Over the past many years, the biomedical industry has been viewed by the market as a high-quality growth track that can cross the cycle, and many super bullish stocks have sprung up. However, after July 2021, the inherent perception of the market was ruthlessly shattered, and China Securities Healthcare drastically retracted by nearly 70%.

Since the beginning of February this year, the general market has rebounded strongly, but the biomedical sector has bucked the trend and is now about to fall below the previous low and return to the level of early 2019. Under all circumstances, the biomedical sector currently has only eight seats with a market capitalization of over 100 billion dollars. Pien Tsai Heng holds one seat, ranking third, after Mindray Healthcare and Hengrui Pharmaceuticals.

As a third-year medical veteran and traditional Chinese medicine brother, Pien Tsai is still retreating by more than 50% from its historical peak, and the evaporated market value exceeds 150 billion yuan. However, the market is still generous. Pien Tzai's current PE valuation is still 49 times higher. There are few companies that can give such a high valuation in traditional Chinese medicine or even on the biomedical circuit. Why is that? What do you think of the current movie series?

01

On April 19, Pien Tsai revealed the report cards for the first quarter of 2023 and 2024. According to financial reports, last year's revenue was 10.058 billion yuan, up 15.69% year on year, and net profit to mother was 2,797 billion yuan, up 13.15% year on year. In the first quarter of this year, revenue increased 20.58%, and net profit to mother increased 26.6%. This is slightly higher than the performance forecast and performance forecast disclosed at the end of January.

Looking at the split, revenue grew by double digits in the fourth quarter, and net profit to mother fell by 6.5%, the third decline in a single quarter in six years. There are two main reasons:

First, the operating costs of the pharmaceutical manufacturing industry (including Pien Tsai and Angong beef yellow pills) increased sharply by 43.3% last year, far higher than the 25.94% revenue growth rate. The reason behind this is a sharp rise in the price of natural beef yolk. The price at the end of 2023 was 1.4 million yuan/kg, which surged more than 140% compared to 570,000 yuan/kg in early 2023. Second, advertising and promotion expenses in the second half of last year increased by 330 million yuan over the same period in 2022, which dragged down net profit performance.

The company's main business, Pien Tsai, is growing rapidly and is relatively stable. The much-publicized cosmetics business had revenue of 700 million yuan last year, an increase of 11.5% over the previous year. Seemingly, the growth was pretty good. The main reason was that the 2022 base was too low, and there was a sharp decline of 24.6% in that year. Looking at it over time, there was a slight increase of 3.2% last year compared to 2021, which is far below the industry average, let alone compared to leaders such as Perea.

The reason for this is mainly due to its own business strategy, that is, over the past few years, it has focused on offline channels for collaborative sales with Pien Tsai Ye Pharmaceutical. The online channel layout is tepid, no special exploits have been released, and no high-end upgrades have been made. Its marketing capabilities and product capabilities are far different from those of cosmetics giants such as Perea.

Pien Tsai's cosmetics business was once highly anticipated by the market, but it is still very poor at present, so it would be nice if it didn't slow down the growth of the main business in the future.

Let's look at profitability again. The gross margin in 2023 was 46.76%, up 1.12% year on year. The increase was not significant. Looking at it separately, the gross margin of drugs used for liver disease, mainly Pien Tsai, fell 2.11%, and Angong beef yellow pills fell 8.44% year on year, all related to a sharp rise in natural beef yolk, even though Pien Tsai's price increased sharply by 28.9% in May last year.

In terms of net sales interest rate, it has rebounded to 31.5% in the first quarter of 2024, which is only slightly lower than the record high of 32.42% set at the end of the third quarter of 2023. During this period, Pien Tsai's internal expenses were well controlled. The latest total sales expenses ratio was only 10.5%, down 10.36% from 2016. Looking at it separately, both the management cost rate and the sales expense ratio have maintained a continuous downward trend, while the R&D expense ratio has maintained a slight upward trend. The latest rate is 2.8%.

Let's look at the dividends again. The dividend ratio will be raised to 50% in 2023, compared to almost 30% in previous years. It can be seen that this time it is in response to the national policy call, and the dividend ratio has increased by nearly 100% compared to the previous one, which has exceeded market expectations.

In summary, Pien Tsai's performance growth rate last year slowed down from the previous high double-digit growth rate (with the exception of 2022, where the growth rate was low due to a high base), which is also an important factor in the sharp decline in valuation. However, the final results for the first quarter of this year were slightly higher than the performance forecast, and a return to high growth of more than 20% is expected to reverse the pessimistic expectations of the past.

02

Duan Yongping, a well-known investor, once said that buying stocks means buying a company; buying a company is buying a discount on its future cash flow, and cash flow is free cash flow, not limited cash. Only a good business model can guarantee future cash flow, and only a deep moat can free and unrestricted cash be guaranteed. If you invest in this way, you may lose countless opportunities, but the chance of making a big mistake will also decrease.

If you look at Pien Tsai in terms of business model, it can be compared to Maotai-like existence. The products are monopolistic, high-margin, repeatable, and scarce. Let's talk about it one by one.

