Seize the value of innovative leaders and explore the opportunity in Hong Kong stock pharmaceutical allocation after the market slump.

Since the beginning of this year, in the pharmaceutical sector, Hong Kong stocks have shown a more cost-effective investment value compared to A shares. In terms of performance in the first half of 2024, influenced by multiple factors such as macroeconomic conditions, high base of the sector from the previous year, and the passage of the U.S. Biosecurity Act, both the pharmaceutical sectors in the AH markets experienced a downturn. However, due to the differences in market investor structure and liquidity between the two markets, the extent of the downturn varied. As of June 30, 2024, the CITIC Pharmaceutical Index, Hang Seng Healthcare, and Hang Seng Hong Kong-listed Biotechnology Index fell by 20.0%, 27.6%, and 27.8% respectively compared to the end of 2023. In the second half of this year, the performance of the pharmaceutical sectors in the AH markets also showed different levels of volatility. Looking at the performance in Q3 of this year, as of September 30, the CITIC Pharmaceutical Index and the Hang Seng Healthcare Index fell by 5.6% and 4.9% respectively. In a period of three months, the decline in Hong Kong stocks narrowed much more than in A shares, indicating that Hong Kong stocks emerged from the market bottom earlier than A shares. As of December 27, the CITIC Pharmaceutical Index and the Hang Seng Healthcare Index fell by 10.75% and 19.48% respectively. In terms of the depth of the decline, Hong Kong stocks in the pharmaceutical sector undoubtedly offer better value for investment. The reason for this may lie in the fact that the 18A companies in the Hong Kong pharmaceutical sector are more sensitive to policy changes and interest rate movements compared to A shares. Coupled with the relatively advantageous chip structure in Hong Kong stocks, this ultimately makes Hong Kong stocks in the pharmaceutical sector have a higher potential for value investing. Behind the warming trend of Hong Kong pharmaceutical IPOs Recently, there has been a noticeable warming trend in Hong Kong pharmaceutical IPOs, in stark contrast to the first half of the year. In the first half of this year, only 5 pharmaceutical companies successfully went public in Hong Kong, indicating a bleak trend in the IPO approval environment, but this situation changed significantly in the second half of the year. As of December 27, the total number of pharmaceutical companies submitting IPO applications in Hong Kong reached 51, an increase of over 30% from the previous year's 39 companies, and the number of first-time applicants was 25, basically unchanged from the previous year's 24. Looking at the performance in each quarter of this year, it is evident that the number of pharmaceutical companies submitting IPO applications in Hong Kong in the first three quarters of 2024 was basically the same as the same period in the previous year. It was not until the fourth quarter that, thanks to the impact of the stimulus policies in the Chinese capital market since September, the number of companies submitting IPO applications increased significantly. In November, 9 healthcare companies submitted prospectuses, and in the first half of December, another 5 companies followed suit, setting a new record for the year. The warming trend in Hong Kong pharmaceutical IPOs may be related to the policy trends in the AH markets and the overall IPO performance in Hong Kong. On the one hand, from a policy perspective, since August 2023 when the China Securities Regulatory Commission announced a phased tightening of the IPO pace, the IPO access has become stricter, and the process of IPO application acceptance has slowed. Prior to this, the A-share Sci-Tech Innovation Board amended the listing approval standards for pharmaceutical companies, increasing the requirement for cumulative R&D investment amount from "over 60 million yuan" in the past three years to "over 80 million yuan"; the number of "invention patents" required from "5 or more" to "7 or more"; and the requirement of the "compound growth rate of operating income reaching 20% in the past three years" to "25%". Apart from operational and financial performance, sales compliance and innovation attributes have become the focus of the review for listing on the Sci-Tech Innovation Board. As a result of these policy adjustments, some biopharmaceutical companies in the queue for listing chose to voluntarily withdraw their applications. Data shows that out of a total of 25 new listings on the A-share market so far, only 2 are in the pharmaceutical sector, while more than 50 healthcare companies from among the three major exchanges chose to terminate their audit process. Faced with a sudden surge in IPO demand, Hong Kong stocks have undoubtedly become an important option for meeting the demand. On the other hand, in Hong Kong, on April 19, the China Securities Regulatory Commission announced 5 measures for capital market cooperation with Hong Kong; on October 18, the Hong Kong Securities and Futures Commission and the Hong Kong Exchange jointly announced the optimization of the timetable for the approval process