Dongyang Guangyao's third-quarter results were significantly lower than expected.

We reiterate our cautious view of the company for the following reasons: 1) the competitive situation has deteriorated and the growth outlook of Kewei has deteriorated; 2) there are no significant catalysts in the future.

We lowered our earnings per share forecast for 2020-21-22 by 64.7% / 38.5% / 18.2% to reflect: 1) weak results in the first three quarters; 2) we lowered our forecast for Kewei. We have lowered our target price from HK $10.24 (6 times 2021 P / E) to HK $8.13 (6 x 2021 P / E, assuming RMB appreciation). Maintain the "hold" rating.

The results in the first three quarters are much lower than the market consensus forecast.

Revenue in the first three quarters was 2.17 billion yuan, down 51 per cent from a year earlier. Net profit was 510.4 million yuan, down 61.3% from the same period last year.

Excluding the impact of convertible bonds, net profit in the first three quarters was 547.6 million yuan, down 64.8 per cent from a year earlier. Net profit in the first three quarters accounts for only about 34% of our / market consensus forecast for 2020, which means it is significantly lower than expected.

In the third quarter alone, revenue was only 88 million yuan, down 93.5% from the same period last year, compared with 1.37 billion yuan in the third quarter of 2019. We think this is mainly due to Kewei's channel inventory; in fact, wearing masks has greatly reduced the spread of influenza. In the third quarter of 2020, Dongyang Guangyao recorded a net loss of 107 million yuan (including the impact of convertible bonds) and a net loss of 147 million yuan (excluding the impact of convertible bonds).

Still cautious about the upcoming traditional peak season

Although the fourth quarter of 2020 and the first quarter of 2021 are the traditional peak seasons, our view is still more pessimistic. Our main concerns are: 1) Channel inventory may still take some time to digest in the fourth quarter; 2) people are increasingly aware of the importance of wearing masks, which will have an impact on Kewei this winter.

The risk of carrying volume purchase of Kewei capsule increases

With the increasing number of registered oseltamivir bioequivalence trials (Zhongrun Pharmaceutical, Wanhan Pharmaceutical, Yangzijiang Pharmaceutical, Qilu Pharmaceutical, Shenzhen Beimei Pharmaceutical, etc.), the risks associated with volume procurement of Kewei have greatly increased. We believe that as Kewei capsules are included in volume procurement, Kewei granules will also be subject to price pressure. Taking into account this risk, we assume in the model that Kewei capsules and Kewei granules will have a revenue decline of 20% and 5% in 2022.

The future catalyst is limited.

We believe that the company does not have significant catalysts or new products in the foreseeable future: 1) We do not think that the company's second-generation insulin and third-generation insulin (expected to be launched in 2021) will drive revaluation, because the domestic insulin market is already very competitive, so we expect insulin's revenue contribution to be very limited in the next year or two. 2) We believe that the size of the HCV market is limited, which will limit the value of the company's HCV business; 3) We expect that the 33 imitation pharmaceuticals acquired by the company will face price reduction pressure due to volume purchases and will be affected by increased competition.