Key points of investment

Xinhua Medical is a leading domestic medical device company. In the context of the reform of state-owned enterprises, the transition of products to high-end products is accelerating, and profitability is rapidly improving. We believe that the market does not know enough about the company's product strength, the company has a large number of invention patents, and is in a cycle where product innovation brings about product structure changes and profit margins. High profit growth can be expected from 2024-2026.

The company's state-owned enterprise reform process?

Focusing on the main business and efficiency, gross margin increased from 20.0% to 27.4% in 2018-2023. In the second half of 2017, as a state-owned enterprise, driven by efficiency requirements, etc., the company began a transition from revenue growth to efficiency growth. In its 2017 annual report, the company proposed a strategy of “eliminating inefficient assets” and “shifting from scale growth to efficiency growth”, and began gradually divesting inefficient subsidiaries in 2017. In 2020, it further clarified the goal of “restructuring, strengthening the main business, improving efficiency, and preventing risk”, focusing on the two major sectors of medical devices and pharmaceutical equipment. In 2018-2023, the company's gross margin increased year by year, from 20.0% to 27.4%, and profitability increased steadily.

Driven by an increase in the company's profit margin?

We believe that the market's understanding or lack of understanding of technical barriers to the company's products is expected to continue to increase as the share of main business increases steadily and the volume of new products continues to be released. In 2018-2023, the company's net profit margin increased from 1% to 7%, mainly driven by an increase in gross margin (20% to 27%). Analysis of the reasons for the increase in the company's gross margin:

(1) Product structure adjustment, increasing the proportion of medical devices and pharmaceutical equipment with high gross margins. Since the company proposed to focus on the main business in 2017 and shift from scale growth to efficiency growth, in 2018-2023, the company's two core sectors with high gross margin, medical devices (the share of revenue in 2018-2023 increased from 22% to 42%) and pharmaceutical equipment (the share of revenue in 2018-2023 increased from 8% to 19%) have continued to increase in revenue share, driving an increase in gross margin;

(2) The release of new products increased the gross margin of the company's medical devices and pharmaceutical equipment sector. The gross margin of the company's medical device sector increased from 37.7% in 2018 to 40.8% in 2023, and the gross margin of the pharmaceutical equipment sector increased from 15.7% to 27.1%. The gross margin of the sector itself is also rising rapidly. We believe it is inseparable from the company's product innovation and volume. Looking at product innovation, we believe that the market is not sufficiently aware of the company's product capabilities. It is widely believed that the company's products are not high-end enough and that the moat is low, but analyzing the number of company patents, compared to Mindray Healthcare, one of the leading domestic medical device companies with a certain advantage in R&D, Xinhua Healthcare has a large number of invention patents and a high patent barrier. In 2023, the company successfully developed the first 16-row 85cm large-aperture spiral CT and successfully launched a double-membrane high-speed continuous BFS device with completely independent intellectual property rights. We believe that the company has high technical barriers, and innovative products can be expected to form a long-term revenue drive as R&D investment continues to grow, thereby driving the company's high gross margin medical device and pharmaceutical equipment sector with higher revenue growth than the company's overall revenue growth (share increase), and the gross margin within the sector continues to rise.

The pace of increase in net interest rates?

Gross margin is expected to increase from 27% to 30% in 2023-2026. We believe that in 2023-2026, driven by the continued release of new products, the growth rate of the company's medical devices and pharmaceutical equipment sector is expected to be higher than the company's overall revenue growth rate, leading to continuous adjustments in the company's product structure (medical devices and pharmaceutical equipment, two high-margin segments, increase in revenue share), and the company's gross margin is expected to increase from around 27% in 2023 to around 30% in 2026.

Driven by the increase in gross margin, the company's net profit margin is expected to rise from 7% to 9%. Under the influence of continued R&D investment, etc., the company's expense ratio may remain at a relatively stable level during the period. The increase in the company's gross margin has led to an increase in net interest rate. Corresponding to 2023-2026, the company's net interest rate is expected to rise from about 7% to about 9%.

Profit forecasting and valuation

We expect the company's revenue for 2024-2026 to be 11.022/12.153/13.253 billion yuan, respectively, up 10.09%, 10.26%, and 9.05% year on year; net profit margin of 0.805/0.956/1.137 billion yuan, up 23.04%, 18.85%, and 18.92% year on year; corresponding EPS will be 1.33/1.58/1.87 yuan (13 times PE in 2024), maintaining the “increase” rating.

Risk warning

Risk of policy changes; risk of commercialization of new products falling short of expectations; risk of increased industry competition; risk of falling short of expectations in managing mergers and acquisitions.