Key points of investment

Heavy Pharmaceutical Holdings: Fast-moving from the west to a leading pharmaceutical distribution leader in the country, which is expected to benefit from state-owned enterprise reform

In the context of deepening medical reform, the concentration of the pharmaceutical distribution industry is increasing at an accelerated pace. Under the current industry integration window, distribution companies are in a critical period for card positions. As a distribution leader in the southwest region, Heavy Pharmaceutical Holdings has an important strategic position. The company has developed rapidly since 2017, with revenue CAGR of 27% in 2018-2022, which is far higher than the growth rate of the pharmaceutical distribution industry. It has achieved rapid growth from being based in Chongqing, to the head of the western region, to a national pharmaceutical distribution service provider.

Financing capacity is the key to scale up, and the company is expected to benefit from national reform. Based on the pharmaceutical distribution business model, we believe that financing capacity and capital costs may be the core barriers to the company's rapid development. In the past, the company provided prerequisites for rapid development through diversified financing methods, but it also brought high financial costs. On February 5, 2024, Heavy Pharmaceutical Holdings issued an “indicative notice on planning changes in actual controllers”. China General Technology Group is carrying out strategic integration matters with Chongqing Chemical Medical Holdings (Group), the company's indirect controlling shareholder, Chongqing Pharmaceutical and Health Industry Company. We believe that if the integration is completed, Heavy Pharmaceutical Holdings may transform from a local state-owned enterprise to a central enterprise, which may greatly optimize the company's balance and liability structure and refinancing channels and costs. We believe that at present, the company is still in a critical period of rapid breakthroughs and national development. Its own business has great potential for growth and room for optimization, and potential positive external changes may provide a strong foundation for the company's long-term rapid development.

Wholesale: Large space for regional expansion, strong commercial momentum

Regional expansion: ① The strategic goal of “300 cities” continues to advance: the company takes the lead in the southwest region and has gradually begun new regional expansion in the central and eastern parts of the country. The company proposed a target revenue of 100 billion dollars in the “14th Five-Year Plan” to cover the strategic goal of “300 cities”. ② In rapid expansion, complete warehousing and logistics facilities, information systems and high human efficiency are strong basic guarantees. In terms of capital expenditure intensity and direction, we found that the company has high standard logistics distribution facilities and information systems. At the same time, the higher per capita income generation reflects the company's strong management capabilities and provides a prerequisite for subsequent efficient expansion. ③ Historical diversified financing costs are high, there is plenty of room for optimization, and sufficient resources for rapid expansion after the actual controller is changed. The ability to finance is one of the core supports the growth of commercial companies. Heavy Pharmaceuticals Holdings has historically had flexible financing methods, providing a solid foundation for the company's rapid regional expansion in the past. In the future, changes in the company's actual controller are expected to complete the transformation of the company's attributes from a local state-owned enterprise to a central enterprise, leading to a significant increase in financing capacity, a marked decrease in financing costs, and providing financial guarantees for rapid expansion.

Equipment: The concentration of equipment distribution has accelerated, or has become the main driving force for the company's performance growth. In 2023, the company's equipment sector achieved revenue of 12.478 billion yuan, an increase of 31.16% over the previous year. The concentration of device distribution is far lower than that of pharmaceuticals. There is plenty of room for concentration improvement, and profitability is strong. Through the establishment of its own subsidiaries and epitaxial mergers and acquisitions, Chongpharmaceutical has consolidated its leading position in the device distribution business in Chongqing, Anhui, Hunan, etc., and has a good foundation for cooperation. We believe that with the gradual deepening of collection, the trend or acceleration of equipment distribution towards the top will be the main driving force for the company's growth.

Distribution of anesthetic essence: Excellent pattern, high growth supported by recovery of surgical volume and increased penetration rate. Heavy Pharmaceutical Holdings is the second-largest wholesaler of cannabis essence in the country (only three in China). The hemp extract sector has an excellent pattern and a strong strategic position. We expect that in 2024-2026, the company's narcotics wholesale will become another driving force for the company's growth due to the recovery in hospital surgery volume and the continuous expansion of cooperation with regional wholesalers.

Retail: Focus on DTP pharmacies and online channel expansion. Optimistic about Out-of-hospital Growth Curve The company's retail business is mainly divided into community pharmacies and DTP prescription pharmacy businesses. As of 2023, the total number of the company's retail stores was 1,034 (yoy +28.28%), including 159 DTP prescription pharmacies (147 directly managed, 12 franchised) and 875 community pharmacies (818 directly managed, 57 franchised). Based on the company's resource advantages upstream and downstream of the industry, the wholesale and zero integration strategy continues to advance, and the number of DTP prescription pharmacy stores and the revenue generated by a single store have greatly increased. At the same time, online platforms gradually realized, and 23H1 increased by about 76% year over year. We believe that with the planning of diagnosis and treatment behavior and the trend of prescription outflow accelerates, there is still plenty of room for improvement in the number of DTP pharmacies opened and the ability of a single store to generate revenue, which is expected to become a new growth curve for the company.

Profit forecasting and valuation

Based on the above analysis, we believe that Heavy Pharmaceutical Holdings is a pharmaceutical distribution company that is expected to accelerate the expansion of the national market under the impetus of state-owned enterprise reforms. We expect the company's revenue for 2024-2026 to be 913.18/1040.27/117.714 billion yuan, respectively, with a year-on-year growth rate of 13.98%/13.92%/13.16%; the net profit for 2024-2026 is expected to be 776/9.52/ 11.30 billion yuan, respectively, with year-on-year growth rates of 18.47%/22.67%/18.73%, respectively. The closing price on May 7, 2024 corresponds to 12 times PE in 2024, giving a “gain” rating for the first time.

Risk warning

The risk of short-term fluctuations in upstream and downstream operations due to the accelerated liquidation of the industry; the risk of innovative distribution business development falling short of expectations; financial leverage and financing risks.