On July 10, Zhaoyan Pharmaceutical (06127) closed at a minimum of HK$6.62. The stock price also hit a new low on its listing. However, the CRO company was injected with a dose of strength medicine in the same night as an “Yingying Police Notice”.

The Zhitong Finance App learned that on the evening of July 10, Zhaoyan Pharmaceutical issued a profit warning: it is expected to achieve operating income of about 0.719 billion yuan to 0.973 billion yuan (RMB, same below) from January to June 2024. Compared with the data for the same period last year, it will decrease by about 38.6417 million yuan to 0.293 billion yuan, a year-on-year decrease of about 3.8% to 28.9%. Net profit attributable to shareholders of listed companies is expected to be about -0.184 billion yuan to -0.136 billion yuan from January to June 2024. Compared with the data for the same period last year, there will be a loss.

However, it was this profit warning that caused Zhaoyan New Pharmaceutical's stock price to close sharply by 10.12% the next day, and even reached 12.08% during the intraday period. On July 12, Zhaoyan New Pharmaceutical's rise continued with the highest intraday stock price increase of 6.45%, with a cumulative increase of 12.24% over the two days.

Although the reverse trend after Zhaoyan Pharmaceutical's profit warning has some relationship with the market's general low expectations, as far as the company itself is concerned, behind a downward trend in both revenue and net profit in this performance forecast, the business side has shown an improvement trend, and the number of orders and inquiries has improved sequentially. The market's sentiment about Zhaoyan Pharmaceutical and the subsequent rebound of the CRO market as a whole was concentrated in this 10% increase.

The aftermath of falling monkey prices continues

In the latest performance forecast released by Zhaoyan Pharmaceutical, the company disassembled and interpreted the factors affecting its own losses. Among them, the net loss of 0.224-0.247 billion yuan due to changes in the fair value of biological assets was the direct cause of the loss. At the end of the day, Zhaoyan Pharmaceutical is still suffering the negative consequences of price drops due to experimental monkeys.

According to the Zhitong Finance App, between 2020 and 2022, the average purchase price of domestic crab-eating monkeys skyrocketed 6 times, and in addition to hoarding monkeys, the aggressive Zhaoyan New Drug also changed the experimental monkey biological asset measurement method in the 2020 annual report from the previous “cost method measurement” to “fair value measurement.”

As a result of this change in accounting policy, when biological assets continue to rise in price, their price surpluses are released in current statements. However, as a double-edged sword, once the monkey price boom cycle is over, the company's net profit will also be negatively affected. This is also the main reason why Zhaoyan Pharmaceutical lost money over the past few quarters.

However, on the other hand, in the first quarter of this year, Zhaoyan Pharmaceutical recorded a net loss of 0.272 billion yuan to mother. In the second quarter, the company achieved a net profit of 0.088 billion yuan to 0.136 billion yuan, which was a significant improvement over the previous quarter.

In other words, the emergence of an inflection point in the short-term operation of Zhaoyan Pharmaceutical can be judged quite clearly from the 2024H1 performance forecast.

First, refer to the 2023 annual report data of Zhaoyan Pharmaceutical. The reason for the decline in net profit given by the company at the time was basically the same as this performance forecast. They all mentioned that the decline in industry sentiment and increased competition caused the company to make concessions on order prices, and profit margins were compressed.

However, from the difference between the 23 annual report and the number of orders placed in 24Q1 and Q1, it can be seen that the overall market is picking up. In the 2023 annual report, Zhaoyan Pharmaceutical indicated that it signed a new order of 2.3 billion yuan, a year-on-year decrease of 39%, but the number of new customers increased 30% year-on-year. At the same time, the company's on-hand orders reached 3.3 billion yuan, and a stable number of on-hand orders and customers provided a guarantee for subsequent performance.

Subsequently, during the 2024Q1 period, the number of new projects signed by Zhaoyan Pharmaceutical increased by 20% year-on-year, and the number of overseas project orders increased by 30%. The increase in the number of orders in progress or the increase in the number of new projects signed may be the leading factor in the recovery of the company's 2024Q2 performance.

