Key points of investment

The drug discovery business grew steadily in 2023, and CDMO/CMO was under pressure in the short term. We are optimistic that the recovery of investment and financing and new technology will drive the CRO business and the release of overseas demand for Grillo's European and American patents to return to a rapid growth trend (the company expects prices to stabilize).

Performance: Revenue grew steadily in 2023, and inventory impairment caused short-term profit pressure. In 2023, the company achieved operating income of 490 million yuan (YOY 2.26%), net profit attributable to mother of 37.62 million yuan (YOY -44.0%), and net profit of 28.73 million yuan (YOY -54.14%) after deducting net income to mother. On a quarterly basis, 2023Q4 achieved operating income of 123 million yuan (YOY -16.52%), net profit to mother of 8.31 million yuan, and net profit of non-return to mother of 13.7 million yuan. The company's revenue continued to grow steadily, but the price of the Grello series products dropped sharply in 2023Q4, and the company planned to reduce inventory prices by 9.93 million yuan, causing the company to lose money in 2023Q4, which in turn dragged down the 2023 performance. 2024Q1 achieved operating income of 131 million yuan (YOY 7.69%), net profit attributable to mother of 3.67 million yuan (YOY -75.99%), and net profit of non-return to mother of 630,000 yuan (YOY -95.45%).

Business split: Drug discovery business is growing steadily, and prices are expected to increase steadily for gurello 1) CRO/CDMO: Drug discovery continues to be steady, and CDMO is under pressure. In 2023, the company's drug discovery business achieved revenue of 293 million yuan (YOY 6.73%), accounting for 59.87% of revenue (+2.5pct year over year). In 2023, the process research and development business achieved revenue of 77.87 million yuan (YOY -3.04%), accounting for 15.9% of revenue (-0.87pct year on year). Looking at project delivery, as of December 31, 2023, the company had delivered a total of 45 drug candidates to customers, of which 38 FIC projects accounted for 84.44%, an increase of 12 compared with 2022. In terms of active customers, the number of active CRO/CDMO customers increased from 135 in 2022 to 200 in 2023. Based on the company's strong R&D capabilities in the field of pioneering drug discovery, and the technology platform has been verified, we believe that it is sustainable for the company to obtain orders. We are also optimistic about the future diversion effects from drug discovery to CDMO/CMO, and continue to be optimistic about the order drive brought about by new technology platforms such as CAD/AIDD.

2) Commercial production: Price reduction for Grillo caused short-term disturbances, optimistic about demand release and new volume elasticity. In 2023, the company's commercial production achieved revenue of 109 million yuan (YOY -6.57%), accounting for 22.34% of revenue (-2.11pct year on year). Among them, Tigrello sales revenue accounted for 90.39% of commercial production revenue (-3.41 pct year over year).

As European and American patents extend the protection period for 2023Q4 products nearing expiration, market demand has increased dramatically while prices have declined sharply, causing inventory prices to drop by 9.93 million yuan, which has had a great impact on performance. The price of Tigrello: According to the company's 2023 annual report, the price of Tigrello series products has stabilized. Furthermore, according to the company's 2024 quarterly report, 2024Q1's asset impairment losses have recovered to 3.26 million yuan. Demand for Tigrello: With the end of the extended protection period for Grello's European and American patents in December 2024, we expect that there will be a high demand for Grello series products abroad. Based on the outlook for tigurelor prices and the company's ongoing development of new incremental API varieties, we believe that the company's commercial production business is expected to resume growth.

Profitability: Falling product prices and rising production capacity led to fluctuations in profitability. The gross margin of the company's main business in 2023 was 29.55% (-6.42pct year on year), of which the gross profit margin of the drug discovery business was 34.5% (-3.62 pct year on year), the gross profit margin of process research and development was 30.18% (-14.02 pct year on year), and the gross profit margin of commercial production was 15.83% (-9.46 pct year on year). Among them, the gross margin of process research and development and commercial production declined significantly. We believe that the decline in gross margin of process research and development is mainly related to the launch of new production capacity by the CDMO business subsidiary Hongbo Yishang, and the capacity utilization rate is still climbing. The decline in gross margin of commercial production is mainly due to the sharp price reduction of the core product Grylor. The net interest rate for 2023 was 7.68% (-6.35pct year on year), mainly due to a sharp drop in the price of Grello, taking into account preparations for a drop in inventory prices.

In terms of cost breakdown, the company's sales expense ratio in 2023 was 2.63% (-0.94 pct year on year), the R&D cost rate was 7.62% (+0.81 pct year over year. The increase in R&D cost rate also shows the company's determination to invest in new technology and expects new technology to fulfill order flow), the management fee rate is 12.39% (-2.65pct year on year), and the financial cost ratio is -0.12% (+1.42pct year on year).

Looking at the quarterly breakdown, 2024Q1's gross margin was 20.61% (-15.2pct year on year), and the net margin was 2.81% (-9.78pct year on year). In terms of cost breakdown, 2024Q1 has a sales expense ratio of 2.44% (YoY +0.32pct), R&D expenses ratio of 8.62% (YoY +0.25pct), management expenses ratio of 12.33% (YoY +1.36pct), and financial expenses ratio of 0.35% (YoY +0.15pct).

Outlook: The growth of the drug discovery business is certain, and I am optimistic about the recovery of the CMO business 1) Drug Discovery: The company continues to increase investment in R&D, and its technical strength establishes the sustainability of receiving orders. From 2021 to 2023, the compound growth rate of the company's R&D expenses was 46.68%, and the number of R&D personnel increased from 554 to 713. The CAD/AIDD platform, the company's core technology platform, has provided technical support for 62 new drug projects. Of these, 3 have entered clinical phase I, 2 are in the clinical declaration stage, and the number of customers serving the procurement company CAD/AIDD has reached 31. In 2024, the company will further increase investment in R&D to develop AI models for drug development. Considering that the company's technology platform has been validated and continued investment in R&D, we are optimistic about the growth and sustainability of the company's drug discovery orders.

2) CDMO: The company's drug discovery business is in synergy with the CDMO business. When providing drug discovery services, after determining candidate compounds, the company can provide customers with follow-up process development services to help customers accelerate drug research and development. We are optimistic about the diversion effect of the drug discovery business on the process research and development business, and expect diversion to be driven by the CDMO business.

3) CMO: We believe that the core product tegrello is expected to accelerate its release under the catalyst of the expiration of European and American patents, and the price of this variety has stabilized. Furthermore, the company is actively developing new varieties of APIs, which is expected to gradually contribute to incremental growth, thereby driving the CMO business back to rapid growth.

Profit forecasting and valuation

Considering the impact of the recovery trend in investment and financing in the pharmaceutical industry on the front-end business, and that the price drop for Grello exceeded expectations, we adjusted our profit forecast for 2024-2025. We expect the company's revenue for 2024-2026 to be 597/766.970 million yuan, EPS of 0.32/0.43/0.56 yuan, respectively (the previous forecast for 2024-2025 EPS was 0.92 and 1.23 yuan, respectively), and the closing price on May 7, 2024 is 112 times PE for 2024.

Considering the company's strong R&D capabilities in the field of pioneering drug discovery, the drug discovery business is expected to maintain steady growth. At the same time, the company's price of gurello has stabilized, and the expiration of the patent has catalyzed overseas demand, so it maintains an “increase” rating.

Risk warning

Risk of worsening investment and financing of innovative drugs, risk of exchange rate fluctuations, competition risk, geopolitical risk