolidate downstream delivery firms to raise coverage of hospitals,resulting in direct hospital sales accounting for a higher share of total sales. We forecastJointown's delivery business to have a 20% revenue CAGR and a 24% gross profitCAGR in 2016-18. Valuation: Rmb25.20 price target implies 39x 2017E PE Our Rmb25.20 price target is based on DCF (WACC 6.7%) and implies 39x 2017E PE.We maintain our Buy rating.

Earnings slightly missed our expectation Cachet's Q1-Q316revenue was Rmb7.923bn, up 36.6% YoY, and net profitattributable to the parent was Rmb170m, up 29.0% YoY. Q316revenue wasRmb2.81bn, up 32.7% YoY, and net profit attributable to the parent was Rmb54m, up28.5% YoY. Q1-Q316net profit slightly missed our expectation, representing only70% of our full-year forecast for 2016, mainly because the drug distribution businessundershot expectations due to a lack of progress at Beijing's transparent procurementinitiative. The company guided for full-year net profit growth of 20-40%. Drug/medical device delivery businesses to have steady growth Cachet's Q1-Q316gross margin contracted 1.88ppts, mainly due to an increasedcontribution from the low-margin medical device delivery business. We project themedical device delivery business to post full-year revenue growth above 30%,becoming the main earnings growth driver. For the drug delivery business, thecompany's market share in Beijing is below 5%. Following the completion of theprevious round of tenders, the company has further improved its warehousing andlogistics capabilities in Beijing. If Beijing's transparent procurement progresses by end-2016, the company's direct sales to hospitals at or above level 2are likely to startaccelerating in 2017. GPO/PBM progressing steadily Under a centralised drug procurement (GPO) model, Cachet has started supply chaincooperation with hospitals run by Shougang Steel, Ansteel Group, China AerospaceCenter, CNNC and China National Aviation Corporation. The cooperation project withShougang Steel generated revenue of Rmb482m in Q1-Q316and has grown steadily.The company also signed a drug supply cooperation agreement with AVIC AviationGeneral Hospital in June 2016. The company's pharmacy benefit management (PBM)business is also expanding. Valuation: Maintain Rmb49.85PT and Buy rating Our DCF-based price target is Rmb49.85(WACC 7.3%). We maintain our Buy rating.

Dantonic phase III results a milestone for Tasly and the TCM sector We think the results of Dantonic's phase III US clinical trial may become available soonand we believe the market has not paid enough attention to this milestone. Given theencouraging phase II data, we believe there is a high likelihood that the phase III resultswill succeed, which could lead to: 1) the launch of Dantonic for angina in the US andother developed markets; 2) partnerships with multinational corporations; 3) expansionof indication for Dantonic; and 4) the opening of a new era for TCM modernization. US sales of Dantonic could reach US$1bn if it is approved by the FDA Ranexa is the only angina drug launched in the US in the past 20years and its annualsales have reached US$700m. Dantonic, which performed well in its phase II trial,boasts milder side effects. If Dantonic demonstrates comparable efficacy and milderside effects with Ranexa, we believe the eligible patient size could be multiple timesthat of Ranexa. With reasonable pricing, we estimate US sales for the angina indicationalone could reach US$1bn, corresponding to Rmb15.8bn NPV to the stock. The drug'sdomestic sales growth may also accelerate due to positive phase III data. Over the long term, FDA approval is just the first step for Dantonic Dantonic is used in a wide range of cardiovascular conditions. As a result, if the drug issuccessfully introduced in the US, Tasly is likely to seek approval for additionalindications (coronary heart disease, diabetic retinopathy, etc.) through further clinicaltrials. Each of these additional indications could bring much larger commercial valuethan angina. Through the Dantonic US trial, Tasly has gained experience with the FDAapproval process and cultivated an international approval team that could take moreTCM drugs to the western market over the long term. Valuation: We are raising our PT 15% to Rmb59.58 Our 2016-18E EPS are Rmb1.45/1.75/2.03. We value Tasly's existing business atRmb48.61per share, based on DCF (WACC 6.4%). We value the Dantonic anginaindication in the overseas market at Rmb10.97per share, assuming that: the productstarts generating overseas revenue in 2018and reaches US$1bn sales in 2023. Wederive our price target of Rmb59.58using sum of the parts, as we are raising it toreflect the addition of the Dantonic NPV. We maintain our Buy rating.

