Embrace monthly volatility; focus on rolling average.

　　Hospital drug sales data exhibited unprecedented volatility recently, marked by 1% YoY growth for YTD Feb, 32% for March 2016, 4% for April and 13% for May. We advise investors to focus on the rolling average instead of monthly data to avoid misreading the growth prospects. We continue to believe a reasonable return could be generated by trading around these data points. We also anticipate a larger discrepancy between hospital sales data and reported growth as inventory de-stocking continues while the two-invoice system is being rolled out.

　　DB top picks exhibit growth stability; Hualan on track for growth acceleration.

　　We highlight that our top pick Hualan Biological delivered 29% YoY growth in QTD 2Q16, vs. 15% in 1Q16 and 9% in 2015. For CBPO, its Guizhou subsidiary had 64% YoY growth in QTD 2Q16, vs. 48% in 1Q16 and 50% in 2015, while its Shandong unit exhibited 21% YoY growth in QTD 2Q16, vs. 23% in 1Q16 and 19% in 2015. For Hengrui, its flagship Jiangsu Hengrui experienced 13% YoY growth in QTD 2Q16, vs. 14% in 1Q16 and 12% in 2015. For 3SBio, the YoY growth was 17% May YTD16 vs. 15% in 2015.

　　We also like SBP despite near-term challenges.

　　SBP's flagship unit JCTT had noticeable growth deceleration, with only 8% YoY growth in QTD 2Q16, vs. 15% in 1Q16 and 22% in 2015. However, Tide sales growth stabilized at around 11-13% in the past six quarters. While we anticipate modest challenges on growth in the next two quarters, we believe this represents a good entry point in order to position for the incoming growth cycle driven by new product launches, including tenofovir and anlotinib, which could reach RMB2.5-3bn peak sales by our estimates.

　　Remaining constructive on sector outlook; most risks reflected in consensus.

　　We remain constructive on the sector due to the reasonable valuation, despite policy challenges. We also expect an inflection point as the majority of the risks are being reflected in the P&L. However, we are aware that there are known unknowns that have not been reflected in consensus, particularly the impact of the implementation of a two-invoice system. We generally use a P/E multiple-based approach as the basis for valuation. Key downside risks include further price erosion and volume pressure from reimbursement funding control, as well as delays in new product launches. Upside risks include less pricing pressure than expected.