Key points of investment

2024Q2's revenue and profit have all reached record highs. We believe that after 2020, the company will enter a period of accelerated capital expenditure and supply capacity upgrade. As investment and production capacity enters a period of release one after another, and the revenue structure improves, the company is expected to enter a new round of high-quality growth cycle driven by supply upgrades.

Financial performance: Q2 revenue & profit reached record highs

On August 15, 2024, the company released its 2024 semi-annual report. 2024H1 achieved operating income of 6.429 billion yuan, an increase of 7.96% year on year; net profit to mother was 0.625 billion yuan, up 3.96% year on year, after deducting net profit of 0.602 billion yuan. Looking at a single quarter, 2024Q2 achieved operating income of 3.231 billion yuan, up 12.61% year on year; net profit to mother was 0.381 billion yuan, up 5.35% year on year, net profit after deducting non-return to mother was 0.363 billion yuan, up 0.48% year on year, and both revenue and profit reached record highs.

Growth capacity: Formulation-driven, APIs and intermediates are still growing rapidly. API and intermediates business: 2024H1 achieved revenue of 4.704 billion yuan, an increase of 11.89% over the previous year. According to the company's semi-annual report, “In terms of production, large-scale production based on orders has been achieved. The monthly output of 12 products has reached a record high, production costs have been further reduced, and the competitiveness of the product market has been further enhanced. On the market side, the market share of strategic varieties has gradually increased, and sales of various products have reached record highs. At the same time, the expansion of the veterinary drug market has been further strengthened, and a cooperation system for related strategic varieties has basically taken shape. The development of new API customers continues to advance. 15 new customers were added in the first half of the year, and several products have generated steady growth.” We believe that H1's API and intermediates business revenue has grown rapidly, probably mainly due to increased product sales; looking ahead to the whole year, we are optimistic that the market share of core antibiotic products will rise steadily, and that the volume of new products and new production capacity will contribute to flexibility, and it is expected to maintain steady growth throughout the year.

CDMO business: 2024H1 achieved revenue of 1.028 billion yuan, a year-on-year decrease of 9.82%; excluding the impact of special projects, revenue continued to grow normally year-on-year. According to the company's semi-annual report, “There were 731 projects quoted, up 51% year on year; 876 ongoing projects, up 44% year on year, including 317 commercialization projects, up 28% year on year, including 228 human drug projects, 48 veterinary medicine projects, and 41 other projects; 559 R&D projects, up 54% year on year. The company also continues to promote business transformation and upgrading from “original API + registered intermediate” to “original API + registered intermediate + API+ formulation”. During the reporting period, there were a total of 103 API projects, an increase of 49% over the previous year; of these, 18 have entered the commercialization stage, 13 are in the verification stage, and 72 API projects are in the small trial development stage. By the end of the reporting period, the company had signed confidentiality agreements with 512 domestic and foreign innovative drug companies”. Looking ahead to the whole year, considering the project structure and delivery pace, we believe that if the impact of special projects is excluded throughout the year, revenue is expected to grow rapidly. At the same time, we are optimistic that with the improvement of the company's CDMO business technology & manufacturing service capabilities, the release of high-end production capacity, and the introduction of talents, the number of projects is expected to maintain a relatively rapid growth trend. As the project progresses, it is expected to provide strong support for the strong growth of the CDMO business.

Formulation business: 2024H1 achieved revenue of 0.68 billion yuan, an increase of 18.37% year over year. According to the company's semi-annual report, “51 research projects have been completed, 9 verification projects have been completed, and 6 projects have been declared, involving various fields such as anti-infective, cardiovascular, central nervous system, phlegm relief and choleretic drugs. Among them, weight loss and sugar reduction projects are expected to enter the clinical phase in the fourth quarter of this year.” Looking ahead to the whole year, we are optimistic that with the accelerated promotion of the “multi-variety” strategy, as the pace of application and approval accelerates and the market expansion of new and old varieties increases, the formulation sector is expected to contribute new momentum to the company at an accelerated pace.

