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China Fund News reporter Fang Li and Cao Wenjing

Since July, the medical industry, which has always been viewed by the capital market as a "long slope and thick snow", has adjusted again. The CSI Pharmaceutical Index even hit a new low since 2015, attracting market attention and heated discussions.

How do you view the adjustments in the pharmaceutical sector in recent years? Has the medium- and long-term investment logic of the pharmaceutical industry changed due to the policy disturbances in recent years? Which sub-sectors are worth paying attention to? What risks and uncertainties need to be paid attention to in the future?

In this regard, China Fund News reporter interviewed 5 investment research professionals, they are:

Wan Minyuan, manager of Rongtong Health Industry Fund

Yuan Zhiyu, Director of Equity Research at Debon Fund

Yin Tao, fund manager of Minsheng Jiayin

Ping An Fund Manager Zhou Sicong

Zhu Mingrui, fund manager of Nord Fund

These fund managers believe that the core reason for the decline in the pharmaceutical industry is the weakness of the A-share market and the sluggish industry fundamentals. After the adjustment, the overall valuation of the pharmaceutical industry is currently low, and the valuation of the CSI Pharmaceutical Index is 25.06 times, which is lower than 98% of the time in history. From the current point of view, the overall downward space of the pharmaceutical sector may be relatively limited. The fundamentals of many pharmaceutical stocks have basically entered the bottoming stage and are expected to usher in a bottom reversal.

Multiple factors lead to continuous adjustment of the pharmaceutical sector

China Fund News reporter: The pharmaceutical sector has continued to adjust downward since its high point in 2021. How do you view the adjustment of the pharmaceutical sector in recent years? What is the core reason behind it?

Wan Minyuan:The core reason for the decline in the pharmaceutical industry is that the A-share market is weak and the industry fundamentals are sluggish. The overall economic recovery is slightly lower than expected. Against this background, the medical insurance policy and price comparison policy, which have little substantial impact on the industry fundamentals, will cause the more sensitive market to overreact.

The fundamentals of the pharmaceutical industry are mainly affected by the fact that the demand in hospitals after the epidemic has not recovered to the pre-epidemic state. In addition, the anti-corruption campaign in the medical field is still ongoing. From July last year to the first half of this year, the entire industry has been repeatedly disturbed by this. However, the anti-corruption campaign in the medical field is actually "short-term short-term and long-term long-term". Centralized procurement, anti-corruption in the medical field, and the reform of earlier drug review policies are important components of China's large medical system reform. In this context of reform, we should pay more attention to real innovation and real treatment needs.

Zhou Sicong:From a fundamental perspective, during the epidemic, the number of hospital consultations and surgeries dropped significantly, resulting in poor performance in most of the pharmaceutical sub-industries. The anti-corruption campaign in the medical sector that began in the third quarter of last year also delayed the recovery of the medical sector to a certain extent. Therefore, in recent years, the performance of most of the pharmaceutical sub-industries has been under pressure, which is the reason for the adjustment of the fundamentals of the pharmaceutical sector.

From the perspective of valuation, from 2019 to mid-2021, most sub-industries of the pharmaceutical sector were at high levels of both absolute and relative valuations. Coupled with the downward trend in performance growth, the valuation digestion process was relatively long, resulting in a decline in the pharmaceutical industry for several consecutive years.

Yin Tao:The main reason for the continued decline of the pharmaceutical sector is that the industry has been facing "internal and external troubles" in recent years. The "external troubles" mainly come from the impact of geopolitics such as the US Biosafety Act, which has led to increased uncertainty in overseas demand; the "internal troubles" are mainly reflected in the fact that with the slowdown in economic growth, the pressure on medical insurance revenue and expenditure has increased, coupled with some tight industry policies, which have affected both the demand and supply of medical care.

Zhu Mingrui:First, the previous wave of sub-sectors represented by CXO and consumer healthcare saw too much growth; second, the overall performance of the consumer healthcare sector was lower than expected; third, the proposed overseas sanctions on CXO companies have a certain impact on the logic of pharmaceutical overseas expansion.

