We forecast the 2023-26 revenue/net profit CAGR of 26%/33%, respectively.

The increase in the number of stores is expected to drive future performance growth; we expect the number of stores to grow at a CAGR of 22% in 2023-26.

Maintain the purchase and raise the DCF target price to $57.48.

The 2023 results were slightly lower than expected; business restructuring affected the decline in gross margin: according to the company's 2023 annual report, the company achieved operating income of 22.588 billion yuan, an increase of 14% over the previous year; realized net profit of 1,412 billion yuan, an increase of 12% over the previous year.

The sales/management expenses rate in 2023 was 24.3%/4.3%, respectively, -0.2pps/-0.3ppts year-on-year. The lower than expected results in 2023 were mainly due to the company opening stores less quickly than we expected. In 2023, the company achieved a gross profit margin of 38.2% (-1.3 ppts year over year) and a net profit margin of 6.3% (-0.1 ppts year over year). The reason for the decline in gross margin was an increase in the share of wholesale revenue with low gross margin and a slight decline in retail business gross margin. By industry, the company achieved retail drug revenue of 2.085 billion yuan (+12%) and pharmaceutical wholesale revenue of 1,892 billion yuan (+39%) in 2023, accounting for 8.38% of the wholesale business revenue (+1.54 ppts year on year). By product, in 2023, the company achieved revenue of 17.095 billion yuan (+15.93%) of proprietary Chinese medicines, 2.80 billion yuan (+23.30%) of traditional Chinese medicine, and 2,803 billion yuan (-2.30%) of non-pharmaceutical revenue. 1Q24 achieved operating income of 5.971 billion yuan, up 13% year on year; net profit to mother was 407 million yuan, up 21% year on year.

The company undertakes the outflow of hospital prescriptions online and offline. On the offline side, as of the end of 2023, the company had 675 hospital side stores and 305 DTP specialty pharmacies, including 246 dual-channel medical insurance stores and more than 4,200 outpatient co-ordinated medical insurance pharmacies (accounting for 41%). On the online side, the company connects with more than 10 provincial and municipal medical insurance and health prescription distribution platforms, and directly or indirectly undertakes prescription circulation services for more than 100 tertiary hospitals and Internet hospitals.

The increase in the number of the company's stores is expected to drive revenue and net profit growth in the next three years: According to the 2023 annual report, the company added 3,196 new stores, including 1,613 self-built stores, 559 mergers and acquisitions, and 1,024 franchised stores. During 1Q24, the company added 701 new stores, including 364 self-built stores, 166 mergers and acquisitions, and 171 franchise stores. By the end of the 1Q24 period, the total number of the company's stores was 13,920 (including 3,157 franchised stores); a net increase of 670 compared to the end of the previous period, the number of stores continued to grow rapidly. Of these, 9,331 stores have obtained medical insurance eligibility (87%). We believe that increased industry concentration remains a long-term trend in the retail pharmacy industry. We forecast the number of stores at the end of the 2024-26 period to be 16,292/19,732/ 23,774, respectively; the number of stores will grow at a CAGR of 22% in 2023-26.

Maintaining purchases and raising the target price of DCF (WACC: 8.3%) to $57.48: Our net profit due to mother in 2024 remains basically unchanged, increasing net profit to mother by 2% in 2025. As the company increased its share capital in the 2023 stock dividend, we cut our 2024-25 EPS by 28%/27%, respectively. Added 2026 forecast. Our target price is 29 times the 2024 P/E, which is 15 times higher than the industry average. Since the company is expected to maintain a high growth rate in the next three years, we think the company should receive a certain valuation premium.

Risk warning: 1) The expansion of mergers and acquisitions fell short of expectations; 2) increased competition in the industry; 3) the price reduction of collected drugs exceeded expectations; 4) the impact of the Internet retail industry; 5) the scale of prescription outflows fell short of expectations.