Profitability: Gross margin increased month-on-month in Q2, and formulation increased significantly 2024H1: The company's gross sales margin was 24.70%, down 1.90pct year-on-year. In terms of breakdown, the gross profit margin of the API and intermediates business was 16.22%, down 2.30pct year on year. We think it was mainly due to a sharp rise in volume and price in the same period in 2023; the gross profit margin of the CDMO business was 40.09%, down 4.68pct year on year, which we think was mainly due to changes in project structure; the gross profit margin of the formulation business was 60.30%, an increase of 9.92 pct year on year. We think it was mainly due to the expansion of the scale of formulation sales and the increase in internal production line efficiency, which led to a sharp increase in gross margin. The net profit margin on 24H1 sales was 9.72%, down 0.37pct year over year. Looking at the cost side split, the sales expense ratio was 4.36%, down 0.13 pct year on year; the management expense ratio was 3.65%, down 0.45 pct year on year; the R&D expense ratio was 4.90%, down 1.01 pct year on year; and the financial cost ratio was -0.72%, up 0.44 pct year on year.

2024Q2: The company's gross sales margin was 25.35%, up 0.21pct year on year and 1.31pct month-on-month. The net sales margin was 11.79 percent, down 0.82 pct year on year. Mainly, the sales expense ratio was 3.96%, down 0.67 pct; the management expense ratio was 3.44%, down 0.31 pct; the R&D expense ratio was 5.01%, down 0.2 pct; and the financial cost ratio was -1.33%, up 1.69 pct year on year.

Looking ahead to the full year of 2024: We expect that as the high gross margin CDMO & formulation business continues to expand, the API intermediates business reduces costs and increases efficiency & high-margin new product release, the overall gross margin will increase; as R&D projects advance, the R&D cost rate may increase; the formulation business promotion will increase or drive a slight increase in sales expenses. Overall, the net interest rate in 2024 will increase.

Operating efficiency: Operating cash flow is improving, inventory & fixed asset turnover is accelerating, and supply capacity upgrades are expected to drive continued high-quality growth

In terms of cash flow, the net cash flow from 2024H1's operating activities was 0.981 billion yuan, which is higher than net profit.

2024H1's net cash flow/net income from operating activities was 143.29%, a significant increase from 2023H1's 103.69%. Looking at the turnover ratio, the 2024H1 company's inventory turnover ratio was 2.53, up 2.36 from 2023H1; the fixed asset turnover ratio was 2.18, up 2.01 from 2023H1. Accelerated turnover and abundant cash flow showed a high quality of operation.

Production capacity is entering the release period one after another, and we are optimistic that supply upgrades will drive high-quality growth: on the API side, 303 and 304 high-end API production workshops will be completed and put into use in March; 07101 new process and new production capacity upgrades are expected to be completed in December; 07110 industrial chain extension and AH22081 construction is expected to be completed in August; AP091 production expansion and transformation, which is expected to be completed in August; the peptide production line is in the design stage; on the CDMO side, the Boston laboratory in the US was completed in May. It has been gradually put into use; a new pilot plant for biological fermentation and extraction has entered the final stage; in terms of formulation, the production line for cephalosporin preparations completed trial production and process verification in June; an international high-end formulation comprehensive workshop is in the design stage.

We believe that after 2020, the company will enter a period of accelerated capital expenditure and supply capacity upgrade. As investment and production capacity enters the release period one after another, and the revenue structure improves (the share of high net profit margin revenue increases, due to the increase in CDMO revenue share, increased share of raw materials, cost reduction and efficiency of APIs & new product release), the company is expected to enter a new round of high-quality growth cycle driven by supply upgrades.

Profit forecasting and valuation

Considering changes in the company's total share capital, we expect the company's 2024-2026 EPS to be 1.03, 1.21, and 1.48 yuan/share, respectively. The closing price on August 16, 2024 corresponds to 15 times the 2024 PE. We are optimistic that the company's production capacity will enter the release period one after another. With an improved revenue structure, the company is expected to enter a new high-quality growth cycle driven by supply upgrades and maintain a “buy” rating.

Risk warning

Risk that sales of core formulations fall short of expectations; risk of exchange rate fluctuations; risk of order delivery volatility, etc.