The overall valuation of the pharmaceutical sector is at a historical bottom

Downward space may be limited

China Fund News reporter: CSI Medical valuation is at a 10-year low. What is the current overall valuation situation? Looking forward from the current point in time, what do you think of the trend of the entire pharmaceutical sector?

Wan Minyuan:At present, the pharmaceutical industry as a whole is oversold, and the valuation of the CSI Pharmaceutical Index is 25.06 times, which is lower than 98% of the time in history. Looking forward from the current point in time, we are full of confidence in the entire pharmaceutical industry. The fundamentals of the pharmaceutical industry may usher in a three-year recovery in the medium and long term, and the slope of the recovery will become steeper and steeper.

Zhou Sicong:Since the base date of the CSI Medical Index on December 31, 2004, the pharmaceutical sector has never closed with two annual negative lines. 2021, 2022 and 2023 are the only three consecutive negative lines in history. From mid-2021 to the third quarter of 2022, the adjustment range and duration are rare. The overall absolute and relative valuations of the pharmaceutical industry are at the bottom of the historical range, and the valuations of almost all pharmaceutical sub-industries are also at the bottom range.

The current situation of the pharmaceutical sector is: long-term logic, theme, differences, low valuation, and low holdings.

Specifically, first, there is a long-term logic. The long slope, thick snow, aging and other big logics are conducive to supporting the big cycle market of the pharmaceutical industry;

Second, there are catalysts and hot investment themes in the short term, which will help boost the attention of the pharmaceutical industry;

Third, differences are conducive to the development of the pharmaceutical market. The market is divided on whether the anti-corruption campaign will continue and its impact on pharmaceutical companies, and whether the United States will impose sanctions on China's biopharmaceuticals. However, differences are often conducive to the continuation and long-term development of the market.

Fourth, the valuation of the pharmaceutical industry has fallen back to the bottom of absolute and relative valuations. The decline in institutional holdings after the rebound and the panic selling caused by CXO have returned to an extremely low level. By the end of the second quarter, the proportion of active fund pharmaceutical holdings and the holdings excluding pharmaceutical funds both fell to historical lows.

Yin Tao:At present, the overall valuation of the industry is very close to the historical lowest level. From the highest to the lowest level in just three years, this process is undoubtedly very painful.

Although valuations are being pushed down and the industry is slowing down, we still observe that the diagnosis and treatment business of medical institutions is gradually recovering; medical products with clinical value are still rapidly increasing in volume, accelerating the process of domestic substitution; domestic innovative drugs shine at international academic conferences and make breakthroughs in major cancers; in terms of policy, innovative drugs and innovative devices are also clear directions of encouragement and support. The pharmaceutical industry is transforming from the past low-level duplication of construction to high-quality development led by innovation, just like many industries in my country.

In the short term, looking ahead to the second half of the year, the pharmaceutical industry may gradually get rid of the impact of high base in terms of performance. With the certainty of the demand side, the calendar effect of performance will be expected to drive most targets to complete valuation switching; at the same time, with the economic recovery and the normal development of diagnosis and treatment, industry investment opportunities are gradually coming.

Zhu Mingrui:At present, the overall valuation of the pharmaceutical sector is at a relatively low historical level. From the current point of view, the overall downward space of the pharmaceutical sector may be relatively limited. The fundamentals of many pharmaceutical stocks have basically entered the bottoming stage and are expected to usher in a bottom reversal.

The overall interim report of the pharmaceutical industry is relatively stable

China Fund News: Based on the 2024 semi-annual performance forecast that has been disclosed, what are the fundamentals and profitability of the pharmaceutical industry? What are the highlights?

Wan Minyuan:Judging from the limited previews disclosed so far, there is a big internal differentiation in the sector. For example, some in-hospital drugs and medical devices are affected by the anti-corruption campaign, and the consumer-oriented pharmaceutical retail sector is affected by the high base of the same period last year, which are relatively poor; while the blood products sector and some raw materials have relatively more bright spots.

