Key points of investment:

Deeply cultivate South China+ expand to other provinces, and work together in a triple expansion model. Since the establishment of the company, South China has been the company's core market, and development outside of South China has been strengthened simultaneously. As of Q1 2024, the number of the company's stores reached 14,915 (including 4,610 franchise stores), covering 20 provinces in major regions such as South China, Central China, and East China, with South China accounting for 62.55%. The proportion of stores outside of South China increased from 19.79% in 2019 to 37.45% in 2024Q1.

At the strategic level, with the South China region as its base, looking at national expansion and expansion, and making joint efforts through self-building+mergers and acquisitions+joining three horse-drawn carriages, the pace of national expansion is accelerating.

To grow bigger, we need to be better, taking into account profitability and operating efficiency. In the process of rapid expansion, the company not only maintained superior scale, but also took into account profitability and operating efficiency, which is mainly reflected in three major aspects: (1) retail gross margin is basically stable, maintaining the profitability advantage. (2) The company's differentiated category system is being built, and the specialty Chinese ginseng herbal medicine business is also gradually being promoted nationwide to hedge the pressure on gross margin brought about by the increase in the share of prescription drugs. (3) Optimize operating efficiency and promote cost rate control: Improve labor efficiency and rent efficiency, and reduce the sales expense ratio year by year. The company's sales expense ratio dropped from 26.02% in 2019 to 22.92% in 2023, and the cost rate control effect is excellent.

Outpatient coordination and the outflow of prescriptions, the industry's room for growth is worth looking forward to. At the industry level, increasing chain rate and industry concentration is still the main theme. The pharmacy chain rate increased from 52.15% in 2018 to 57.76% in 2023, and the market share of TOP10 pharmacy chains increased from 20.64% in 2018 to 34.11% in 2023, but there is still plenty of room for improvement compared to developed countries. In terms of prescription outflow policies, a series of policies have had a profound impact directly or indirectly on the drug retail industry. The abolition of key measures such as drug bonuses, “dual channels” for medical insurance negotiations, electronic prescription circulation, and outpatient co-operation have continued to advance the trend of drug separation and prescription outflow, enabling prescription drugs sold by hospitals to flow more to the out-of-hospital market, and retail pharmacies as important players. The “Notice of the Office of the National Health Security Administration on Further Improving the Integration of Designated Retail Pharmacies into Outpatient Coordination Management” issued by the National Health Insurance Administration in February 2023 will further accelerate the outflow of prescriptions. The notice makes it clear that eligible designated retail pharmacies will be included in the overall management of outpatient clinics. This has enabled pharmacies that have obtained outpatient co-ordinated funding to add additional payers for co-ordinated medical insurance funds, so they can accept more prescriptions outside of hospitals.

Profit forecast and valuation: We expect the company's 2024-2026 revenue to be 29.389 billion, 35.094 billion, and 41.495 billion, respectively, with year-on-year increases of 19.80%, 19.41%, and 18.24%, respectively; net profit to mother is 1.469 billion, 1.759 billion, and 2.089 billion yuan, respectively, with year-on-year increases of 25.9%, 19.8%, and 18.8%, respectively. The average PE valuation method weighted by market value is used to value the company. The average PE weighted by the market value of the comparable company in 2024 is 15 times. The target market value is 22 billion yuan. Compared with the latest market value on June 27, the target market value is 22 billion yuan. Compared with the latest market value on June 27, there is room for an increase of 31.01%, giving the company a “buy” rating.

Risk warning: 1. The outflow of prescriptions fell short of expectations; 2. The expansion rate of markets outside the province fell short of expectations; 3. Profits from newly opened stores fell short of expectations; 4. The profitability of Chinese ginseng products declined; 5. Listed companies involved litigation risks and regulatory risks.