HONG KONG – The health care industry in China could go through a period of flux over the next year as it responds to widespread changes to the country's economy.

Economic growth in China through 2014 ended up a little lower than expected, but the biopharmaceutical sector has continued to do well. The conditions that made it possible for the sector to grow are likely to continue through 2015, including a sustained effort by the government to encourage more research and development in the space and, from a more macroeconomic perspective, more monetary easing and micro stimulus measures.

More health care spending is likely, too.

But some uncertainty will continue for companies across all sectors, not the least of which is biopharma.

"China's health care system, ironically, is actually better [than] what it was before. Over the last 20 years, the health care system has been privatized. The problem of China's health care system is they don't have a good model or benchmark from anyone in the world. They need to create their own system," said Francis Cheung, head of China-HK Strategy at CLSA, a brokerage and independent investment house.

Cheung said that the government needs to spend more to improve public services, and health care is at the top of the list. The likelihood of continued spending in the space could be good news for listed companies.

"In general it is a very good sector to be in, but it is actually very hard to find stocks because of so many regulations and a lot of them are not very big cap," said Cheung.

2014: MISSED TARGETS

China had an unusual year in 2014 in terms of economic performance.

"It was the first time in a very long time that China missed a lot of targets," said Cheung. The country missed targets for gross domestic product (GDP) growth, M2 money supply growth, consumer prices, inflation and retail sales, among others.

"Something is not right," he said.

And going into 2015, every sector should be concerned about inflation, which has been too low for comfort.

"If you look at November inflation, it was 1.4 percent. This is amazingly low for a country supposed to be going normally at 10 percent. Japan's inflation rate is higher than China. There is something wrong here," said Cheung.

CLSA's Economic Growth Index shows that economic growth in China has become much more volatile. And even though China has been stimulating the economy, growth is slowing.

BIOPHARMA WAS GROWTH DRIVER

The health care sector, including biopharma, was one of the drivers of growth in 2014. The sector is the second best performer in the MSCI China Index, having climbed around 20 percent through the year. The information technology sector is another strong performer.

Luye Pharma Group (HK: 2186), which went public in mid-2014, is one company that did well through the year. Cheung has an overweight rating on it. Luye was trading at HKD9.55 ($1.21) as of Dec. 30, up more than 50 percent from its listing price.

Other companies with exposure to the space have also done well. Lee's Pharmaceuticals Ltd. (HK:0950), for example, was trading at HKD10.48 and Sinopharm Group (HK:1099) at HKD27.20 on the same day. Both have done well through 2014 with Sinopharm returning more than 23 percent and Lee's up more than 50 percent for the year.

Mainland China markets as a whole ended the year on a high note, powering forward through December thanks to some market easing measures and the launch of the Shanghai-Hong Kong Stock Connect Scheme that allows investors in Hong Kong to buy into Shanghai listed companies and vice-versa.

Pharma stocks were among the beneficiaries of the program known as the Through Train, even if the program started off in a relatively subdued note with volumes much lower than expected.

"The Through Train has disappointed this year, but it will get better in 2015. It is highly likely that we will see relaxed regulations to improve investor interest," said Cheung in a note.

M&A ON THE RISE

Notably, the amount of mergers and acquisition activity in the health care sector was on the rise.

Within Asia Pacific (excluding Japan), China was the most targeted country for M&A with transactions worth a record $256 billion for the first 11 months of 2014, up 24 percent from the total $206 billion for all of 2013.

M&A in the health care sector was worth $11.3 billion in the first 11 months of 2013, up 13 percent compared with last year's $10 billion, according to Dealogic.

But listed companies with exposure to the China story could face some headwinds through 2015.

"Credit growth in 2014 slowed more than expected and the trend will continue in 2015," said Cheung.

For analysts like Cheung, the concern is that not only has loan growth slowed, but so has deposit growth. And even though the government has sought to regulate the large shadow finance environment, money has not flown back into the mainstream banking system.

The People's Bank of China reacted quickly in November to concerns over slowing growth by cutting interest rates. More such monetary easing is expected early in the coming year.

While this could be good news, it is not a guarantee.

"The market followed the economy, not the policy. Even if the market gets very excited about the policy, if the economy is not doing very well, it is very hard for the market to rally," said Cheung.