Zhou Sicong:Judging from the semi-annual performance forecasts that have been disclosed so far, the overall performance of the pharmaceutical industry is relatively stable, but also relatively flat, because last year's second quarter report was a relatively high performance base. However, there are also high-growth sub-industries, such as the innovative drug industry. Many innovative drug companies that have entered the commercialization stage have entered the product volume cycle, and their revenue growth is extremely explosive, and their performance has shown high growth.

Yin Tao:Overall, the performance forecasts of most companies are in line with expectations. However, because the epidemic was just relaxed in the first half of last year, the demand for medicines was high, resulting in a high base for pharmaceutical companies during the same period. Therefore, the apparent growth rate of most companies is average, with few highlights.

Zhu Mingrui:Judging from the semi-annual reports that have been disclosed, the overall performance of the API sub-sector is relatively good. In addition to the contribution brought by the weight loss drug industry chain, the prices of many API varieties have shown an upward trend. However, the pharmaceutical and medical equipment sub-sectors experienced certain performance pressure in the second quarter, but we believe that there is a high probability that there will be some improvement in the third quarter of 2024 compared with the third quarter of 2023.

Focus on innovative drugs, consumer healthcare, and overseas pharmaceutical exports

China Fund News reporter: Due to the policy disturbances in recent years, has the mid- and long-term investment logic of the pharmaceutical industry changed? Which sub-sectors are worth paying attention to?

Wan Minyuan:The mid- to long-term investment logic of the pharmaceutical industry has always been based on the two core variables of "quantity" and "price". "Quantity" benefits from aging and changes in the disease spectrum, while "price" is subject to medical insurance policies. The substantial adjustment of the valuation of the pharmaceutical sector in the past two years is also mainly due to the disturbance of medical insurance policies. The current medical insurance cost control policy has improved marginally and the boundaries are gradually becoming clear.

Currently, the market price of the sector is at a ten-year low, the valuation is near the historical bottom, and the long-term growth logic of the industry has not been destroyed. High-quality pharmaceutical stocks with matching valuations are expected to usher in real value investment opportunities.

There is an expected turning point in the performance rhythm. For example, hospital equipment will get rid of the base effect after the second quarter, and at the same time, there is a potential equipment renewal policy; or it may be oversold varieties caused by market style or short-term pessimistic policy expectations. For example, there are many targets in the pharmaceutical sector with a PB of less than 1, and net assets are mainly cash or easily convertible inventory, concentrated in the IVD sector and the pharmacy sector.

Yin Tao:The mid- to long-term demand logic of the pharmaceutical industry mainly comes from two aspects: one is the increase in the demand for essential medical care brought about by my country's accelerated entry into an aging society, and the other is the increase in the demand for higher-level optional medical care brought about by the increase in my country's per capita disposable income. Although the logic of the industry's demand side has weakened in recent years, in the long run, the people's demand for better medical services is unlikely to change.

In addition, the logic on the supply side is strengthened for innovative drugs/devices, and the most important driving force comes from the recognition at both the national and corporate levels that only innovation can lead development.

In the past few years, the average R&D intensity (R&D investment/operating income) of all listed companies in the A-share pharmaceutical industry has increased every year, from 2.47% in 2015 to 5.66% in 2023, more than doubling; while the total R&D expenditure increased from 17.7 billion yuan in 2015 to 136.7 billion yuan in 2023, an astonishing 6.7 times in 10 years. From the perspective of shareholders, the money earned by companies now has more technological content, which means that they have the opportunity to earn more and more sustainable cash flow in the future.

Zhou Sicong:The pharmaceutical industry's medium- and long-term investment logic based on the long-term prospects of aging and the silver economy has not changed. Although the development of the pharmaceutical industry is greatly affected by policies, national policies have continued to improve in recent years and encourage innovation, which will promote the further development of the pharmaceutical industry in the future, especially the development of innovative drugs and innovative medical devices and equipment.