of new listings. These measures have provided policy support and convenience conditions for mainland healthcare companies to list in Hong Kong, leading to more healthcare companies choosing Hong Kong stocks as their IPO route. Furthermore, since the second half of this year, as the performance of Hong Kong stocks market has improved, IPO new stocks have received a more positive response from the market. For pharmaceutical companies, this market trend will help alleviate the contradiction between the past high valuation of financing and the enthusiasm of market investors. From a data perspective, based on the current situation of IPO applications launched in the Hong Kong market, the number of companies expected to land on the main board through IPO in the whole year of 2024 is estimated to be between 67-69, which is roughly the same as the 68 companies in the previous year. However, the corresponding net raise of funds has increased significantly. As of the third week of December, a total of 62 IPO new companies have been listed on the Hong Kong main board, with a net raise of funds amounting to 71.628 billion Hong Kong dollars, an increase of 89.95% compared to 37.708 billion Hong Kong dollars in the previous year. In addition, In the second half of this year, the average subscription ratio for international allocation of Hong Kong IPOs has reached 4.19 times, higher than the 1.56 times in the first half of the year, which indicates a significant increase in market activity and has become an important factor for domestic pharmaceutical companies to choose Hong Kong stocks. Significant differentiation in 18A, focus on top value by funds As mentioned earlier, the reason why Hong Kong stocks pharmaceuticals have a higher potential for value investing largely comes from the 18A sector, but entering the 18A does not mean worry-free. On the contrary, only showing top value can attract the favor of funds. It is understood that currently, about 80% of the pharmaceutical sector in Hong Kong stocks are small-cap enterprises with a market value below HK$1 billion, and the market value of companies in the sector varies greatly. Under the dual factors of liquidity in most stocks being extremely poor, this phenomenon is more pronounced in 18A enterprises. Especially in the last three years since 2021, the average and median monthly turnover of the pharmaceutical sector in Hong Kong stocks were 146.6 billion Hong Kong dollars and 128.1 billion Hong Kong dollars respectively, with an average daily turnover of only 6.6 billion Hong Kong dollars, increasing to 8.8 billion Hong Kong dollars per day only in the fourth quarter of this year. For 18A, this is the problem of "more wolves and less meat", which also makes funds in Hong Kong stocks more concerned about the top value that companies show, intensifying differentiation within the 18A. Statistical data shows that out of the current 66 listed 18A companies in Hong Kong, a total of 20 companies have a market value below 1 billion Hong Kong dollars, accounting for 31%; 21 companies have a market value of 10-30 billion Hong Kong dollars, accounting for 32%. It is worth mentioning that, apart from the top 30% of companies, the remaining 70% ...The valuation of 8A enterprises has dropped by over 50% from historical highs. Most enterprises have a daily turnover of less than one million Hong Kong dollars, and some even have only tens of thousands of Hong Kong dollars.According to Southwest data, the total revenue of the selected 50 18A sample companies in the first half of 2024 is 29.5 billion yuan, with a net profit of -12.08 billion yuan; the revenue growth in the first half of this year is -2.83%, while the net profit growth is 26.4%, and the non-GAAP net profit growth is 40.8%. There are 27 companies that achieved revenue growth in the first half of this year, accounting for 54%; 15 companies achieved profit growth in revenue, accounting for 30%. Although the performance of the top companies varies, they are basically in the niche segments of innovation, scarcity, strong defensive attributes, and high dividends. For example, in the past two years in the Hong Kong 18A market, BEIGENE (06160) as a preliminary mature Biopharma, has become the company with the highest market value in the Hong Kong 18A market; in addition, top Hong Kong 18A innovative drug companies such as EVEREST MED-B (01952), HENLIUS (02696), ASCENTAGE-B (06855), SKB BIO-B (06990), while continuously releasing their own innovative value, have also achieved impressive growth in their stock prices. Guosen Research points out that from the supply side, the industry is undergoing a more intense supply side structural reform and is expected to enter a new growth cycle by 2025. Since 2019, the industry's loss ratio has been increasing year by year, stabilizing at over 30% this year. The healthcare industry continues to be affected by external factors such as macroeconomics, geopolitics, and medical insurance cost control policies. Leading companies have shown strong resilience in this round of industry consolidation cycle, further increasing market share. After the industry hits bottom and rebounds, they are expected to demonstrate stronger competitiveness.