Key points of investment

The company disclosed the 2023 annual report and the 2024 quarterly report. Revenue for 2023 was $22.588 billion, up 13.6% year on year; net profit to mother was $1,412 million, up 11.9% year on year (after adjustment). 2024Q1's revenue was 5.971 billion yuan, up 13.4% year on year, and net profit to mother was 407 million yuan, up 20.9% year on year. 2024Q1 profits are growing at a high rate. We believe that as refined management continues, human rental efficiency increases due to scale effects, and amortization of equity incentive expenses decreases, high profit growth can be expected throughout 2024.

Growth: Continued growth in the number of stores is expected to drive long-term revenue growth (1) Continued store growth, which is expected to lead to long-term high revenue growth. In 2023, the company added 3169 stores (2,816 new in 2022), including 1,613 self-built stores, 559 mergers and acquisitions, and 1,024 franchise stores; by quarter, the number of new stores added in a single quarter in Q1-4 2023 was 661, 762, 817, and 929, respectively. 2024Q1 added 701 stores, and there was a clear trend of accelerated store growth. By the end of 2023, the total number of stores was 13,250 (including 2986 franchisees); as of 2024Q1 The total number of the company's stores is 13,920 (including 3157 franchisees), and the number of stores continues to grow rapidly. We believe that increasing industry concentration is still the core trend, and the increase in the number of stores is the core driver for future revenue and profit growth. As the company's store expansion accelerates, it is expected to lead to an increase in revenue and profit in 2024. (2) Accelerated implementation of coordination is expected to increase the outflow of prescriptions. By the end of 2023, the company had 675 hospital side stores and 305 pharmacies specializing in DTP, including 246 dual-channel medical insurance stores; more than 4,200 outpatient co-ordinated medical insurance pharmacies, connected with more than 10 provincial and municipal medical insurance and health prescription circulation platforms, and directly or indirectly undertook prescription circulation services for more than 100 tertiary hospitals and Internet hospitals. We believe that the acceleration of integrated implementation is expected to increase the outflow of prescriptions and drive the company's revenue growth.

Profitability: There may be a downward trend in gross margin, but net margin is expected to increase (1) gross margin or decline, but it is still expected to maintain a high level in the industry. In 2023, the company's gross profit margin was 38.21%, down 1.32pct year on year; 2024Q1's gross profit margin was 39.25%, down 0.41pct year on year, mainly due to the increase in the share of franchised stores and the increase in the share of proprietary Chinese and Western medicines, etc. We believe that the company's gross profit margin, especially that of Nakanishi Pharmaceutical, is at a high level in the industry, mainly due to the company's level of refined management. In the future, we believe that as the size of the company increases, upstream bargaining power and product structure adjustments, retail gross margin is still expected to maintain a high level of the industry. However, as the share of prescription drugs increases and the share of franchises increases, overall gross margin may be declining; (2) amortization of expenses such as equity incentives declined, and net interest rates may increase in 2024. The company's net interest rate in 2023 was 7.0%, down 0.18pct year on year; 2024Q1's net interest rate was 7.47%, up 0.26pct year on year. According to the company's 2022 equity incentive plan, the amortization of equity incentive expenses was 10.68/37.45/16.89/1.86 million yuan respectively. We believe that in 2024, with refined management and scale effects, the company's net interest rate is expected to increase in 2024.

Profit forecasting and valuation

Based on the above assumptions, we estimate that the company's total revenue for 2024-2026 will be 273.07/337.40/40.519 billion yuan respectively, up 20.89%, 23.56%, and 20.09% respectively; net profit to mother will be 17.47/21.84 billion yuan, up 23.73%, 25.02%, and 20.21% year-on-year respectively; the corresponding EPS will be 1.73/2.16/2.60 yuan, corresponding 25 times PE in 2024, maintaining the “gain” rating.

Risk warning

The risk of increased competition in the industry; the risk of policy changes; the risk of demand fluctuations.