Key points of investment

Core view: The trend of ROE improvement is clear. The high dividend undervaluation characteristics continue to highlight our belief that new financing channels and innovative business development are important variables supporting the continuous improvement of Kyushu Express's ROE. At the same time, the company's own high dividend and undervaluation characteristics are also becoming more prominent. In 2023, the Kyushu Outpatient Market accounted for about 74% of sales. It is a scarce private company among the top four leading pharmaceutical distributors in China that mainly covers the out-of-hospital market. We believe that the company's ROE has shown signs of improvement, and the quality of operations continues to improve. Looking ahead, we believe that based on the company's relatively complete logistics supply chain service system and omni-channel, full-scenario digital marketing platform, the company's general CSO business, innovative franchise brand strategies such as “Good Pharmacist Ten Thousand Stores”, and “Jiuxin Clinic” are expected to drive the company's rapid growth. Furthermore, the company's REITs project is about to be released, which is expected to effectively change the company's asset structure and business model, and provide a solid financial guarantee for subsequent expansion. At the same time, the company reached a cash dividend rate of 45% for two consecutive years in 2022 to 2023. Based on our judgment on the company's ROE increase and sufficient cash, we assume that the company's 2024 cash dividend rate will remain unchanged. We expect the closing price on August 2, 2024 to reach 4.74% of the company's dividend rate in 2024, which currently has a high investment cost ratio.

Distribution: Innovative models such as Joining Good Pharmacists and Joining Clinics may continue to unleash momentum and accelerate progress across the country. The number of “Good Pharmacist Ten Thousand Stores” franchises and individual revenue generation are expected to increase rapidly. In 2023, franchise store procurement revenue from Kyushu-dori reached 3.48 billion yuan (yoy +83.25%), and Good Pharmacist franchisees generated 0.1642 million yuan in single-store procurement revenue. Referring to the national average single-store revenue level in 2022, we expect the current share of franchisees' purchases to Kyushu-dori will only account for about 20%. Looking ahead, we expect that the double increase in the number of stores and the share of purchases will drive 10,000 stores to maintain a high growth rate in franchise revenue. As of the first quarter of 2024, the number of direct-operated/franchised stores of the company had reached 21,192 (mainly franchised stores), and the compound growth rate of the number of stores reached 85.8% in 2021-2023. According to the company's plan, the number of franchised stores is expected to exceed 30,000 in 2025. On the other hand, there are large differences in the implementation progress of the “Seven Unifications” policy for drug retail chains across the country, but we are concerned that from 2023-2024, there are signs of acceleration at the implementation level in many parts of the country, which is expected to drive the proportion of Good Pharmacists national franchisees purchasing from Kyushu Express to accelerate.

The increase in clinics and new changes in the “new medical treatment” strategy in 2023 may bring new momentum to the third terminal's business growth. As of 2023, the company's primary medical institution business covered more than 60% of the country's community health service centers and stations, township hospitals and village health rooms. We believe that the number of clinics continues to grow, the outflow of drugs for chronic diseases etc. from grade hospitals to the third terminal, and Kyushu Express's “Jiuxin Clinic Brand Joining” plan will drive the continued growth of primary care terminals: ① The “Clinic Registration System” will be implemented nationwide in 2023, and domestic clinics are expected to grow into a new window; ② The co-ordinated medical insurance reimbursement rate for outpatient expenses of designated medical institutions at level 1 and below is generally above 70%, 20 pct higher than that of third-level medical institutions. As policies such as hierarchical diagnosis and treatment, outpatient support, and county medical communities continue to advance at the grassroots level Demand for medication in medical institutions is expected Continued increase; ③ Similar to the “Good Pharmacist Ten Thousand Stores Join” strategy, Kyushu Express proposed the “Jiuxin Clinic Brand Franchise Strategy” in the 2023 Annual Report to further increase its procurement share in primary medical institutions and the penetration rate of value-added services in digital intelligent operations. The goal is to join 200 companies by 2024, and is optimistic about subsequent growth.

