According to zhongtai's research reports, statistics indicate that in Q3 2024, traditional chinese medicine companies had a total revenue of 260.8 billion yuan for the first three quarters, down 3.25% year-on-year; the net income excluding non-recurring items was 27.6 billion yuan, down 8.59% year-on-year; the operating cash flow was 19.43 billion yuan, down 17.59% year-on-year; the sector's gross margin for the first three quarters was 42.19%, down 2.51pp year-on-year; the net margin excluding non-recurring items was 10.59%, down 0.62pp year-on-year; the decline in gross margin is expected to be related to the decrease in centralized procurement prices and the increase in prices of upstream traditional chinese medicine materials. In terms of end demand, from July to September, the national retail pharmacy market has warmed up, showing growth for three consecutive months in both year-on-year and month-on-month comparisons, with a slight increase of 0.9% in September. For selected symbols, it is suggested to focus on stocks related to state-owned enterprise reform and those with improving operational trends and major products that bring performance elasticity.

Zhongtai Securities' main points are as follows:

Q3 performance is under temporary pressure, but the gross margin is expected to recover upwards starting from 2025.

According to statistics from zhongtai, excluding special treats and companies with abnormal performance fluctuations, the performance of 63 traditional chinese medicine companies in Q3 2024 shows: total revenue of 260.8 billion yuan for the first three quarters, down 3.25% year-on-year; net income excluding non-recurring items was 27.6 billion yuan, down 8.59% year-on-year; operating cash flow was 19.43 billion yuan, down 17.59% year-on-year. The sector's gross margin for the first three quarters is 42.19%, down 2.51pp year-on-year; net margin excluding non-recurring items is 10.59%, down 0.62pp year-on-year; the decline in gross margin is expected to be related to the decrease in centralized procurement prices and the increase in prices of upstream traditional chinese medicine materials. Since the beginning of 2024, the increase in traditional chinese medicine materials has slowed, especially since mid-year when prices have been relatively stable. Zhongtai forecasts that as the high stock price medicines that were stockpiled earlier are depleted, starting in 2025, the cost pressures on the traditional chinese medicine sector are expected to gradually ease, leading to an upward recovery in gross margin.

Operational quality is steadily improving, and the sales expense ratio continues to optimize.

In the first three quarters of 2024, the median expense ratio for the traditional chinese medicine sector was 44.4%, down 1.8pp compared to 2023; the median sales expense ratio was 31.9%, down 1.5pp compared to 2023. Against the backdrop of stringent industry regulations, many traditional chinese medicine companies are exploring new models in marketing and promotion, achieving significant optimization of the sales expense ratio. As of Q3 2024, the accounts receivable + notes receivable/total revenue and inventory/total assets ratios for the traditional chinese medicine sector were 32.8% and 13.0% respectively; while the proportion of accounts receivable in total revenue has increased slightly, it has dropped slightly compared to the first half of 2024, indicating a slight improvement in cash flow. The growth rate of contract liabilities + income turned negative from the first half of 2024, and the decline in Q3 2024 has narrowed, which may be related to the warming of end demand.

Terminal demand has slightly warmed up, awaiting the turning point in the industry.

According to Zhongkang data, from January to September 2024, the retail scale of physical pharmacies in china (pharmaceutical + non-pharmaceutical) was 384.8 billion yuan, a year-on-year decrease of 2.2%, which is expected to be due to multiple factors such as policy regulation, consumer downgrade, and changes in medication demand. Month by month, from July to September, the national retail pharmacy market has shown signs of recovery, with three consecutive months of year-on-year and month-on-month growth, where September saw a slight year-on-year increase of 0.9%. As the terminal pharmacy policies are digested, the impact of channel inventory on upstream traditional chinese medicine enterprises is expected to diminish, and it is anticipated that the income side of the traditional chinese medicine sector will warm up in 2025.

Investment suggestions: Looking ahead to 2025, after experiencing the cyclical fluctuations in demand and inventory in the post-COVID era, the traditional chinese medicine sector is expected to return to normalized growth, with the income side anticipating a recovery. Meanwhile, the relief from the cost pressure of traditional chinese medicine materials will also drive an upward repair of the gross margin.

Focus on the following two directions: 1) Stocks related to state-owned enterprise reform, which are expected to continue to gain strength in the concluding year of the 14th Five-Year Plan, with a bullish outlook on china resources sanjiu medical & pharmaceutical (000999.SZ) and dong-e-e-jiao (000423.SZ); also consider chongqing taiji industry (600129.SH), kpc pharmaceuticals, inc. (600422.SH), and beijing tongrentang (600085.SH); 2) Good operating trends and key varieties driving performance elasticity, with a bullish outlook on hunan fangsheng pharmaceutical (603998.SH) and zhejiang jolly pharmaceutical (300181.SZ).

Risk warnings: Risks related to fluctuations in raw material prices, risks from changes in pharmaceutical policies, risks from untimely updates of research reports, and risks of distorted third-party data.