Key points of investment

The company's production and delivery in 2022 were disrupted by the epidemic, but the application boom of PEG derivatives in fields such as precise release and optimization of efficacy in pharmaceuticals continues, and the release of production capacity in 2023 is expected to be the starting point for the accelerated growth of the company's product sales business. We believe that the company, as a typical representative of the pharmaceutical hard technology and innovation supply chain, is expected to continue to benefit from iterations in the pharmaceutical innovation cycle and promote PEG material manufacturing globally.

Financial performance: Under the turmoil of the epidemic, short-term quarterly growth is under pressure

The company announced its 2022 annual report, with revenue of 407 million yuan for 2022, an increase of 16%; net profit of 187 million yuan, an increase of 6.3% over the previous year; net profit of Fumo was 178 million yuan, an increase of 13.1% over the previous year; and Guimu's net interest rate was 45.9%, down 4.2 pct from the previous year. Looking at a single quarter, 2022Q4's revenue was 86 million yuan, a year-on-year decrease of 3.5%; Guimu's net profit was 22 million yuan, a year-on-year decrease of 35.2%. We believe the growth rate of the company's net profit to the mother in 2022 was lower than our previous expectations.

Growth capacity: The release of production capacity is expected to be the starting point for accelerating product sales business ① Looking at each business sector, revenue from technical services increased dramatically, partly hedging the disturbances in growth such as delivery and commissioning. According to the company's annual report, product sales revenue in 2022 accounted for 79.7%, up 6.7% year on year. Its domestic product sales in China increased 14.9%, foreign product sales increased 1.4% year on year. Excluding the influence of LNP products, foreign product sales increased 15.3% year on year (LNP products fell 42.1% year on year); technology usage fee revenue accounted for 20.1%, up 75.8% year on year. “The increase in technology usage fee revenue mainly comes from a commission from sales revenue of Terbo biopolyethylene glycol interferon alpha-2b injection”. Looking specifically at various business segments, we believe that the company's revenue growth in 2022 is mainly due to: (1) the increase in sales share revenue brought about by the continuous increase in revenue of Tepo Biotech Pegbin's revenue (according to the Terbo Biotech Annual Report, 2022 Pegbin's revenue was 1.16 billion yuan, an increase of 50.7% over the previous year); (2) Product sales growth from other domestic customers (according to Changchun Hi-Tech's investor exchange record table on March 30, 2023, “In terms of revenue, revenue growth from long-term products increased by about 60%”, “The subsidiary Jinsai Pharmaceutical's overall growth hormone product revenue growth increased by about 60%”, “the subsidiary Jinsai Pharmaceutical's overall growth hormone product revenue growth increased by about 60%.” More than 25%, of which powder needles account for about 10% and water needles account for about 66%; the proportion of long-acting water needles increased from 18% last year to about 23%”, it is estimated that Changchun Hi-Tech's long-term water needle revenue in 2022 was about 2.35 billion yuan. Assuming that PEG costs accounted for 3-3.5% of revenue, the company's revenue from Changchun Hi-Tech was about 70-83 million yuan, corresponding to the revenue volume of the second largest customer); (3) Clinical promotion of overseas service projects led to an increase in sales volume.

Looking ahead to 2023-2025, we expect the growth to come from: (1) Terbo Biotech related: We believe that the expiration of Terbo Biotech's sales share contract may lead to a decline in the company's technology usage fee revenue, but the continued rapid increase in Pegbin's sales revenue is expected to drive a significant increase in the company's product sales revenue, partly hedging the negative effects of contract expiration. (2) Expansion of foreign projects: The official listing and NDA of service projects serving foreign countries is expected to drive a significant increase in sales volume (according to the “Investor Exchange Record Form” announced by the company on February 27, 2023, “there are currently 3 phase III trials overseas (2 have completed phase 3, 1 is nearing completion), 7 phase 2 clinical trials (Sanofi's project has returned from phase II clinical trials to phase 1)”. Looking at the pace, we expect that out of the three clinical phase III projects, 1 will be officially approved for listing in the US by the end of 2023 (which may bring stock demand for 2023H2), 1 long-acting anti-cancer drug will be officially NDA in 2023H1 and is expected to be approved in 2024H1, and 1 project that is nearing the end of phase III clinical trials is expected to be officially NDA in 2023H2 and is expected to be approved in 2024-2025). (3) Other projects:

Other domestic customers and overseas device gel projects have increased (mainly due to downstream demand growth of 10% +, and the gradual absorption of factors such as terminal delivery and demand recovery). (4) LNP related: Considering that global demand for COVID-19 vaccines is relatively low, we expect LNP-related revenue to continue to decline in 2023. Under clinical applications at home and abroad, we expect this product to still have a certain amount of sales. We assume that the product will grow slightly and be basically stable from 2024. (5) Research project cooperation: According to the company announcement, the company's polyethylene glycol irinotecan small cell lung cancer indications were approved by CDE for phase III clinical trials in January 2023, and the product's glioma indications were officially enrolled in November 2022. We are optimistic about the progress of cooperation between the company's innovative drugs and medical and aesthetic pipelines, and its contribution to the company's revenue and profit growth in 2023-2025. We believe that PEG is still a highly promising innovative drug modification consumable. The global COVID-19 pandemic in 2022 affected investment and financing and early development needs for innovative drugs. We expect that the number of PEG applications in the fields of small nucleic acids, ADCs, peptides, cytokines, etc. is expected to increase significantly and clinical progress will continue. We continue to be optimistic about the growth potential of the company's PEG pharmaceuticals and device-related projects as global innovative application scenarios expand.

