Incidents:

On August 30, 2024, the company released its 2024 interim report. In the first half of 2024, the company achieved operating income of 9.763 billion yuan, an increase of 0.02% year on year; realized net profit of 1.021 billion yuan, an increase of 3.49% year on year; realized net profit deducted from mother 0.992 billion yuan, an increase of 1.35% year on year. Looking at a single quarter, in 2024, the company achieved operating income of 4.496 billion yuan, a year-on-year decrease of 2.64%; realized net profit due to mother 0.445 billion yuan, a year-on-year decrease of 3.90%; and realized net profit deducted from non-mother of 0.421 billion yuan, a year-on-year decrease of 8.41%.

The overall performance is running smoothly, and there is a lot of phased pressure on the cost side.

In 2024, H1's overall performance was running smoothly, and both the pharmaceutical industry and the pharmaceutical business achieved slight growth. By business: the pharmaceutical industry achieved revenue of 6.472 billion yuan, an increase of 5.30% year on year; the pharmaceutical business achieved revenue of 6.03 billion yuan, an increase of 8.94% year on year; among them, the company's top five series products achieved revenue of 3.047 billion yuan, an increase of 4.18% year on year.

In 2024, H1 was under heavy pressure on the cost side, and gross margin was under phased pressure. Specifically, the gross profit margin of the pharmaceutical industry was 41.39%, down 3.53 pct year on year. We speculate that this was mainly due to a sharp rise in the price of Chinese herbal medicines such as natural beef yolk; among them, the gross profit margin of the top five series was 48.08%, down 8.49pct year on year. We speculate that the gross profit margin of the pharmaceutical business was 26.67%, down 3.74 pcts year on year, mainly due to the relatively high base for the same period.

The joint stock company performed excellently, and Sinopharm was under phased pressure.

From the perspective of business entities, Tongrentang Co., Ltd. performed excellently, and Tongrentang Sinopharm was under phased pressure. 1) Tong Ren Tang Co., Ltd. (parent company): In 2024, H1 achieved operating income of 2.605 billion yuan, a year-on-year increase of 20.56%; realized net profit of 0.889 billion yuan, an increase of 13.20% over the previous year.

2) Tongrentang Technology Co., Ltd.: In 2024, H1 achieved operating income of 4.05 billion yuan, a year-on-year increase of 2.63%; with reference to Tongrentang Technology's interim report, revenue from the H1 Liuwei Dihuang pill series increased by about 3% year on year in 2024, revenue from the cold clean-up granule series increased by about 20% year on year, and revenue from the Xihuang pill series increased by about 25% year on year. 3) Tong Ren Tang Sinopharm: In 2024, H1 achieved operating income of 0.605 billion yuan, a year-on-year decrease of 16.36%; realized net profit of 0.2 billion yuan, a year-on-year decrease of 15.52%; the decline in performance was mainly due to a decline in sales revenue in Hong Kong and Macau. Refer to Tong Ren Tang Sinopharm's report, the retail market in Hong Kong and Macau is weak, changes in the consumption patterns of visitors and local citizens, and a decrease in the time spent by travelers and per capita consumption. 4) Tong Ren Tang Commercial Company: In 2024, H1 achieved operating income of 5.626 billion yuan, up 0.75% year on year; achieved net profit of 0.295 billion yuan, up 7.84% year on year; Tong Ren Tang commercial company bucked the trend and expanded. As of the 2024 mid-year report, it had 1,116 stores, of which 116 new stores were set up and 1 store closed in the first half of 2024.

Implement the “Quality Strategy” and the “Big Variety Strategy”.

The company thoroughly implements the “quality strategy” and “large variety strategy” to enhance the company's core competitiveness. 1) In terms of boutique strategy: Focus on building an echelon to build a product group, gradually promote the “Legend of Imperial Medicine” series products in stages and regions, promote the scale of “Legend of Imperial Medicine” series products, improve customer satisfaction and customer stickiness; dig deeper into the market needs of different consumers, drive the common development of other varieties with key varieties, and increase the product market size in an orderly manner; some stores have set up counters for Legendary Medicinal Products, equipped with professional explainers to increase the sales contribution rate of boutique products. 2) In terms of large variety strategy: The company favors resources in production, supply, R&D and marketing for selected varieties with high potential for cultivation, establishes a “one product, one policy” marketing strategy, carries out accurate and differentiated promotion, integrates resources from all parties to form joint efforts to do a good job in key cultivation of large varieties; accelerate the improvement of insurance and supply capabilities, focus on production efficiency and cost control of large varieties, and raise profit levels. We believe that the “boutique strategy” can effectively improve the company's brand positioning and average customer unit price, and the “large variety strategy” can effectively focus on core assets and enhance their profitability. The two major strategies are important engines driving the company's performance growth.

The price of natural beef yolk is running high, and opening up imports is expected to ease the cost pressure.

Natural beef yolk is an important raw material for Angong beef yolk pills, and price fluctuations have a great impact on the company's profit level. According to Chinese Herbal Medicine World, the price of natural beef yolk rose from 0.57 million yuan/kg to 1.4 million yuan/kg from January to December 2023. Since 2024, the price of natural beef yolk has stabilized at 1.4 million yuan/kg. The price has remained high, and there is no sign of further increase for the time being. In June 2024, the State Drug Administration, together with the General Administration of Customs, drafted the “Notice on Matters Relating to Allowing the Import of Beef Yellow for Pilot Use in the Production of Proprietary Chinese Medicines (Draft for Comments)”. For bezoar from countries (regions) where there is no mad cow disease epidemic ban and meets China's customs quarantine requirements and drug quality inspection requirements, the applicant for the import of beef yolk should be the drug marketing license holder for prescription of proprietary Chinese medicines containing beeswax within the pilot area.

We believe that if natural beef yolk is opened for import, it is expected that the gap between supply and demand will be appropriately mitigated, market prices will be stabilized, and the pressure on the company's cost side will be reduced.

Investment advice:

We expect the company's revenue for 2024-2026 to be 18.704 billion yuan, 20.988 billion yuan, and 23.565 billion yuan, respectively, and net profit to mother will be 1.708 billion yuan, 2.048 billion yuan, and 2.471 billion yuan, respectively. The corresponding PE valuations will be 28.2 times, 23.6 times, and 19.5 times, respectively. We gave the company a buy-A investment rating of 43.75 yuan for 6 months, which is equivalent to a dynamic price-earnings ratio of 35 times in 2024.

Risk warning: risk of fluctuations in raw material prices; pressure on macro-consumption sentiment; boutique strategies and large variety strategies falling short of expectations; drug retail price supervision risks.