A preview of an upward CXO cycle?

Since mid-January 2023, the stock price of Zhaoyan Pharmaceutical has been in a state of decline. Combined with its dismal net profit performance of 75.58% and 48.17% year-on-year, respectively, the stock price of Zhaoyan Pharmaceutical spent the whole of 2023 in an accelerated decline, and there are no obvious signs that its stock price will stop falling in 2024.

Based on the intraday stock price high of HK$35.07 on January 16, 2023, up to now, even with the stock price recovery on July 11 and 12 this year, the cumulative decline in Zhaoyan Pharmaceutical's stock price is close to 80%. The reason for this is that previously, the market still had differences in its judgment on the downstream sentiment of the CXO sector. In this context, the traditional CXO enterprise valuation model has almost failed, and the cyclical nature of CXO companies is becoming more and more obvious.

In fact, since the third quarter of 2023, Zhaoyan Pharmaceutical's own performance has improved significantly from month to month. For example, in the 2023Q2 and Q3 quarters, Zhaoyan Pharmaceutical's key financial indicators showed a clear year-on-year decline, but the month-on-month growth data on the laboratory's main business performance after excluding the impact of biological assets shows that it has not lost its ability to make money. It also shows that the industry moat built by Zhaoyan Pharmaceutical with scarce and comprehensive international certification qualifications is still in effect.

However, in the face of a downward cycle in the CXO industry, the weight of performance in valuation evaluations fell to a new low, and the company's stock price continued to decline without support. This is a typical characteristic of cyclical stocks.

Under this logic, in the face of Zhaoyan Pharmaceutical's 2024H1 performance forecast, the market reaction seemed somewhat beyond imagination. In other words, if the valuation of Zhaoyan Pharmaceutical were to reverse in the future, its own performance fluctuations would not have that much influence. To a certain extent, improvements in the biomedical investment and financing environment are needed to drive an overall rebound in the domestic CXO sector.

On July 9, local time, Federal Reserve Chairman Powell attended the Senate Banking Committee hearing, testified about the semi-annual monetary policy, and was questioned on issues such as monetary policy and bank supervision. Powell said in his speech that although inflation has eased somewhat, it is still above the 2% target, and policymakers are still firmly committed to reducing the inflation rate to 2%. Analysts believe that Powell's testimony shows that the Federal Reserve's trade-off between stable prices and maximum sustainable employment is changing. This cautious shift has brought the Fed one step closer to cutting interest rates.

Earlier, on July 3, the ISM service industry PMI index for June this year announced by the US was 48.8, which is expected to be 52.6, and the value before May was 53.8. Since the PMI index is 50 and the boom and bust line, the actual value is now only 48.8 below the boom and dry line, which is far below expectations, directly heating up the market's expectations of the Fed's interest rate cut. The US dollar index also experienced a wave of diving on the same day.

On July 5, the US Department of Labor released non-farm payrolls data for June: The number of new jobs was 0.206 million, a sharp drop from the previous value of 0.272 million; the unemployment rate rose to 4.1%, the highest since 2021. This has also raised expectations that the Federal Reserve will start cutting interest rates in September. According to the Chicago Mercantile Exchange's “Federal Reserve Watch Tool” data, the market currently expects a 73% chance that the Fed will cut interest rates by a cumulative total of 25 basis points by September.

The above data indicates to some extent that the US interest rate hike cycle is coming to an end. The biomedical investment and financing environment can be expected to improve, which will spread to the upstream market, and the CXO sector may usher in a new upward cycle. However, it is only in the upward cycle of the industry that Zhaoyan New Pharmaceutical can hope to raise its valuation with its leading position in safety assessments and scarce qualifications. To some extent, using new orders as an anchor point in the market to look forward to the subsequent performance of Zhaoyan New Drug is a prediction of the arrival of the CXO upward cycle.