One of the leading national pharmaceutical distribution companies. After a period of restriction we resume coverage with a Buy rating and new Rmb23.19price target. The pharmaceutical distribution/manufacturing segments contributed arespective 89%/11% of revenue and 63%/37% of operating profit to the company in2015. The company's PE implies the market is overly concerned about its change ofchairman and institutional issues, with its A-shares having a large discount to A-sharepeers and mostly the same valuation as its H-shares. We believe the market fails to seethe distribution segment's prospects for expansion and potential for profit marginimprovement. Moreover, the new management team is relatively young and likely toimprove its operating efficiency if it remains stable. Distribution market share is likely to keep rising for the next 3 years. The company plans to extend its distribution segment from 18 provinces currently to 28in the next 5 years. Also, the implementation of the two-invoice system is likely toimprove the concentration of the distribution market and help the company's extensionof channels to lower-tier markets, with inter-provincial M&A. As it gets driven byorganic/inorganic expansion, we estimate the distribution segment to post a 16%revenue CAGR in the next 3 years, with its market share likely to improve from 5.9% in2015 to 7.1% in 2018. Profit margin to remain the same; conformance evaluation has limited impact. Despite pressure from the tender price reduction, we believe the company couldmaintain the manufacturing/distribution segments' current profit margin level viaproduct mix improvement/economies of scale. In the long run, conformance evaluationof the quality/efficacy of generic drugs could lead to fewer generic drug companies,helping maintain or even increase product prices. However, we see a limited impact onrevenue/profit, given the limited number/scale of products in the company's first batchof generics for evaluation and stability of the competitive landscape. Valuation: Resume coverage with Buy and Rmb23.19 PT, implying 19x 2016E PE. Since our last note in late 2015, the A-share market has had great volatility, withchanges to sector fundamentals. We are lowering our 2016-18E EPS toRmb1.20/1.34/1.49 from Rmb1.28/1.47/1.69 and terminal ROIC to 7.5%. Our DCFbasedPT assumes 6.9% WACC. The stock is trading at 16x 2016E PE, with a heavydiscount to the A-share peer average PE (35x). We believe current valuation isattractive, as management/operating efficiency could improve.

Tasly plans to list its distribution platform on the New Third Board. The company plans to split off Tasly Medicine Distribution Group (TMDG), a whollyownedsubsidiary, in a transaction that would see the subsidiary restructured into ajoint-stock company and listed on China's New Third Board (NTB). The Taslymanufacturedproducts previously handled by TMDG will be transferred to anotherfully-owned subsidiary of Tasly, and the distribution of self-manufactured products toother distributors will be discontinued. By our estimates, the company generated overRmb5bn in revenue and ~Rmb150m in net profit from delivering third-party medicinesin 2015, and TMDG's revenue could grow 15-20% this year to Rmb6-7bn. Separate listing could raise TMDG's access to financing and boost motivation. Pharmaceutical distribution is a fairly capital-intensive business. We think the separatelisting could, on the one hand, improve TMDG's ability to independently accessfinancing. Another consideration is that after the joint-stock restructuring, TMDGwould be likely to have a more robust management system, as well as a moremotivated team due to management shareholding. In addition, we think separatelylisting the distribution business could allow Tasly to capitalize on M&A opportunities forlarge pharmaceutical distribution firms as the two-invoice system is expanded. Valuation discount vs. A-share listed pharmaceutical distributors is likely. Considering that both NTB stocks as a whole and the NTB pharmaceutical segmenttrade at a discount to A-shares, we would expect the distribution company's valuationon the NTB to be lower than A-share pharmaceutical distributors such as Jointown,Realcan and Cachet. Valuation: Maintain price target and Buy rating. Our Rmb52 price target is based on DCF and assumes a 9% WACC. We maintain ourBuy rating.

