According to reports from Zheshang Securities on the Intelligent Financial APP, the switch of the old and new dynamics in the pharmaceutical industry will continue in the future, with innovative drug equipment, areas with good structure or supply clearance (such as innovative drug supporting industry chain, large infusions, anaesthetics, blood products, pharmaceutical distribution, traditional Chinese medicine OTC) benefiting from the slow recovery of demand, which could have better growth potential; however, under the influence of the comprehensive medical reform policies, some companies may experience slowdowns due to channel adjustments, where changes in operational efficiency are overlooked by the market, leading to misjudgments in the expectations for company growth.

In terms of specific investment recommendations: bullish on companies that focus on out-of-hospital sales, have strong brand influence, and high control over downstream channels, such as Dong-E-E-Jiao (000423.SZ), Beijing Tongrentang (600085.SH), etc. Bullish on CXO's new business expansion leading to sustained performance growth, such as Wuxi AppTec (603259.SH), Tigermed (300347.SZ), etc. Bullish on scientific service targets with improved profitability and cash flow, such as Shanghai Titan Scientific Co., Ltd. (688133.SH), etc.

Furthermore, optimistic about the advancement of support policies for innovative drugs, and the continuous improvement of international competitiveness leading to an increase in the valuation of innovative drug companies, such as Dizhi Pharma (688192.SH), Zejing Pharmaceutical (688266.SH); focusing on the different growth potentials of companies in the active pharmaceutical ingredient industry, such as Zhejiang Xianju Pharmaceutical (002332.SZ), etc. Bullish on the continuous expansion of new businesses driving growth and profitability, such as Sh Pharma (601607.SH), etc.

Zheshang Securities' main points of view are as follows:

Stock Price: Pharmaceutical and biological sub-sectors are generally adjusting

Review: Sub-sectors differentiated. Since 2020, the pharmaceutical industry has experienced significant external fluctuations, leading to further differentiation within various segments of the pharmaceutical and biological industries due to rapid changes in supply and demand. From January 1st to October 31st, 2024, the stock prices of vaccine (-35.3%), other biological products (-34.5%), medical consumables (-31.6%), offline pharmacies (-27.8%), and hospitals (-23.9%) have seen more adjustments. In terms of valuation, as of October 31, 2024, the PE-TTM of the pharmaceutical and biological sectors was 31.6X, at a historically low level since 2020 (with a valuation range of 24.2X~58.0X), with the top three valuations in sub-sectors being hospitals (49.15X), active pharmaceutical ingredients (40.46X), chemical preparations (38.09X), pharmaceutical distribution (16.87X), offline pharmacies (17.27X), and medical research outsourcing (25.79X).

Performance: In the medical and biological sector (according to the 2021 classification of Shenwan industries), as of Q3 2024, the year-on-year growth of operating income of listed companies increased by 0.16%, while the year-on-year decline of net profit attributable to mother was 13.49%. The growth rates changed by +3.01pct and -4.18pct respectively. Among them, the sub-sectors with the highest year-on-year growth rates of net profit attributable to mother and operating income in the medical and biological sector in 2024 Q3 are respectively active pharmaceutical ingredients (+26.91%, +6.99%), chemical agents (+14.15%, +3.43%), medical consumables (+13.57%, +10.62%), and in vitro diagnostics (+10.74%, +4.28%).

From a retrospective perspective on the proportion of profitable companies: In Q3 2024, out of 497 medical and biological enterprises, 399 achieved profitability (making up 80.3%). According to the 2021 Shenwan three-level classification of the medical and biological industry, other blood products, medical consumables, pharmaceutical distribution, and active pharmaceutical ingredients had a higher proportion of profitable companies, at 100%, 94%, 92%, and 89% respectively.

Profitability: Under supply-side adjustments, there are fluctuations in business cycles.

Growth: There are discrepancies in data between the industry and the sector, which we believe is a natural phenomenon of structural adjustments. In September 2024, the added value of the pharmaceutical industry reached a new high since 2022 (+11%), and the year-on-year growth rate for the first 9 months also showed good recovery, with a growth rate of 3.1%. After experiencing multiple quarters of negative growth, the pharmaceutical manufacturing revenue began to turn positive in the first 9 months (+0.2%). However, we also found that the year-on-year profit growth rate in the first three quarters is still relatively low (-0.4%). Meanwhile, when combined with the year-on-year revenue and profit growth of the secondary market healthcare sector, a slightly different trend emerged with the sector's revenue and profit still showing negative year-on-year growth. In particular, after the non-recurring profit growth in the first two quarters, there was a negative growth in Q3 2024, indicating that the pharmaceutical sector is still in a stage of business cycle fluctuations. We believe that this difference further reflects the industry's stage of supply-side adjustments, with significant differences in performance among individual stocks, leading to significant discounts in the reliability of sector-wide data, and even increasing uncertainty in the answer to the question of whether there has been an improvement in the medical industry in Q3 2024.

