Introduction to this report:

The retail growth rate is slowing down, and the franchise business is growing rapidly; gross margin is under phased pressure on profit levels. As the profitability of stores outside the province increases, the company's net interest rate is expected to increase and maintain an increase in holdings rating.

Key points of investment:

Maintain an increase in holdings rating. 2024H1 achieved revenue of 13.345 billion yuan (+11.3%), net profit of 0.658 billion yuan (-28.3%), net profit of not attributable to mother 0.659 billion yuan (-26.6%); of these, 2024Q2 achieved revenue of 6.593 billion yuan (+9.07%), net profit to mother 0.259 billion yuan (-38.4%), net profit of non-return to mother 0.263 billion yuan (-34.43%). The results fell slightly short of expectations. The 2024-2026 EPS forecast was lowered to 1.07/1.24/1.43 yuan (originally 1.25/1.53/1.84 yuan), the 2024 PE15X was given, and the target price was lowered to 16.20 yuan, maintaining the holdings increase rating.

The franchise business is growing rapidly, and retail sales are relatively slowing down. In the 2024Q2 segment, retail/wholesale grew by 5.06%/32.61% respectively, and the wholesale business maintained a relatively rapid growth rate due to the large number of franchised stores. By product, the growth rates of proprietary Chinese and Western medicines, Chinese ginseng, and non-drugs were +10.0%/+8.7%/+1.8%, respectively. Demand for Chinese and Western proprietary medicines was relatively more rigid, but it was also constrained by the decline in demand for the four types of drugs; the growth rate of Chinese ginseng and non-pharmaceuticals slowed down due to the impact of the consumption environment. As a result, the average daily efficiency of a single 2024H1 store dropped to 71 yuan/square meter (78 yuan/square meter for 2023H1). As of 2024H1, the company's outpatient co-ordinated pharmacies were 1,782, and Guangdong's liberalization and coordination is expected to bring significant growth to the company.

Gross margin declined due to product structure, regional structure, etc. The gross profit margin of the 2024H1 company is 24.89% (-2.55pp), which has a large impact on net profit. We believe that the main reasons are (1) structural changes brought about by the increase in the share of wholesale revenue with low gross margin, the 2024H1 wholesale gross profit margin of 11.76% (+0.09pp); (2) the retail gross profit margin of 37.22% (-2.17pp) has also declined. It is estimated that ① the share of revenue from outside the province has increased but the gross profit margin is lower. The gross profit margin in South China is 35.7%, while the gross profit margin in South China is 35.7%. ② East China/other regions were 27%/31.2%/28.9%, respectively. In the future, as the company's market share outside the province gradually increases and costs are gradually optimized, gross margin is expected to increase. The 2024H1 sales/management/R&D/finance expense ratios were +1.14/-0.09/+0.02/-0.04pp, respectively. The increase in sales expenses was mainly due to the high upfront cost of opening a new self-built store, and there was no significant change in the remaining cost rates.

The first half of the year maintained a relatively fast pace of store opening. The total number of 2024H1 stores reached 16,151 (including 5,379 franchisees), and 797/284/1214 new self-built/acquisitions/franchises were added, respectively, and the store growth rate reached 35%. By region, 1,059 stores have been opened in South China, continuing to strengthen the leading position in South China's dominant regions; the rate of opening stores outside the province has also accelerated. The revenue growth rate of 2024H1 in East China/other regions reached +18.73%/+44.16% respectively, and there is plenty of room for development outside the province.

Risk warning: Competition increases risks, and the overall progress of outpatient care is falling short of expectations.