Events:

Haixiang Pharmaceutical released its 2019 results report on August 20, 2019. In the first half of the year, the company realized operating income of 1.733 billion yuan, year-on-year + 26.84%, and homed net profit of 496 million yuan, + 79.73% compared with the same period last year. Of these, the second quarter realized operating income of 901 million yuan, year-on-year + 19.34%, month-on-month + 8.29%; return-to-home net profit of 294 million yuan, 27.27%, + 45.54%. The company expects third-quarter net profit of 1.74-254 million, year-on-year-16% quarter-on-quarter 22.7%, quarter-on-quarter-40.8% September 13.6%.

Overseas sales such as CMO, the pharmaceutical business, grew and profits exceeded expectations. The pharmaceutical sector realized operating income of 935 million yuan, + 36.35% year-on-year, gross profit margin of 37.94%, an increase of 8.02% over the same period last year, and a net profit of 191 million yuan, + 167.81% over the same period last year, far exceeding market expectations.

There are two main reasons for the increase in profits: 1) 4AA and other core intermediates are in short supply under the pressure of safety and environmental protection, resulting in a substantial price increase. 2) the number of pharmaceutical production enterprises has decreased significantly in the past two years, and the company is located in the High-quality Pharmaceutical Park (Taizhou, Zhejiang). The domestic and foreign orders have increased and the pricing power has been enhanced; especially the superior products such as Peinan and clindamycin series.

Dye plate price increase and new product launch combined, the performance is in line with expectations. The operating income of the dye sector was 798 million yuan, + 19.95% over the same period last year; the gross profit margin was 64.1%, an increase of 10.6% over the same period last year, and the net profit was 305 million yuan, + 48.97% over the same period last year.

There are two main reasons for the increase in profits: 1) after the "321" incident, the gross profit margin of products represented by brominated acid and KNR increased. 2) the company's newly expanded small varieties of dyes, such as reactive Blue 220,221, were gradually put into production, bringing profit growth.

Demand is expected to reverse in the third quarter, focusing on the Sino-US trade war and downstream inventories. Compared with previous years, the demand for dyes in June-August this year was extremely weak, and dye prices fell sharply, mainly for two reasons: 1) after the 321 incident, dye prices soared. Downstream dealers and manufacturers overdrawn the demand in the second and third quarters to a certain extent; 2) the trade war between China and the United States suppressed demand, the United States added tariffs to squeeze the profits of the downstream textile and clothing industry, and a large number of manufacturers stopped production, weakening the demand for dyes. And 1) and 2) under the joint action, dye prices fall, traders wait and see to stop buying, further reduce demand, forming a vicious circle.

But 1) and 2) are, after all, short-term factors, after a quarter of the downturn, downstream manufacturers and traders inventory is currently in a very low position; tariff issues to suppress demand in the short term, but in the long run clothing consumption is difficult to be long-term weak due to policy reasons; once the industry confidence is repaired, demand recovery superimposed low inventory, the dye industry is expected to usher in a market reversal, especially the upcoming September-October clothing season.

The company has high barriers, and the launch of new capacity in the fourth quarter is expected to increase new profit growth points. The high barrier of anthraquinone dyes lies in two points: first, it is difficult to examine and approve, the production of raw materials 1-aminoanthraquinone and brominic acid involves dangerous nitrification processes and produces a large amount of waste acid wastewater; second, the product process is complex, involving dozens of processes, and it is difficult to put into production, so Haixiang's dye plate has maintained a gross profit margin of about 60% since it was listed in 2014. With the gradual production of 15500 tons of anthraquinone reactive dyes and 18500 tons of anthraquinone disperse dyes in the fourth quarter, the company is expected to produce new profit growth points.

Main points of investment:

Medicine and dyestuff dual main industry development, strong profitability. The company's main business is divided into two parts: medicine and dye. The pharmaceutical sector is mainly engaged in the production and sales of characteristic intermediates, APIs and related preparations, as well as international pharmaceutical CDMO/CMO professional services. The products cover many fields such as anti-infection, cardiovascular, mental illness, metabolism and immunity. Dye plate is mainly engaged in the production and sales of environment-friendly reactive dyes, dye intermediates and pigment intermediates, and the products are mainly reactive brilliant blue KN-R dyes. In 2018, the company realized operating income of 2.719 billion yuan (yoy+17.74%) and net profit of 605 million yuan (yoy+76.79%) belonging to the parent company. Among them, the pharmaceutical sector realized operating income of 1.469 billion yuan (yoy+13.24%) and net profit of 199 million yuan (yoy+55.13%), while the dye sector realized sales income of 1.25 billion yuan (+ 23.51%) and net profit of 406 million yuan (yoy+89.82%).

Optimize the structure of pharmaceutical products and expand international customized cooperation business. The pharmaceutical business of Haixiang Pharmaceutical is mainly engaged in the production and sales of characteristic raw materials and preparations, as well as providing customized production and supporting R & D services for international pharmaceutical enterprises. The company maintains good cooperative relations with international well-known pharmaceutical companies and has cooperated with Pfizer Inc for more than ten years. It is the only strategic partner of German BII in China. The company's Peinan series, clindamycin series and florfenicol series have absolute advantages in scale, quality and technology in the market, and are in the leading position in the industry. In 2018, by strengthening internal management, reducing costs and increasing efficiency, the company continued to consolidate the market share of leading products such as clindamycin series and Pei Nan series, and the profitability of the pharmaceutical sector was stable.

The variety and output of dye products will be expanded, and there will be more room for growth in the future. Haixiang Pharmaceutical reactive brilliant Blue KN-R is in a leading position in the field of high-end reactive dyes, has an absolute say on its price, and its downstream customers are stable. At present, Taizhou Qianjin Phase I and Phase II reactive brilliant Blue KR-N have been put into production with a total production capacity of 15000 tons. Due to the strictness of environmental protection in 2018, the price increase performance of the company's dye products has expanded. In the future, the company will comply with the general trend of the upgrading of the dye industry, extending from a single anthraquinone series of reactive blue dyes to more than 10 reactive blue dyes such as methylene reactive blue and fluorinated reactive blue, as well as other color series reactive dyes and acid dyestuff products, helping to enhance the ability to cope with market risks, while expanding the company's competitive advantage in the field of high-end dye segments and market share.

Profit forecast and investment rating: give a "buy" rating. The company's pharmaceutical sector is developing rapidly, and the new production capacity of the dye plate is about to be put into production, which is expected to bring new profit growth points, but the downturn in dye demand in the second and third quarter affects product prices and shipments, so the company's profit forecast is lowered. It is estimated that the EPS for 2019-2020 will be 0.59,0.77 and 0.94 yuan, corresponding to PE12.04, 9.21 and 7.54 times. Considering that the profit is affected by short-term factors, the company's pharmaceutical and dye business has higher barriers and more room for growth in the long run, so it maintains a "buy" rating.

Risk tips: intensified competition in the pharmaceutical industry; resumption of production by competitors in the dye industry; lower-than-expected downstream demand, downward risks in dye prices; safety and environmental protection production risks; impact of RMB exchange rate fluctuations on the company's performance.