Overall profitability of the medical and biological sector declined in Q3 2024. The gross margin of the medical and biological sector was 31.57%, a year-on-year decrease of 1.59%; the net margin was 7.17%, a year-on-year decrease of 1.26%. Analyzing the sequential gross margin, vaccines (+7.99%), hospitals (+2.41%), other biological products (+2.33%), other medical services (+2.11%), and medical research outsourcing (+0.71%) showed significant improvements, while medical devices (-3.49%), chemical agents (-3.27%), traditional Chinese medicine (-2.39%), diagnostic services (-1.98%), and blood products (-1.44%) saw more significant declines. Analyzing the sequential net margin, other biological products (+9.42%), other medical services (+2.82%), and hospitals (+2.31%) saw the most improvement, while medical devices (-7.26%), medical research outsourcing (-4.49%), and diagnostic services (-4.38%) experienced declines.

Expense ratio: The sales expense ratio decreased significantly. The overall sales expense ratio for the medical and biological sector in Q3 2024 was 12.75%, a year-on-year decrease of 0.76%; the management expense ratio was 5.48%, a year-on-year decrease of 0.02%; and the financial expense ratio was 0.92%, a year-on-year increase of 0.5%. By sector, in Q3 2024, traditional Chinese medicine, blood products, and chemical agents saw a significant decrease in the sales expense ratio.

Operational quality: Operational efficiency fluctuates, with more cautious capital expenditure.

Operational quality: Key factors leading to fluctuations and even slowdown in growth for some companies in Q3 2024. Within the context of supply-side structural adjustments and the combined macroeconomic and pharmaceutical policy impacts, changes in operational quality have been a focal point when introducing industry investment logic to investors. The third quarter report for 2024 shows that the operational efficiency of the pharmaceutical sector has continued the downward trend from before, especially in areas like traditional Chinese medicine, vaccines, pharmaceutical distribution, pharmacies, medical devices, and consumables, where this downward trend is particularly pronounced (analyzing days of accounts receivable turnover as an indicator).

Capital expenditure intensity: all sub-sectors are trending downward, reflecting changes in capital expenditure trends under the context of supply clearance as we mentioned.

Investment advice:

Trends: In the process of supply adjustment, the gradual manifestation of the driving effect of incremental innovation. We believe that the transition of old and new dynamics in the pharmaceutical industry will continue in the future. Innovative drugs, sectors with good structure or clearance (innovative drug supporting industry chain, large intravenous infusion, potent anesthetics, blood products, pharmaceutical distribution, traditional Chinese medicine OTC) may have better growth potential driven by slow recovery on the demand side; however, we also caution that under the influence of comprehensive medical reform policies, the possibility of some companies slowing down due to channel adjustments cannot be ruled out. This adjustment process, ignored by the market, leads to changes in operational efficiency and misjudgments on the company's growth expectations.

Implemented into specific investment recommendations:

Bullish on companies mainly focused on outpatient sales, with strong brand influence and high control over downstream channels, such as: dong-e-e-jiao, beijing tongrentang, yunnan baiyao group, henan lingrui pharmaceutical, china resources sanjiu.

Bullish on the continuous performance growth under the continuous expansion of CXO's new business, such as: wuxi apptec, tigermed, asymchem laboratories, pharmaron.

Bullish on science service targets that have improved profit margins and cash flow, such as shanghai titan scientific co.,ltd., nuodezan, haoyuan pharmaceutical, bide pharmaceutical.

Bullish on the valuation elasticity of innovative drug companies driven by policy support and continuous enhancement of international competitiveness, such as: dizhi medical, zhejing pharmaceutical, akeso, remegen, zhixiang-jintai, simcere pharma, fosun pharma.

Focus on the bottom of the active pharmaceutical ingredient industry different company growth elasticity, such as: zhejiang xianju pharmaceutical, apeloa pharmaceutical, nanjing king-friend biochemical pharmaceutical, aurisco pharmaceutical, national pharm.

Bullish on the continuous expansion of new business driving growth and profitability enhancement of trading targets, such as: sh pharma, jointown pharmaceutical group.

Risk warning:

Industry policy uncertainty risk; risk of product research and development failure; risk of ongoing trade friction.