In the context of functional skincare business adjustments, Huaxi Biotech's 2023 revenue recorded its first negative growth since launch (-4.5%), and the net profit margin fell to 9.8%, which is basically in line with the 2023 performance report. We are happy to see 1Q24 revenue and profit margins return to the growth channel, but we think there is still time to confirm the return of business conditions. We maintained Huaxi Biotech's “hold” rating and lowered the target price to RMB 58.5.
Functional skincare business adjustments have begun to bear fruit: In 2023, weak growth in functional skincare products prompted the company to take the initiative to make adjustments. The annual functional skincare business revenue fell 18.5% year on year, causing the company's revenue to drop 4.5% year on year. We believe that as we enter 1Q24, the effects of the company's business adjustments are beginning to show. 1Q24 single-quarter revenue returned to a positive growth channel after two quarters of negative growth, but the year-on-year growth rate (4.2%) was low at a low base. According to the “Improve Quality, Increase Efficiency, and Reward” special action plan announced by the company, we believe that in 2024, Huaxi Bioscience's skincare business will continue to grow, driven by focusing on large products, strengthening product characteristics, consolidating channel power, and deepening brand value.
The raw materials and medical terminal business is still highly resilient: despite pressure on the functional skincare business, the raw materials and medical terminal business still provided strong revenue support for the company. Revenue in 2023 increased 15.2% and 59.0% year over year, respectively, and the revenue share also increased 3.2 pct and 7.2 pct to 18.6% and 17.9%, respectively. Among them, pharmaceutical-grade raw materials with high gross profit in the raw materials business increased 19% year over year; driven by more than 200% increase in revenue from doll needles and moisturizer fillers, dermatological medical products in the medical terminal business increased 60.3% year on year.
Refined spending led to a recovery in profit margins: the 1Q24 sales expense ratio decreased 10.4 pct year over year to 36% (low since 1Q20). We believe that this is mainly due to (1) the adjustment of the functional skincare business line, which reduced the company's 1Q24 investment efforts according to the business pace, while the company paid more attention to the refined investment of expenses to improve marketing efficiency; (2) the sales expenses rate in the medical and aesthetic sector continued to decline. Although the increase in employees and equipment increased the 1Q24 management expense ratio by 1.9 pct year on year, it still drove the profit margin of core operations to a high level of 9.3 pct to a high level of 23% year over year. Looking ahead to 2024, although sales expenses for skincare products will increase with major marketing promotions, improvements in the company's cost management and improved resource utilization efficiency will drive the optimization of annual cost rates.
The performance trend is positive, but business recovery needs to be further clarified: although revenue and profit margins both rebounded in 1Q24, considering that 1Q24 only achieved a medium unit growth rate under a low base, we think it is too early to confirm that the business situation has returned. We believe that the adjustment of the effective skincare business has not yet been completed, and we look forward to the further release of the effects of the company's reforms to drive performance recovery.
Lower profit expectations and maintain the “hold” rating: Considering that the adjustment of Huaxi Bio-functional skincare products will take time to be fully achieved, we lowered our profit expectations, gave Huaxi Biotech 34x 2024E PE, lowered the target price to RMB 58.5, and maintained the “hold” rating.
Investment risks: Industry demand slows; online competition intensifies; sub-brand growth falls short of expectations.