Matters:

The company announced that it achieved operating income of 6.36 billion yuan (-26% yoy), net profit of 0.55 billion yuan (-68% yoy), deducted non-net profit of 0.51 billion yuan (-69% yoy); 3Q24 achieved operating income of 1.76 billion yuan (-1.3% yoy), net profit of 0.02 billion yuan (-84% yoy), and deducted non-net profit of 0.003 billion yuan (-97% yoy).

The month-on-month deceleration on the revenue side was mainly due to a decline in respiratory shipments, and the large decline on the profit side was mainly due to a large decline in gross margin (impact of the decline in gross margin on revenue structure and mental categories), and higher government subsidies during the same period.

Commentary:

Breathing category: Removing the inventory cycle, next year is expected to reach an inflection point. We expect revenue from 3Q24 respiratory products to decline month-on-month. It is expected that shipments will remain under control throughout the year after the inventory removal cycle, and are expected to return to a reasonable level next year: 1) Lianhua Qingfeng: We expect 1-3Q24 Lianhua Qingfeng's revenue side to remain in the adjustment period, and net sales are expected to be relatively benign. We expect social inventory to bring an inflection point after the expiration period in the middle of next year, leading to a significant recovery on the shipping side; 2) Lianhua Qingqi: Marketing strategy adjustments are expected to drive volume growth next year.

Mindset category: The performance of the industry is relatively steady under pressure. We expect slight fluctuations on the 3Q24 shipping side of the Mind category, mainly due to active control and focused marketing compliance upgrades, and sales are expected to increase slightly. Gross margin is expected to decline significantly due to the cost of medicinal herbs. Along with the fall in herbal medicine prices, gross margin is expected to recover next year. The company focused on sales compliance upgrades this year. Affected by this, mentality is expected to decline throughout the year, and is expected to resume steady growth next year, driven by sales focus and academic marketing.

Innovative traditional Chinese medicine leaders, and the R&D pipeline is progressing steadily. The company has achieved great results in research and development in recent years. Class 1 new drugs to relieve depression (mild to moderate depression) and improve kidney health (insomnia) will be covered by medical insurance in 2023, and the dosage will be steady; Class 1 new drug communication was approved in October 2023 and participated in this year's national negotiations. In addition, the company has already reported production of Chai Huang Zhi Li and Qi Fangtong, which are expected to contribute to the increase.

Investment advice: Stable restoration of core products and maintenance of the “recommended” rating. We expect the company's net profit to be 0.9/1.08/1.3 billion yuan in 24-26, with a year-on-year growth rate of -33%/+20%/+20%. Considering that the company's core business development is at a new starting point, we have slightly adjusted the valuation method. Under segmental valuation, the company's reasonable market value is 38.2 billion yuan: 1) The PE valuation method is used for the company's stock varieties and business, and the estimated 25-year stock business profit is 1.08 billion yuan, with an industry-comparable company valuation, and a 25-year target PE 20x with a corresponding market value of 21.7 billion yuan; 2) For innovative traditional Chinese medicine within 5 years of marketing (the promotion period of new drugs is relatively small, contributing relatively little to the profit side) and clinical phase III traditional Chinese medicine innovation The drug is valued using the peak sales multiplier method (3 times PS), and the corresponding market value is 16.5 billion yuan. Corresponds to the target price of 22.8 yuan, maintaining the “recommended” rating.

Risk warning: Sales volume of core products fell short of expectations.