This direction has huge potential!
2024-08-13
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(The author of this article is Xue Hongyan, Vice President of Xingtu Financial Research Institute)
If there is an industry that is recognized for its excellent historical performance and broad prospects, the pharmaceutical industry will definitely have a place; if there is an industry that has both consumer and technological attributes, which can defend steadily in a bear market and attack fiercely in a bull market, the pharmaceutical industry will also have a place.
In fact, both US and A-shares have excellent performance records for pharmaceutical stocks. The S&P 500 Equal Weight Healthcare Index has an annualized return of 12.12% since 1990 (August 8, 2024, the same below); the CSI Pharmaceutical 50 Index has an annualized return (including dividends) of 13.37% since the end of 2004.
Because of this, a large number of investors have been trapped in the pharmaceutical sector during the past three years of adjustment.
Similarly, the CSI Pharmaceutical 50 Index has fallen by an average of 22.06% over the past three years, and has fallen by 61% from its peak in February 2021. Based on their long-term belief in the pharmaceutical sector, many investors either increased their positions when the market fell or made fixed investments, all of which suffered heavy losses.
What is the inspiration? Buying at a low price is always the best way. It is not the pharmaceutical sector that is wrong, but buying at a high price is wrong.
Since 2017, driven by the dual catalysis of supply-side reform and residents' leverage, the leading white horse style of A-shares has gradually become dominant. By 2020, public funds with heavy positions in white horse style have been popular, and a large amount of funds have poured in, creating a positive feedback loop, and leading white horse stocks have gradually entered a bubble state.
As a typical blue chip stock, the pharmaceutical industry also reached a high valuation in early 2021, with the industry's static unemployment rate exceeding 60 times. A large number of investors began to invest in the pharmaceutical industry at this stage and entered the market at a high level. In the subsequent decline, in order to dilute the cost, they bought more as the price fell, gradually increased their positions, and suffered heavy losses.
Since 2021, the pharmaceutical sector has been adjusted for three years, and the current industry valuation is at a historical bottom. From a fundamental logic point of view, in the past few years, the pharmaceutical sector has encountered multiple pressures such as policies, industries, demands, and external environment, and its valuation has repeatedly hit new lows. A brief analysis is as follows:
(1) On the payment side, faced with the pressure of centralized procurement and medical insurance cost control. In recent years, in order to cope with the pressure of medical insurance expenditure under the background of population aging, the pharmaceutical industry has carried out a series of reforms and rectifications based on cost control, including but not limited to the substantial price cuts of drugs and equipment under the pressure of centralized procurement; DRG/DIP reforms on the hospital payment side to control disease costs; the implementation of the two-invoice system on the circulation side to squeeze out water, and the promotion of drug price transparency in terminal pharmacies; and the strengthening of anti-corruption in the pharmaceutical industry and the rectification of the industry on the hospital side.
As a result, the expectations for stable cash flow of pharmaceutical companies formed over the past decade have been shattered, and pharmaceutical stocks have suffered a double whammy in terms of valuation and performance.
(2) On the market side, the COVID-19 pandemic has caused high volatility in the performance of the pharmaceutical sector. From 2020 to 2022, driven by the surge in demand during the pandemic, pharmaceutical companies' profits grew rapidly, masking the impact of factors such as medical insurance cost control; in 2023, the pandemic-related demand plummeted, the pressure on medical insurance cost control increased, and the pharmaceutical sector's profits fell sharply, suppressing the sector's valuation.
Taking the Pharmaceutical 50 Index as an example, the net profit attributable to the parent company of the constituent stocks in 2023 fell to 86.984 billion yuan, a year-on-year decline of 29.1%; in the first quarter report of this year, it continued to decline by 15.83%. Although the decline has narrowed, it is still negative growth. The second quarter report has not yet been released, but according to the statistics bureau, the total profit of the pharmaceutical manufacturing industry in Q2 increased by 8.99% year-on-year, which has turned positive.
(3) Geopolitical factors have increased uncertainty in the innovative drug sector. As my country's innovative drugs are still in their infancy, the world's high-value new drugs are concentrated in European and American multinational pharmaceutical companies, and the orders of domestic CXO leaders are highly dependent on overseas markets. In the context of deglobalization, the uncertainty of the operating prospects of domestic CXO companies has increased. In addition, under the high-interest environment, the global innovative drug venture capital activity has declined, and the valuation of the A-share innovative drug industry chain has shrunk significantly. Innovation is the driving force of the pharmaceutical market. The innovative drug sub-sector is weak in upward movement, which in turn suppresses the valuation space of the entire pharmaceutical sector.
Having said that, are the above factors going to be reversed?
In fact, not really. In addition to the epidemic disturbance becoming a thing of the past, medical insurance cost control and geopolitical risks are expected to exist for a long time, otherwise, the valuation of the pharmaceutical sector would have rebounded long ago.
For the vast majority of investors, the correct way to invest in the pharmaceutical sector is not to predict changes in national medical insurance policies in the next few months, the progress of leading companies going overseas, or the impact of the US biosafety bill, etc. These are beyond our capabilities.
All investors need to focus on is the long-term prospects and current valuations. If the long-term prospects are good, the development space is large, and the current valuation is cheap enough, then you can buy the pharmaceutical sector and wait for changes to happen.
The current valuation of the pharmaceutical sector is low enough, and the long-term development space is still broad, and the investment conditions are ready. In terms of changes, some positive factors are also fermenting, such as the normalization of anti-corruption and centralized procurement in the pharmaceutical industry, the global interest rate cut cycle, and the strengthening of domestic policy support for innovative drugs. The valuation suppression factors of the pharmaceutical sector have been significantly alleviated.
As for the long-term development space, it is still a long way to go. According to the data of the National Health Commission, between 2013 and 2022, my country's total health expenditure will increase by an average of 11.6% per year, and its share of GDP will increase by 1.4 percentage points to 7%. Considering the trend of my country's aging population, the increase in per capita income and health awareness, and the large gap with major countries in the world (the US's healthcare expenditure accounted for 17.3% of GDP in 2022), my country's total health expenditure will continue to grow at a higher rate than the GDP growth rate in the future. Accordingly, the fundamental prospects of the biopharmaceutical industry remain broad.
In terms of target selection, for ordinary investors, pharmaceutical investment has both bad news and good news. The bad news is that pharmaceutical companies are highly specialized and have a fast pace of innovation and iteration, so the research threshold is high and investment uncertainty is great; the good news is that the pharmaceutical sector as a whole can achieve ideal returns through index investment. As Buffett said in his 2008 letter to shareholders:
"We don't know how to view the drugs that pharmaceutical companies are developing. Even if we understand them now, in five years, another batch of new drugs will be in the research and development stage. We don't know which one of Pfizer and Merck has more potential, and we don't know which one can develop a blockbuster new drug. What we know for sure is that the companies we bought as a portfolio are reasonably priced, and their overall performance in the future should be good."
Buffett said something similar in 2002: "The long-term performance of the medical industry is very good. In 1993, we did not invest in pharmaceutical stocks. We made a mistake. It is difficult to pick the biggest winners, but making a combination will definitely work."
Back to A-shares, we cannot predict when the pharmaceutical sector will reach its right side, let alone pick out the stocks with the largest gains in the next few years. However, based on historical rules, if we invest in the pharmaceutical sector now and hold on patiently, we will most likely achieve good investment returns.
This article only reflects the author’s views.