The innovative drug industry is a clear investment theme for the pharmaceutical industry and even the entire market in the next few years. Encouraging innovation is the will of the state. The innovative drug industry is a typical representative of new quality productivity. The innovative drug sector will have continuous catalysis at the policy level. At the same time, the external authorization of domestic innovative drugs continues to maintain strong growth, which is also a strong main line for going overseas. 2023 is the first year that China's innovative drugs going overseas will exceed the import of innovative drugs. 2024 will be the starting point of the intensive approval period for China's innovative drugs. The number and total amount of external authorizations for innovative drugs in the first half of 2024 have far exceeded the first half of 2023. Starting in 2025, China's innovative drug companies will accelerate the realization of commercial development. 2026 to 2027 will be a new stage for a large number of Chinese innovative drug companies to achieve profitability. We are optimistic about the large-scale market in the innovative drug industry that is just around the corner.

Zhu Mingrui:The medium- and long-term logic of the pharmaceutical industry has changed slightly, but the general direction has not changed. For example, it was previously expected that with the aging population and the increase in people's willingness to consume, consumer healthcare is expected to usher in a state of rising volume and price. However, due to policies such as centralized procurement of dental implants, the consumer healthcare sector has shown a trend of increasing volume and decreasing price, and as a result, the stock price of the consumer healthcare sector has also experienced a significant decline.

In terms of the logic of pharmaceutical overseas expansion, the policy of sanctioning the CXO sector has indeed affected the logic of pharmaceutical overseas expansion to a certain extent, but in some less sensitive areas, the logic of pharmaceutical sub-sectors going overseas still holds. In terms of sub-sectors, the traditional Chinese medicine sector, the innovative medicine sector, and the consumer medical sector are still worthy of attention.

Yuan Zhiyu:The main logic of investment in the pharmaceutical industry has always been to focus on "unmet clinical needs." In addition to the disease field, from a general perspective, investment opportunities that have created treatments from scratch, have increasingly better treatment effects, and can obtain overseas premiums are more worthy of long-term attention.

Pay attention to uncertainties such as R&D failure, medical anti-corruption, and overseas sanctions

China Fund News reporter: The pharmaceutical industry is currently in a relatively sluggish period in the past decade. What risks and uncertainties need to be paid attention to in the future?

Wan Minyuan:In the long term, the risks that need to be paid attention to are that domestic demand is mainly concentrated on payment policies, such as whether medical insurance policies will become more stringent under the expected pressure of future revenue and expenditure balance; foreign demand requires careful consideration of the uncertainty in actual operations, especially in the current context of relatively optimistic pricing for foreign demand. However, in general, the pharmaceutical sector is in a relatively good stage from the perspective of valuation cost performance and odds, and the current opportunities outweigh the risks.

Zhou Sicong:From the perspective of the entire pharmaceutical industry, with the overall upward policy cycle and the background of a new round of global product cycle, the overall risk is not great, but there may still be some uncertainties at the level of individual stocks. For example, whether anti-corruption in the medical field will lead to illegal sales by a certain company, or whether geopolitical tensions will cause disturbances in investment sentiment for individual stocks. But in general, opportunities outweigh risks at the market level, and the overall risk will not be too great.

Yin Tao:Geopolitical issues are currently of great concern to everyone, but the real impact is the domestic demand issue. We expect the macro economy to gradually stabilize and the turning point of demand in the pharmaceutical industry will also come.

Yuan Zhiyu:Trial failure during product development is a risk factor that must be considered in pharmaceutical industry investment. In addition, geopolitical risks will also have a periodic impact on the industry and corporate business, which also needs to be considered more in the short-term investment process.

Zhu Mingrui:In the future, we will focus on the progress of overseas sanctions against the CXO sector, as well as the scale and rhythm of equipment replacement.

Editor: Joey

Audit: Wooden Fish

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