② The release of production capacity is expected to be the starting point for the accelerated growth of the company's product sales business. (1) Judging from changes in operating efficiency, capacity utilization is an important limiting factor. 2022 was the year in which fixed asset turnover declined for the first time since 2016 (fixed asset turnover in 2022 was 2.98, 2021 was 3.23; if revenue from product sales was divided only by the fixed asset average, then the adjusted fixed asset turnover ratio in 2022 was 2.38 and 2021 was 2.79). Analyzing changes in operating efficiency, judging from the project structure and project unit price, we calculated the unit sales price of polyethylene glycol derivatives in 2022 and 2021 based on the product sales revenue and polyethylene glycol derivative sales volume disclosed in the annual report. The unit sales price of polyethylene glycol derivatives remained basically unchanged in 2022 and 2021 (230,000 yuan/kg in 2022 and 232,000 yuan/kg in 2021). Judging from the order situation, according to the company's 2022 mid-year report, “the revenue amount corresponding to the performance obligations signed but not yet fulfilled or not yet fulfilled at the end of the reporting period was 278,498,132.97 yuan”, that is, the order in hand to be delivered in the second half of 2022 was about 278 million yuan; according to the company's 2022 annual report, “the revenue amount corresponding to the performance obligations signed at the end of the reporting period but not yet fulfilled or not yet fulfilled is 193,858,592.06 yuan”, that is, the order in hand to be delivered at the end of 2022 194 million yuan; considering the company's revenue for the second half of 2022 is about 215 million yuan, and considering that the company will also sign new orders in the second half of 2022 and deliver them directly in the second half of 2022, we don't think the orders in hand in mid-2022 were fully delivered by the end of 2022. In summary, we believe that the decline in the company's fixed asset operating efficiency in 2022 was not due to changes in the project structure and the decline in orders, but may be due more to capacity utilization constraints. We believe that in 2022, this factor may be related to factors such as logistics and commissioning under special domestic circumstances. (2) The biggest marginal change in 2023 is that after Panjin's production capacity was released, production capacity no longer became a constraint on the company's project growth and delivery. According to the company's annual report, the project under construction was 254 million yuan at the end of 2022. Looking at the detailed items, the “Medicinal Polyethylene Glycol and Derivatives Industrialization and Application Achievement Transformation Project” was completed 57.6%, and the “Pre-filled Injectable Product Filling Workshop Project” was completed 91.7%. It is expected that Panjin will continue to undertake non-GMP and GMP production capacity projects in Tianjin after the completion and commissioning of production capacity in Q2 2023. We believe that the release of production capacity and the subsequent commercialization of overseas projects have led to an increase in product sales volume. 2023H2 is expected to become an inflection point in the company's product sales growth. In 2024, as the share of revenue from overseas projects increases and the revenue disturbance base related to LNP falls, we believe that revenue from the product sales business is expected to continue to grow rapidly.

Profitability: Gross margin is expected to decline, net profit margin is basically stable. In 2022, the company's net interest rate to the parent fell 4.2 pct year on year, net interest rate of non-return to the parent fell 1.1 pct year on year. Among them, the gross margin fell 0.4 pct year on year, the sales expense ratio decreased 0.9 pct year on year, the management expense ratio increased 0.2 pct year on year, and the R&D expense ratio increased 3.6 pct year on year. The difference between non-recurring profit and loss in 2022 and 2021 mainly comes from the difference in profit and loss between financial assets and liabilities outside the hedging business. We think net profit margin is better after deducting non-homing net profit margins. It reflects changes in the company's operations. Looking ahead to changes in profitability from 2023-2025, we anticipate:

① Looking at gross margin, the gross margin of the domestic product sales business is stable. As the process of foreign projects stabilizes and sales volume increases, the gross margin of foreign projects is expected to increase, and the gross margin of the product sales business is expected to increase; however, in terms of revenue, we expect the share of technical service revenue to decline in 2023-2025 (the gross margin of this business is between 99-100%), leading to a decline in gross margin in 2023-2025. ② Looking at net interest rates, we expect management expenses related to equity incentives to decline year by year, leading to a decrease in the management expense ratio; we assume that the R&D expenses ratio is 17-19%, resulting in a comprehensive profit margin of around 47-47.5%.

Changes in cash flow: Cash flow is also growing rapidly. It is expected that future capital expenditure intensity will decline. According to the company's annual report, cash received by the company from sales of goods and labor services increased 33.1% year-on-year in 2022, and net cash flow from operating activities increased 57.2% year-on-year. The growth rate was significantly higher than the growth rate of revenue and net profit. Judging from supplementary data, the improvement in cash flow came partly from the impact of operating receivables. From the perspective of capital expenditure, cash payments for the purchase and construction of fixed assets, intangible assets and other long-term assets in 2022 were 210 million yuan, a significant increase over the previous year. We expect that in 2023, as domestic downstream pharmaceutical demand recovers and clinical progress in overseas projects progresses, the company's cash flow repayments are expected to continue to improve, driving cash flow growth; with the release of production capacity in Panjin, we expect the intensity of the company's capital expenditure to decline.

Profit forecasting and valuation

Based on the analysis of the company's core business segments, we expect the company's EPS for 2023-2025 to be 4.05, 5.07, and 6.1 yuan/share respectively (the previous values were 4.16, 5.15, and 6.52 yuan/share, respectively. The reduction comes from the adjustment of the assumption that some domestic customer technology service share revenue will fall after the annual report). The net profit CAGR from 2022-2025 is expected to reach 25.3%, and the cooperation and sharing of our own pipelines is expected to constitute additional profits and market value increases (2023 is expected to be the starting point for monetizing self-developed innovation pipelines) , maintaining the “buy” rating.

Risk warning

Risk of raw material self-supply/order transfer for core customers; risk of excessive R&D investment or clinical failure in core projects; risk of order delivery volatility; production safety accidents and quality risks; risk of exchange rate fluctuations.