Core views

On April 29, the company released its 2023 annual results report, which achieved operating income of 22.437 billion yuan, a year-on-year increase of 11.21%, achieved net profit of 929 million yuan, an increase of 18.35% over the previous year, achieved net profit of 844 million yuan without return to mother, an increase of 14.68% over the previous year, and achieved basic earnings of 1.59 yuan per share. The performance was in line with our expectations. Looking ahead to 2024, the size of the company's stores will continue to increase, outpatient coordination will steadily promote the outflow of prescriptions, and the company will continue to adjust the product system to increase gross profit margin, and we expect the company's performance potential to be steadily unleashed.

occurrences

The company released its 2023 annual report and 2024 quarterly report. The performance is in line with our expectations. On April 29, the company released the 2023 annual report and the 2024 quarterly report. In 2023, the company achieved operating income, net profit attributable to mother and net profit after deduction of RMB 22.437 billion, RMB 929 million and RMB 844 million respectively, up 11.21%, 18.35% and 14.68% year-on-year respectively. The first quarter of '24 achieved operating income, net profit attributable to mother, and net profit after deducting non-return to mother of $5,539 million, $321 million, and $311 million respectively, up 1.81%, 10.27% and 10.35% year-on-year respectively. The results were in line with our expectations.

Ordinary people plan to distribute cash dividends of RMB 6.6 (tax included) to all shareholders for every 10 shares based on the share capital on the share registration date of the 2023 profit distribution plan.

Brief review

Steady growth in performance and continuous improvement in profitability

In 2023, the company's revenue increased 11.21% year-on-year, mainly due to: 1) the company's store scale continued to expand, adding 3,388 new stores throughout the year, including 1,471 self-built stores, 331 mergers and acquisitions, and 1,586 franchises; 2) retail revenue grew steadily by 9.96% on a high base basis to 19.349 billion yuan, and the franchise, alliance and distribution business increased 19.62% to 2,931 billion yuan. Net profit to mother increased 18.35% year on year, and net profit without return to mother increased 14.68% year on year, faster than revenue growth, mainly due to the 18.19% increase in sales of high-margin Chinese medicines, which led to an increase in the gross margin of the retail business.

In the first quarter of 2024, the company achieved revenue of 5,539 billion yuan, up 1.81% year on year, and the growth rate slowed, mainly due to: 1) the number of stores purchased in the first quarter decreased, to only 6, with little external contribution, but the number of self-built stores remained high at 351; 2) 107 stores were adjusted and closed in the first quarter; 3) the revenue base for the same period last year was high. In 24Q1, the company's net profit to mother increased 10.27% year on year, and net profit after deduction increased 10.35% year on year, faster than revenue growth. Mainly due to the company actively promoting the implementation of the torch project, transforming the commercial procurement system and key business processes, and making efforts to increase the gross profit margin throughout the sales and marketing process, the company's gross margin increased 2.2 percentage points to 35.2% in the first quarter.

The scale of stores is expanding steadily, and the advantages of core regional scale gradually reflect the steady expansion of store size, and the profitability of core regions may increase. In 2023, the company thoroughly implemented the “9+7” expansion strategy and adopted the “four-wheel” three-dimensional expansion model of self-construction, mergers and acquisitions, alliances and alliances to accelerate the expansion of the sinking market. Throughout 2023, the company added 3,388 stores, including 1,471 self-built stores, 331 mergers and acquisitions, and 1,586 franchise stores. In the first quarter of 2024, the company maintained a fast pace of store expansion, adding 642 new stores, including 351 self-built stores, 6 acquisitions, and 285 franchisees. By the end of March '24, the number of company stores reached 14,109, including 9470 directly-managed stores and 4,639 franchise stores, covering 18 provincial markets and more than 150 local levels. city. We believe that the company may continue to maintain a faster growth rate, regional advantages may become more obvious, and profitability is expected to increase.

Focus on the sinking market, and there is plenty of room for expansion. By the end of 2023, the company had 11 provinces with the top three market share, including 4 provinces with the highest market share, with 76% of stores in prefecture-level cities and below. Of the new stores added in 2023, 2,913 new stores were added in dominant provinces and key cities, accounting for 86%, and the proportion of stores in prefecture-level cities and below was 78%. In the first quarter of 2024, the company continued to deeply cultivate the sinking market. As of March 31, 2024, the company's stores in prefecture-level cities and below accounted for 76%; of the company's new stores in the first quarter of 2024, dominant provinces and key cities accounted for 85%, and stores in prefecture-level cities and below accounted for 77%. We believe that the sinking market has a high aging population, strong demand for drugs for chronic diseases, and that stores in the sinking market have advantages such as low rent and low labor costs, and that their overall profitability is not weak compared to the provincial capital-level market, and there is relatively plenty of room for future expansion.

Specialized services enhance customer stickiness, and the Torch Project optimizes overall gross margin, strengthens specialized store construction, and continuously enhances store customer flow. In 2023 and the first quarter of 2024, the company continued to strengthen the specialized capacity building of stores. By the end of the first quarter of 2024, the company had 1,595 stores with designated qualifications for “outpatient chronic diseases”, 325 dual-channel stores, 176 DTP stores, and the number of outpatient co-ordinated stores reached 4,673, of which directly managed stores accounted for 39.78%, of which 3,338 stores were interoperable. In addition, the company continues to pay attention to services for patients with chronic diseases. By the end of the first quarter, the company's chronic disease management services had registered more than 14 million people, and the advantages of professional services were obvious. We believe that the company's co-ordinated stores account for a relatively high proportion at this stage. As the outflow of prescriptions continues to advance, enterprises with strong specialized advantages may prioritize attracting and consolidating incremental customer traffic, and their growth potential will continue to increase.