Monopoly. Pien Tsai's exclusive secret recipe created monopoly, unlike Ejiao and Angong beef yellow pills. Pien Tsai Yi is the only product, making the company's operating pressure almost zero, and at the same time, the product has a stronger right to raise prices.

Since its launch in 2005, Pien Tsai's price has increased 13 times. The retail price has increased from 325 yuan to 760 yuan, an increase of 134%. Through continuous price increases, Pien Tsai passed on the price increase of raw materials to consumers and gained a driving force for high performance growth. It is also a spillover of product monopoly.

High gross profit. Pien Tsai's gross profit is about 80%, and the net profit margin is as high as 60%. It is possible to maintain a high ROE without maintaining a high asset turnover ratio and capital leverage. Second, there is no need to invest too much capital to obtain a good return on profits, and rising raw materials have a low impact on companies' profits.

Repeatability. Pien Tsai products have dual properties. One is pharmaceutical properties. There are long-term use and short-term use, but the number of potential users is large enough. One is a health supplement. It relieves alcohol and protects the liver and can be consumed repeatedly.

scarcity. In addition to Pien Tsai's own prescriptions and craftsmanship, the upstream raw material, natural musk, is a precious medicinal herb, making Pien Tzai Lai scarce properties. The supply of musk, snake gall, and beef yolk is limited, causing the supply of pianzai to be in short supply, leading to price speculation in the primary market like Maotai. You need to know that the number of protected varieties of traditional Chinese medicine has been drastically reduced, from 2,469 in 2007 to 204 in 2019. As one of the two first-level protected varieties, Pien Tsai is even more scarce.

The attributes and characteristics of the above four major products determine that Pien Tsai's business model is excellent in the A-share market, and it is also the underlying driving logic for maintaining rapid growth in performance throughout the year. At present, the company's revenue has broken through the 10 billion mark, and future performance growth will inevitably decline, but the core drivers have not yet changed, and growth can still be expected.

However, there is one potential risk point worth tracking and observing.

The country's first batch of first-class protected varieties of traditional Chinese medicine has a total of 6 varieties, namely Fuzi Ejiao, Longmuzhuang Bone Infusion, Pien Tsai Gong, Yunnan Baiyao, and Liushen Maru. Among them, 3 have been adjusted to Level 2 protected varieties; there are only 2 Tier 1 varieties left, namely Pien Tsai Gong and Yunnan Baiyao.

The protected types of Chinese medicines are classified as grade 1 and 2. According to the “Regulations on the Protection of Chinese Medicines”, the protection periods for first-class protected varieties are 30 years (none yet), 20 years, and 10 years, respectively, and the protection period extended each time must not exceed the protection period approved for the first time.

According to the State Drug Administration's Document No. 25 of 2018, the latest protection period for pianzai is from February 7, 2018 to September 15, 2024. It has expired, and it is necessary to track whether Pien Tsai's insurance will be renewed and the possibility of a change in the upgrade. Historically, the Rokushin Maru was a national top secret breed in 1984, and the protection period was permanent; in 1996, it was classified as a first-class protected breed, with a protection period of 10 years. In 2007, it was a second-level protected breed, with a protection period of 7 years.

As a top-secret variety with both formula and craftsmanship, top secret does not mean an eternal protection period; it is also possible to change to level 2 protection later. In particular, for drug varieties that claim to be the sole owner, market speculation, and continuous price increases, there is a small probability that measures such as downgrading the open protection period have formed a market pattern produced by multiple companies. Beware of black swans, profoundly changing the core logic of Pien Tsai's performance growth.

Of course, there is also a potential benefit in terms of demand for Pien Tsai. There are quite a few legendary stories circulating about Pien Tsai Hao's cure for liver cancer patients, but modern technology is unable to explain its effectiveness. As for Pien Tsai Hsiang Company, clinical research on the treatment of liver cancer functions has already begun. There has been some progress in recent years.

In March 2020, the supplementary application for drug registration submitted to increase the functional treatment of pianziline tablets for the treatment of advanced primary liver cancer was reviewed and accepted by the State Drug Administration. In June 2022, Pien Tsai's primary liver cancer treatment program progressed to phase II clinical stage.

According to the minutes of the previous meeting, the second phase of the research report is expected to be delivered in July 2024. After completing the second phase, it is necessary to report to the CDE communication meeting based on the results, and then the State Drug Administration decides whether phase III clinical trials are needed (generally required). Phase III has a larger sample size and is expected to be completed by the end of 2027.

03

Currently, China Securities Healthcare's PE is 27.5 times, which is within the lower valuation range over the past 10 years. It has made a relatively full pricing interpretation of policies such as speeding up collection and expansion, and major disadvantages such as valuation bubbles.

The pessimistic environment of Big Pharmaceuticals also posed a hindrance to Pien Tsai's valuation repair. However, the good news is that the fundamentals of performance have not wavered, and good growth is still there. It is considered one of the few high-quality leaders among hundreds of pharmaceutical companies. The current valuation may still be investigated. Whether it can continue to have good valuation returns in the future also requires tracking and research on potential business risk points. (End of full text)