Key points of investment

Growth: Self-development transformation and large-scale clinical business release support high growth. Looking at orders, the company signed new orders of 1,504 billion yuan in 2023, an increase of 36.50% over the previous year, and current orders of 2,566 billion yuan, an increase of 28.69% over the previous year. Looking at R&D investment, from 2017 to 2023, the company invested a total of 326 million yuan in R&D, while the 2023 R&D investment was 124 million, an increase of 38% over the previous year, and self-development project reserves were rich; in terms of sales expenses, the company's sales expenses rate in 2023 reached 4.7%, an increase of 1.7 pct over the previous year. We believe that changes on the cost side may also reflect that the company is experiencing a new window from project, technology, and capacity reserves to release.

Looking ahead, we believe that the company's abundant on-hand orders will drive the continuation of a high growth rate in the short term, and the release of new momentum in the innovative drug business, new technology platform layout, and equity sharing will further support long-term growth.

R & D technology achievement transformation business: New drug projects that have been deeply cultivated for many years, and the transformation of generic drug projects with high barriers to market demand may explode. Looking at the company's R&D investment of 124 million dollars in 2023, generic drug projects accounted for 74% of R&D investment, up 49% year on year, and investment in innovative drug R&D increased 15% year on year. In 2023, the company established more than 100 new self-research projects (over 350 in total). Specifically, in terms of innovative drug projects, the 2023 report revealed a total of 10 new drug products under development, accounting for more than 60% of the current R&D investment. Among them, STC007 has begun phase 2 clinical trials for the analgesic indications of the Class 1 drug, phase 1 clinical trials for pruritus symptoms, and most of the new peptide drugs and improved new drug projects have also advanced to the critical pre-clinical stage; in terms of generic drug projects, we found that among the 28 self-developed project details disclosed in the company's annual report, there are 7 types of drugs that are expected to invest over 10 million in R&D and Class 4 and 3 drugs that are difficult to imitate Species. Referring to the NHKC-1 transformation case of the Class 2 new drug and the transformation of generic drug projects in the company's history, we believe that the abundance, scarcity, and R&D progress of the company's current reserve projects can support it to enter a new phase of rapid release in 2024. The capacity has been verified, and the deepening of cooperation and front-end diversion support continues to increase. In 2023, the company's clinical business achieved revenue of 362 million yuan, an increase of 54.54% over the previous year. At the same time, the number of personnel in the clinical trial and bioanalysis division of the company was 368, an increase of 26.46% over the previous year. We believe that with the verification of the execution efficiency of major clinical projects undertaken by the company in the early stages, the company has accumulated a wealth of on-hand orders through rapid expansion of teams and indications and undertaking a large number of clinical projects in emerging fields based on customer structures. We believe that with ongoing projects gradually progressing to the post-clinical stage, the deepening of cooperation with existing pharmaceutical company customers, and the continuous development of incremental customers after competency verification, the external demand for large clinical businesses may be booming; in addition, we believe that the company's front-end R&D projects and the transformation of Class 3 and Class 2 drugs from self-developed reserves may be concentrated to the clinical stage, and the demand for verifiable clinical trials directed by the front-end pharmaceutical research business may become a new support for continuous growth.

New changes in the technical platform layout: Obtaining a Japanese patent for transdermal patch technology, and adding R&D platforms for traditional Chinese medicine and pet medicine. In 2023, the company obtained patent authorizations for two transdermal patches from Japan's KNK, further enhancing the company's technical capabilities in patch products such as gel stickers and hot melt stickers. Furthermore, in 2023, the company built the Novo Shengxin Traditional Chinese Medicine Development Platform and established the pet medicine division Novo Ruipong to continue expanding the boundaries of differentiated service capabilities.

Profitability: Efficiency advantages continue to be reflected. We are optimistic that new business releases will support high profitability. In 2023, the company's gross margin was 56.68%, up 1.19 pcts year on year, and the gross margin of 2024Q1 was 59.58%, up 10.29 pcts year on year. Looking at the breakdown, the company's gross margin of pharmaceutical research in 2023 was 67.41%, up 0.68pct year on year, and the gross profit margin of clinical business was 39.72%, up 5.44pct year on year. Although the company undertakes projects or faces price pressure due to industry competition, the company's gross margin trend performance in the first quarter of 2023 and 2024 also reflects the continuous reflection of its generic drug development efficiency advantages and cost scale advantages. Looking ahead, the company is expected to support the continuation of high gross margins through the transformation of self-developed new drugs and the gradual release of equity shares. In terms of cost rates, we expect that as the company enters a new window of new business expansion and release, the sales expense ratio and R&D expense ratio may continue to remain high, while the management cost ratio may be further optimized.

Quality of operation: Under pressure in the short term, optimistic about the gradual optimization of trends

In 2023, the company achieved net operating cash flow of 93 million yuan, a slight decrease over the previous year, and achieved net operating cash flow of 06 million yuan in the first quarter of 2024, an improvement over the previous year. In terms of account period, the company's accounts receivable turnover in 2023 reached about 96 days, reaching 113 days in the first quarter, which is a significant increase over the previous year. We expect it to be mainly related to factors such as large customers, more integrated, multi-project and large-package orders, and changes in the pace of repayment. In addition, the company's bad debt accrual increased a lot in 2023, mainly related to individual bad debt accruals for Hunan Hang Seng Pharmaceutical and Beijing Beilu Pharmaceutical. The remaining combined accounts receivable accrual ratio remained around 9%-10%, with no significant change. As of 2023, the number of cooperative customers of the company has reached 800. We believe that the number of downstream traditional pharmaceutical companies is abundant and that pharmaceutical companies have relatively sufficient capital. As the bonds between the company and high-quality customers continue to deepen, we expect that the company's accounts and net operating cash flow may be gradually being optimized.

Profit forecasting and valuation

We expect the company's revenue in 2024-2026 to be 1,268/17.17/2,261 billion yuan, with year-on-year growth rates of 36.05%/35.38%/31.69%, respectively; net profit to mother of 249/334/435 million, respectively, with year-on-year growth rates of 34.84%/33.93%/30.25%, respectively. The closing price on May 7, 2024 was 26 times PE in 2024, maintaining the “Overweight” rating.

Risk warning

Risk of domestic policy fluctuations; increased risk of market competition; risk of failure of independent R&D projects