China Securities Co., Ltd.: Multiple factors accelerating consolidation of the pharmaceutical distribution market, leading companies' valuations are expected to improve.

China Securities Co., Ltd. released a research report stating that the pharmaceutical distribution industry is experiencing steady growth and increasing market share. With the restoration of order in hospital treatments combined with long-term growth in medical insurance expenditures, the pharmaceutical distribution industry has sufficient growth momentum. Additionally, the introduction of a prepaid fund policy by the Medical Insurance Bureau is beneficial for the industry's scale and efficiency improvement, and the acceleration of growth in innovative businesses has also contributed to additional growth. Furthermore, factors such as centralized procurement and economies of scale have led to clear advantages for leading companies, accelerating market concentration. Key points from China Securities Co., Ltd. include: Industry Overview: Market size is steadily expanding with continued support from various factors The demand for household drugs is increasing, leading to steady growth in the pharmaceutical distribution industry. Since 2011, with steady growth in disposable income per capita, expanded coverage of medical insurance, increased supply of drugs, and an increase in awareness of health among residents, the demand for household drugs has continued to grow. The sales revenue of China Meheco Group in the distribution market has increased from 751.1 billion yuan in 2011 to 2.2902 trillion yuan in 2023, with an annual compound growth rate of 9.7%. In addition, the accelerated repayment by the Medical Insurance Bureau to hospitals is beneficial for the industry's scale and efficiency improvement. Various factors support growth in the short and long term. In the first three quarters of 2024, the performance growth of listed companies slowed down due to various factors. However, factors such as compliance sales within hospitals and centralized procurement have continued to accelerate the market concentration, with leading companies enhancing their innovation business development and expected positive operations. Furthermore, the current stage of steady growth in medical insurance expenditures provides long-term growth momentum for the pharmaceutical distribution market. Industry Trends: Various factors promote the acceleration of market concentration, and innovative businesses and outpatient markets are developing rapidly Industry barriers are apparent, with various factors promoting the acceleration of market concentration. Currently, China has formed a competitive landscape with "4 national + several regional" players, among which SINOPHARM (A state-owned enterprise), CHINARES PHARMA, Shanghai Pharmaceuticals Holding, and Jointown Pharmaceutical Group, leading the first tier of logistics and distribution networks covering the entire country. The company believes that factors such as expanding centralized procurement, highlighting economies of scale, and transitioning hospital-side demand will further enhance the operational advantages of leading companies, leading to an accelerated increase in market concentration. Accelerated growth in innovative businesses continues to contribute additional growth. Listed pharmaceutical companies are actively promoting the transformation and innovation of their businesses, focusing on optimizing their overall profitability with synergistic businesses around their main distribution operations: 1) Engaging in comprehensive commercial insurance services covering the entire supply chain; 2) Upstream: Focus on the research and development of industrial products such as drugs, equipment, specialty medical foods, and medical beauty products; 3) Distribution industry: Engaging in innovative businesses such as Supply, Processing, and Distribution (SPD), innovative drug marketing, and contract sales organization (CSO); 4) Downstream: Engaging in comprehensive disease management, large medical equipment maintenance, and systematic support for pharmacies and clinics. Outpatient markets are growing rapidly, continuously stimulating terminal demand. The company believes that with the implementation of outpatient coordination policies and the increasing awareness of residents' health, the scale of drug use in outpatient markets is expected to accelerate, driving upstream distribution companies to accelerate their expansion into outpatient markets. Research Framework: Focusing on multiple indicators, optimizing state-owned enterprise reform valuation Stable revenue growth, continuous improvement in cash flow. The revenue growth in the pharmaceutical distribution industry mainly comes from the increasing proportion of medical institutions covered by drug supplies and the increasing number of covered medical institutions. There are differences in gross profit due to the different proportions of centralized procurement of drugs and equipment sales. The sales expense ratio is showing a slow downward trend, while management expenses and financial expenses remain relatively stable, leading to continuous improvement in cash flow. State-owned enterprise reforms continue to be implemented, and the valuation system is expected to be optimized. In 2023, a new round of state-owned enterprise reform top-level design was implemented, focusing on "functional reform" and "system and mechanism reform." On January 24, 2024, the State-owned Assets Supervision and Administration Commission announced the further inclusion of market value management in the performance assessment of central enterprise leaders, attracting market attention. The valuation level of pharmaceutical distribution companies is relatively low, but their defensive attributes are evident. With the reform of state-owned enterprises and the improvement in dividend payout ratios, the valuation system is expected to be optimized. Risk Warning: The progress of state-owned enterprise reforms is difficult to predict, drug price reductions exceed expectations, market competition intensifies, product development risks, policy risks, underperformance of targets in external mergers and acquisitions leading to significant impairment of goodwill.