Phase III results for Compound Danshen Dripping Pills to be un-blindedTasley attended our A-share conference in Shenzhen. Management said tabulation ofthe data for the Compound Danshen Dripping Pills phase III trials is essentially finished. Tasly has recently been in further communication with the FDA and expects the phaseIII results to be un-blinded in the next 2-3 months. The company is optimistic on theresults and on receiving final approval from the FDA. Actual end-market sales in H116 were likely stronger than reportedDue to clearing out channel inventories and control of receivables, Tasly'spharmaceutical manufacturing revenue declined 15% YoY in H116, but actual endmarketsales still grew over 10%. Q216 pharmaceutical manufacturing revenue was flaton Q215 and far higher than Q116. We expect to see progressive improvementcontinue in Q3 and Q4. Tasly's three injections to benefit from this round of medical insurance changesThe selection process has kicked off for the next version of the medical insurance druglist, with adjustments likely to be completed by year-end. Products that have alreadyentered many provincial reimbursement lists, been added to evidence-based medicineand clinical treatment guidebooks, or have economic advantages will have anadvantage in the selection process. The company's three major injections ? prourokinase(2 guidebooks), salvianolate (6 provincial reimbursement lists), and Yiqi Fumai(10+ provincial reimbursement lists) ? are likely to benefit from this round of medicalinsurance adjustments. Valuation: Maintain Rmb47.35 price target and Buy ratingOur Rmb47.35 price target is based on DCF and assumes a 9.0% WACC.

Main products are selling well At our China A-share Conference in Shenzhen, the company's management said itsmain products are selling well. E-jiao bar will likely retain its high-end positioning. Witha target consumer base numbering 3-4m, there is still room for price increases. E-jiaosyrup delivered revenue growth of above 40% in H1, helped by price adjustments andmore motivated dealers. Taohuaji is likely to maintain c30% revenue growth in 2016asit extends to markets outside Shandong and Beijing. The management believes thecompany's profit will maintain double-digit growth. Expanding direct distribution to drugstore chains In the past, the company mainly relied on dealer sales. Now it has begun to directlydistribute products to drugstore chains, thus reducing the middle level andstrengthening the incentivisation of retail drugstores. The company has a 1,000-strongsales force, with 10,000+ drugstores engaged in hide-boiling services, contributing250-300tonnes of annual output, significantly boosting retail sales. Donkey hide prices remain on uptrend; overseas donkey-hide purchases rose The company believes the low rate of return (c10%) of donkey breeding due to theunderdeveloped downstream donkey meat industry is the main reason for the tightsupply of donkey hide. Despite the improvement in recent years, a fundamental turningpoint is still yet to be seen, with donkey hide prices remaining on an upward trend.Year to date, donkey hide prices have increased by c10%. Although donkey hide fromoverseas is cheaper, the company pays hide merchants basically the same price as thatfor domestic procurement in order to encourage overseas donkey hide procurement.Donkey hide sourced from overseas now accounts for c40% of the company's donkeyhide supply, and it has set up 20+ donkey-breeding facilities in China to improve thecountry's donkey species in order to improve the yield and quality of e-jiao. Valuation: Maintain Rmb66.92PT and Buy rating Our DCF-based price target is Rmb66.92(7.2% WACC). With the growing marketdemand for e-jiao, we are upbeat on the company's development and leading positionin the e-jiao industry. We therefore maintain our Buy rating.

Interim results largely in line The company realised revenue of Rmb10.452bn (+9.53% YoY) and net profitattributable to parent of Rmb1.388bn (+10.58% YoY) in H116, accounting for45%/44% of our full-year forecasts, respectively, largely in line with our expectations. Its H116 net cash flow from operations was Rmb2.09bn (+7.71% YoY). Toothpaste growth slower than we expected due to tight capacity By segment, the company realised revenue of Rmb4.544bn for its manufacturingbusiness (+6.60% YoY) and Rmb5.891bn for its distribution business (+12.04% YoY),which are lower/slightly higher than our expectations. We estimate toothpastecontributed cRmb2.0bn revenue (up c10% YoY), with growth visibly lower than that in2015 due to insufficient capacity. The company has started to find OEMs and weestimate toothpaste growth may pick up in H216 with net margin largely flat overH215. We estimate its drug revenue grew c4% YoY in H116, largely in line with ourexpectations; Qingyitang (sanitary napkins) continued to fall. SOE reform gradually on the moveYunnan SASAC, the company's actual controller, is actively pushing for the mixedownership reform for Baiyao. As of now, the potential partner has completed duediligence and both parties are conducting business negotiations. We believe thecompany's operating and decision making efficiency and management scheme couldfurther improve if the reform could complete successfully. Valuation: PT at Rmb73.39; maintain BuyWe derive our DCF-based price target of Rmb73.39 (WACC=6.3%), which implies 24xour 2016 PE estimate. We maintain our Buy rating.