General CSO: Capabilities have been verified, optimistic that channel advantages will continue to be realized, pharmaceutical general generation CSO: historical cooperation and verification capabilities, CSO brand upgrade in 2023, sales control advantages will continue to be released, and the new business format will enter a new stage of stable and high growth. Based on the company's advantages in channel coverage outside the hospital and channel management capabilities, the company's general CSO business has grown rapidly since 2018-2019. As of 2023, the company has created successful cases of operating brand products such as Kewei (oseltamivir phosphate tablets), Kangwang (compound ketoconazole hair lotion, etc.), and Beipin (metoprolol tartrate tablets) in retail channels, achieving large-scale contract renewals and variety cooperation expansion with the same manufacturer. The total number of the company's total drug contract products declined for the first time in 2023, but revenue increased markedly. We judge that the company has entered a new stage of adjusting the product structure and increasing the revenue generation of individual products. In 2024, the company plans to introduce 20 more than 10 million new products, and has completed the introduction of 13 more than 10 million new products in the first half of the year; in June 2024, the company announced the signing of a 3-year 1.8 billion contract for sales of Eisai methylcobalamin tablets (Micobalamin) across the country in retail channels and medical channels (excluding collection and distribution). Looking ahead, we believe that with the continuous improvement of the standardization of the out-of-hospital market in medical reform and the continuous demand of pharmaceutical companies for cost reduction and efficiency, the decentralized market outside the hospital has strong demand for marketing platforms with a more complete logistics supply chain service system and omni-channel, full-scenario digital marketing control capabilities. With the continuous improvement of Kyushu Express's own CSO team and the continuous replication of successful models, we are optimistic that the CSO business will become the company's new growth engine.

General equipment generation: Equipment distribution capabilities are outstanding, manufacturers have a broad base of cooperation, and the continuous expansion and iteration of the number of cooperative products is expected to support the rapid growth of the general equipment generation business. Looking ahead, we believe that the company has established a deep foundation of cooperation with leading overseas product distributors such as Johnson & Johnson, Abbott, Fresenius (Blood Penetration), Roche, and Mamerton. Continued iteration of leading overseas products may support the company's general equipment business to maintain a relatively rapid growth rate in the future. We believe that based on a good foundation of cooperation, the company may achieve a continuous increase in the number of agent product regulations and a steady increase in revenue generation from individual product regulations in the future by continuing to undertake iterative product and field expansion from overseas device brands.

REITS: Scarce new financing channels are expected to drive ROE growth. Given the pharmaceutical business's demand for capital turnover, expanding low-cost and sustainable financing methods plays a key role in the development of Kyushu Express. The company announced the issuance of public and private REITs in March 2023 and July 2024 respectively, and is expected to become the first domestic pharmaceutical logistics company to issue REITs. We believe this financing model is sustainable and relatively difficult to replicate. A successful launch will help improve the company's asset structure and drive it to accelerate high-ROE business development. Looking ahead, we expect the company's profitability and ROE center to continue to increase as the company gradually becomes asset-light and capital-assisted by new financing channels.

Profit forecasting and valuation

Based on the above analysis, we believe that Kyushu Express is a leading pharmaceutical distribution company in the scarce outpatient market, and the capital help brought by new business development and REITs will support it to enter the acceleration window. As of the publication date of this report, the company's REITs issuance has not been officially approved. Based on prudential principles, without considering the potential impact of REITs issuance on the company's three tables, we forecast the company's revenue for 2024-2026 to be 161.8/175.8/191.9 billion yuan, respectively, corresponding growth rates of 7.78%/8.65%/9.12%, respectively: the estimated net profit to mother is 2.427/2.728/3.064 billion yuan, respectively, with year-on-year growth rates of 11.64%/ 12.40%/12.31%, the closing price on August 6, 2024 corresponds to 10/9/8 times PE, which covered the “buy” rating for the first time.

Risk warning

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