Incidents:

Red Sun Pharmaceutical released the first quarter report of 2023: in the first quarter of 2023, the company achieved revenue of 1,659 million yuan (-4.23% YoY), net profit of 175 million yuan (-26.35% compared to the same period last year), and net profit of 157 million yuan (-22.74% year-on-year) after deducting net profit of non-Gumo.

Investment highlights:

The revenue side of the first quarter was in line with expectations, and the profit side was slightly lower than expected. The company achieved revenue of 1,659 million yuan in 2023Q1 (-4.23% YoY), net profit of 175 million yuan (-26.35% YoY), and net profit of 157 million yuan (-22.74% year-on-year) after deducting net profit of non-return to the mother. We expect revenue from formula pellets to decline year-on-year in the first quarter, and that the revenue elasticity of oximeters and blood will benefit net from the pandemic is expected to be high. 1) There are not enough national standard varieties of formula pellets; 2) Since the national standard switch for formula pellets was in the early stages at the beginning of last year, we expect the company's 202Q1 formula pellet shipments to be relatively high, leaving pressure on formula granule performance in the first quarter and leading to a decline in overall profit.

We expect changes in the company's gross margin to be mainly affected by changes in product structure, and the decline in net interest rates is mainly due to short-term pressure on the formula pellet business. The company's sales/management expenses ratio for the first quarter of 2023 was 34.67%/6.65%, respectively, up 4.41/1.18 percentage points over the previous year. The company's gross margin in the first quarter was 57.07%, up 2.62 percentage points from the previous year, and the net interest rate was 10.78%, down 3.06 percentage points from the previous year.

We expect the performance of formula pellets to be highly elastic in the second half of the year. There are still restrictions on not having a complete variety of formula pellets, but newly developed medical terminals will contribute incrementally. Judging from the number of varieties, at the beginning of February 2023, the Pharmacopeia Commission announced that 48 new national standard varieties were officially issued. We expect that they will be put on sale as soon as the filing is completed. At the same time, as the number of national standard varieties increases and switches, we expect that the negative impact of provincial standard protection and enterprise standard sales in some regions will gradually be weakened, and benefits for leading enterprises will gradually become apparent.

Profit forecasts and investment ratings consider that the current slow progress in national standards for formula pellets affects normal sales. We adjusted the company's 2023-2025 EPS to 0.27/0.35/0.44 yuan, corresponding to the current stock price PE of 21.69/16.55/12.96 times. Due to an incomplete number of varieties, the amount of formula pellets prescribed has not returned to the same period in the short term. In the long run, health insurance supports the increase in provinces and the liberalization of sales terminals, promotes the expansion of the traditional Chinese medicine formula pellet industry, is optimistic about the long-term market space after the implementation of the national standard for formula granules, and maintains the “buy” rating.

Risks suggest that the switch to national standards for formula pellets fell short of expectations; the company's operations fell short of expectations; the epidemic affected business operations; competition intensified; macroeconomic development fell short of expectations; pharmaceutical policy risks, etc.