Pacific Securities: The revenue and profits of the raw materials sector in Q3 have accelerated significantly, and we are optimistic about the continued high growth trend in Q4 performance.

Pacific Securities released a research report stating that in the first three quarters of 2024, the total revenue of the raw materials sector achieved a slight year-on-year increase, with the net profit attributable to owners and non-GAAP net profit growing rapidly year-on-year. The profit situation has improved significantly, with both revenue and profits increasing quarter by quarter, and the increase in profits is more evident. The profitability of the sector in Q3 reached a near three-year high, and the valuation of the sector has been slightly adjusted upwards but remains at historically low levels. As key product patents expire and overseas destocking approaches completion, the demand side of the raw materials sector is expected to continue to recover in the fourth quarter of 2024. The main viewpoints of Pacific Securities are as follows: In the first three quarters of 2024, a total of 32 companies were selected in the raw materials sector, with the sector achieving operating income of 89.738 billion yuan (+6.74%), net profit attributable to owners of 12.66 billion yuan (+27.89%), and non-GAAP net profit of 11.63 billion yuan (+24.42%). In Q3 of 2024, the sector achieved operating income of 29.125 billion yuan (+12.64%), net profit attributable to owners of 4.111 billion yuan (+58.93%), and non-GAAP net profit of 3.885 billion yuan (+63.07%). The main reasons for the high-speed growth in profit of the sector in Q3 are as follows: 1) In the second half of 2023, the sector was affected by factors such as product price declines and destocking in the downstream, resulting in a relatively low base; 2) In Q2-Q3 of 2024, global downstream manufacturers gradually completed destocking, raw material pharmaceutical companies gradually resumed shipments, and some companies accelerated the release of new products; 3) In terms of prices, in Q3 of 2023, prices of some products had already dropped to a low level, and in Q3 of 2024, the year-on-year decline in product prices compared to the first half of the year had significantly narrowed; 4) Various companies continue to show cost reduction and efficiency improvement, with a year-on-year decrease in expense ratio; 5) The impact of impairments decreased year-on-year. The profitability of the sector in Q3 reached a near three-year high. In the first three quarters of 2024, the net profit margin of the sector experienced a significant year-on-year increase, and the gross profit margin showed a trend of improvement each quarter. The main reason is that in 2023, the industry faced intensified competition, reduced shipments due to destocking in the downstream, weakening economies of scale, an increase in expense ratio, and substantial decline in net profit margin in the second half of 2023. In the first three quarters of 2024, the decrease in prices of some products gradually narrowed and stabilized, and as global downstream manufacturers gradually completed destocking, shipments of raw material pharmaceutical companies gradually recovered, economies of scale improved, cost reduction and efficiency improvement effects began to show, expense ratio decreased, and the impact of impairments greatly weakened, leading to the restoration of profitability. The valuation of the sector has been slightly adjusted upwards, but remains at historically low levels. Since 2023, the raw materials sector has faced pressure from intensified industry competition and declining product prices, resulting in pressured sector performance and continuous valuation at historically low levels. As of the end of Q3 of 2024, the PE ratio of the raw materials sector was 30.33 times, which is at the 18th percentile historically, an increase of 8 percentage points compared to the end of Q2, and a premium of 19.38% compared to the pharmaceutical and biotechnology industry. Several key product patents are set to expire successively, and the patent cliff is expected to bring incremental demand for raw materials. From 2023 to 2026, the expiration of downstream formulation patents will affect sales by 175 billion US dollars, an increase of 54% compared to the total from 2019 to 2022. In the first half of 2024, the production of raw materials by industrial enterprises with a scale above designated size was 1.789 million tons, a year-on-year increase of 2.2%. Among them, 864,000 tons were produced in Q1, a 7.0% year-on-year decrease, and 924,000 tons were produced in Q2, a 12.8% year-on-year increase. In the first half of 2024, the import of raw materials and intermediates from China to India was 1.685 billion yuan, a 6.78% year-on-year increase, with 827 million yuan in Q1 and 859 million yuan in Q2, corresponding to a 3.35% and 10.41% year-on-year increase respectively. The import volume was 190,700 tons, a significant year-on-year increase of 14.53%, with 91,400 tons in Q1 and 99,300 tons in Q2, representing a 7.21% and 22.18% year-on-year increase respectively. Both import value and import volume reached the highest level in the past four years. Considering the situations in China and India, there is a significant improvement in the demand side of the raw materials industry, indicating that the destocking phase may be nearing its end. Investment recommendations: 1) Continuously expand into the formulation sector in 2024 and focus on stocks with strong performance certainty, such as Aurisco Pharmaceutical (605116.SH) and Zhejiang Ausun Pharmaceutical (603229.SH); 2) Focus on stocks with a high proportion of new product business or relatively aggressive capacity expansion, such as Jiangxi Synergy Pharmaceutical (300636.SZ), Zhejiang Huahai Pharmaceutical (600521.SH), and Hubei Goto Biopharm (300966.SZ); 3) Look at stocks with significant impact from destocking on existing products or relatively low current profit levels but with potential for significant performance recovery, such as Guobang Pharma Ltd. (605507.SH); 4) Consider stocks with investment attributes related to themes like weight-loss drugs, such as Aurisco Pharmaceutical (605116.SH). Risk points: Unexpected delays in capacity release, risk of declining product prices, risk of product R&D and technological innovation, intensified market competition, environmental policy risks, and exchange rate risks.