The Torch Project optimizes the gross profit structure, and its own brand continues to contribute. In the first quarter of 2024, the company implemented the torch project to transform the commercial procurement system and key business processes, optimize the product system in multiple dimensions, such as front-end product selection, post-evaluation and elimination, intelligent requisitioning, optimize marketing incentives, and increase the share of unified procurement, and increase the gross profit margin. In the first quarter of 2024, the company's comprehensive gross profit margin was 35.2%, up 2.2 percentage points from the previous year, and consolidated sales accounted for 69.5%, up 1.4 percentage points from the same period last year. In addition, the company's own brands focus on product advantages and enhance product competitiveness. In the first quarter, sales of its own brand stores reached 830 million yuan, accounting for 20.8% of sales, an increase of 1.3 percentage points over the same period last year. We believe that in the context of the steady increase in the size of the company, the company optimizes the product system through diversified measures, increases the gross profit margin of the product, and can be expected to grow continuously.

Outpatient coordination is being implemented steadily, and profitability is expected to increase

Looking ahead to 2024, we believe that regional outpatient coordination policies may be implemented at an accelerated pace, which is expected to accelerate the outflow of prescriptions. The company currently has 4,673 outpatient co-ordinated stores, accounting for 33.12% of the company's total number of stores, and the scale continues to expand, which is expected to attract additional incremental traffic. In addition, the company continued to push forward the implementation of the Torch Project. The gross margin performance in the first quarter was excellent. In addition, the company actively promoted digital intelligence development. It is expected that the cost side will reduce, drive continuous improvement on the profit side, and I am optimistic that the company's profitability will continue to increase.

The product system was adjusted to optimize gross profit margin, and the rest of the indicators were relatively stable

In 2023, the company's comprehensive gross margin was 32.55%, up 0.67 percentage points year on year, mainly due to the increase in the share of high-margin traditional Chinese medicine sales; the sales expense ratio was 20.35%, up 1.03 percentage points year on year, mainly due to the expansion of the company's size; the management fee ratio was 5.29%, down 0.20 percentage points year on year, the control effect was obvious; the financial expense ratio was 0.79%, down 0.36 percentage points year on year, and the fee control effect was obvious. Net cash flow from operating activities increased 17.95% year over year, mainly due to the increase in the size of the company. The number of inventory turnover days was 96.35 days, up 8.88 days year on year, mainly due to the increase in sales scale; the number of accounts receivable turnover days was 34.51 days, up 3.69 days year on year, mainly due to the increase in sales scale; and the number of accounts payable turnover days was 54.43 days, an increase of 0.26 days year on year, which remained stable. The rest of the financial indicators are generally normal.

In the first quarter of 2024, the company's comprehensive gross margin was 35.20%, up 2.2 percentage points year on year, mainly due to the company's launch of the torch project and optimized product structure; the sales expense ratio was 21.61%, up 1.43 percentage points year on year, mainly due to the expansion of the company's size; the management expense ratio was 4.46%, up 0.01 percentage points year on year, which remained stable; and the financial expenses ratio was 0.77%, up 0.09 percentage points year on year, basically stable. Net cash flow from operating activities decreased by 50.89% year over year, mainly due to a decrease in cash received from sales of goods. The number of inventory turnover days was 105.28 days, up 5.26 days year on year, mainly due to the increase in sales scale; the number of accounts receivable turnover days was 35.68 days, up 3.26 days year on year, mainly due to the increase in sales scale; and the number of accounts payable turnover days was 57.52 days, down 5.81 days year on year, mainly due to the high base for the same period last year. The rest of the financial indicators are generally normal.

Profit forecasting and investment ratings

We expect the company to achieve operating income of 26.384 billion yuan, 31.041 billion yuan and 36.589 billion yuan respectively in 2024 to 2026, up 17.6%, 17.7% and 17.9% year-on-year respectively. Net profit to mother was 1,114 billion yuan, 1,343 billion yuan and 1,613 billion yuan respectively, up 20.0%, 20.5% and 20.1% year-on-year respectively. Equivalent EPS was 1.91 yuan/share, 2.30 yuan/share and 2.76 yuan/share, corresponding to valuations of 18.5X, respectively. 15.4X and 12.8X, maintaining the buy rating.

Risk analysis

1) Risk of changes in industry policies: If a country or locality introduces measures favorable to drug sales in medical institutions or policies restricting the development of the retail pharmacy industry during the medical system reform process, it may adversely affect the company's operations; 2) Market competition intensifies: the concentration of the industry gradually increases, and competition may become more intense, which may adversely affect the company's operations; 3) The progress of scale expansion falls short of expectations: if the expansion of store size falls short of expectations, the company's long-term performance growth potential may not be unleashed, or may adversely affect the company's long-term performance growth;

4) Merger and acquisition store integration falls short of expectations: For merger and acquisition projects, if the company does not meet expectations in terms of subsequent business integration, personnel integration, performance improvement, etc., it may affect the company's operating performance;

5) Goodwill impairment calculation: The company's merger and acquisition assets have a certain amount of goodwill. If subsequent operations fall short of expectations, or there is a risk of impairment, it will affect profit growth.