WuXi Biologics Stock: Positive Developments, Long-Term Concerns

Elevator Pitch

I keep my Hold investment rating for WuXi Biologics (Cayman) Inc.’s (OTCPK:WXXWY) [2269:HK] shares unchanged.

In my earlier October 7, 2022 article for WuXi Biologics, I touched on the company’s “geopolitical risks” and its new share repurchase plan.

With my latest write-up, I consider both recent positive developments and long-term concerns for WuXi Biologics. I reach the conclusion that the risk-reward for WXXWY is balanced, implying that a Hold rating for WuXi Biologics is justified.

It is necessary to mention that investors have the choice of dealing in either WuXi Biologics’ OTC shares or its Hong Kong-listed shares. The three-month average daily trading value of WuXi Biologics’ shares listed on the Hong Kong Stock Exchange is in excess of $200 million, and brokerages like Interactive Brokers offer trading access for international markets including Hong Kong. Alternatively, the liquidity of WuXi Biologics’ OTC shares is pretty decent as well with a three-month average daily value of approximately $2 million.

Taking A Positive View Of Recent Developments

I had noted in my prior early-October write-up that WuXi Biologics’ “future financial performance might be adversely affected, if the US is determined to restrict and limit the outsourcing of biomanufacturing activities to China.”

But recent developments suggests that WuXi Biologics’ risks on the geopolitical front might have eased to some extent in the very near term.

In late-October, WXXWY announced that its subsidiary “WuXi Biologics (Shanghai) Co., Ltd.” has “successfully completed the end-use on-site visit conducted by the U.S. Department of Commerce.” In the announcement, WuXi Biologics referred to this as “an important step towards the delisting of this subsidiary from the U.S. Department of Commerce’s Unverified List” or UVL. Seeking Alpha News reported earlier on October 10, 2022 that WXXWY’s “subsidiaries in Wuxi (another Chinese city like Shanghai) is getting off the U.S. Commerce Department’s ‘Unverified List’, effective October 7, 2022.”

On the US Bureau of Industry and Security of the Department of Commerce’s website, it is stated that entities on the UVL “are ineligible to receive items subject to the Export Administration Regulations by means of a license exception.” Considering that North America represented over half of WuXi Biologics’ top line in 1H 2022, it is a negative thing for WuXi Biologics’ subsidiaries to be on the UVL.

Looking ahead, there is a potential catalyst for WuXi Biologics that could possibly materialize soon.

It is very likely that WuXi Biologics’ Shanghai subsidiary will be taken off the UVL in the early part of 2023. As a reference, the company’s Wuxi subsidiaries got off the UVL in October 2022 following site inspection that was carried out in June 2022. Going by this line of reasoning, WXXWY’s Shanghai subsidiary could potentially be removed from the UVL as early as February 2023 after its October 2022 site inspection.

But Long Term Concerns Won’t Go Away Easily

There are still long term concerns surrounding WuXi Biologics and other Chinese companies with a meaningful reliance on the US market.

Specifically, it is important to note that while nine Chinese companies (including WXXWY’s Wuxi subsidiaries) were taken off the UVL in early-October, 31 new companies from China were included in the UVL at that time. Notably, these new additions to the UVL were largely semiconductor and technology companies in China. As such, the changes made to the UVL in October might be reflective of the US’ focus on targeting Chinese semiconductor names (versus biologics outsourcing companies) for now, rather than a shift in US-China relations. Therefore, it might be a just a matter of time that the US starts zooming in on Chinese biologics outsourcing companies like WXXWY again.

In the long run, there are two major worries for WuXi Biologics and its Chinese peers.

The first worry is that a growing proportion of revenue contributed by foreign (outside of Mainland China) production facilities will be a drag on WXXWY’s future profitability.

I emphasized in my October 2022 article for WXXWY that “it will be tough for WuXi Biologics’ non-Chinese operations to generate a similar level of profitability as its operations in China” as a result of “cost differentials.” WuXi Biologics had revealed in a late-November 2022 investor call (audio recording and transcript not publicly available) that the gross margin for US and European operations is in the 30%-35% range which is lower than its Mainland China operations’ 45% gross margin. WXXWY also mentioned at the investor call that it expects to have a 65:35 split between China and non-China operations by 2026.

The key risk for WuXi Biologics is that an increasing proportion of its clients request that the work is done on foreign sites, which might have a negative impact on its profitability.

The second concern relates to competition.

WXXWY’s key competitors are Switzerland’s Lonza Group (OTCPK:LZAGY) (OTCPK:LZAGF) and South Korea’s Samsung (OTCPK:SSNLF) (OTCPK:SSNNF) Biologics. Samsung Biologics is typically very competitive on pricing, while Lonza has a strong reputation by virtue of its long history having being started in 1897. It is uncertain if geopolitical considerations will compel more companies to turn to non-Chinese biologics manufacturing peers like Samsung Biologics and Lonza Group.

Concluding Thoughts

I still rate WuXi Biologics’ stock as a Hold. Although there have been positive developments for WXXWY in recent months, WuXi Biologics is still exposed to geopolitical risks in a significant way unless there is a meaningful change in US-China ties.