Huayuan Securities' 2025 pharmaceutical industry investment strategy: Innovation + Aging Population + Overseas Expansion, bullish on structural opportunities.

Huayuan Securities released a research report stating that the pharmaceutical index has been continuously declining for 4 years, and healthcare reform may have entered a stable period. As of 2024Q3, the proportion of healthcare holdings in public active funds is still relatively low, with healthcare valuations continuing to digest and premium rates at historical lows. It is expected that marginal improvement can be expected in 2025, with promising structural opportunities. With anti-corruption becoming the norm, the industry is expected to further recover in 2025, combined with proactive transformation of pharmaceutical companies, innovation, and prospects for overseas expansion. The main points of Huayuan Securities are as follows: Review: The pharmaceutical index has been declining for 4 years, and healthcare reform may have entered a stable period Since the establishment of the health insurance bureau in 2018, the industry has been continuously impacted by structural changes in healthcare. From 2018-2020, collective procurement assets were affected, CXO and consumer assets performed well, core assets performed well from 2020-2022, and pandemic-related assets performed well. Since 2023, traditional Chinese medicine and innovative drugs have performed well, especially since 2024, innovative drugs have stood out. Overall, the pharmaceutical index has dropped by 16% since 2018, and 25% since 2023, excluding the impact of the pandemic for three years. The performance of the index since 2018 has followed the trend since the introduction of the new healthcare reform. Since the establishment of the health insurance bureau in 2018, reforms have been intensified around the "Three-Link" initiative, including efforts in health insurance, pharmaceuticals, and medical services. Currently, healthcare reform has reached a critical phase, with the industry's impact bottoming out. Multiple measures have become normalized, and marginal improvement can be expected, with healthcare expected to stabilize and rise. The proportion of healthcare holdings has decreased, and the current allocation is at a historical low. As of 2024Q3, the proportion of healthcare holdings in active public funds is still relatively low Excluding passive funds, as of 2024Q3, the total market value of healthcare holdings in all active funds is 198.4 billion RMB, accounting for 10.7% of the total portfolio, an increase of 0.09 percentage points compared to the previous quarter, but still at relatively low levels over the past 3-4 years. For non-healthcare themed funds, the proportion of holdings in medical equipment has been the highest in recent quarters, reaching 32% in 2024Q3, followed by innovative drugs which reached 22% in 2024Q3. Healthcare valuations continue to digest, with premium rates at historical lows Taking the PE (TTM) valuation of the pharmaceutical and biological industry in the past ten years, based on the Shenwan A-Share, the analysis shows that the pharmaceutical and biological industry valuation has been at relatively low levels in the past ten years. As of January 12, 2025, the overall PE valuation of the Shenwan pharmaceutical sector is 28.82 times, ranking 12th in the Shenwan primary classification. Outlook: Expect marginal improvement in 2025, optimistic about structural opportunities With anti-corruption becoming the norm, the industry is expected to further recover in 2025. In July 2023, the Central Commission for Discipline Inspection and the National Health Commission launched a concentrated anti-corruption campaign in the healthcare sector. Currently, anti-corruption measures in healthcare have become normalized, and healthcare activities are gradually returning to normal. Additionally, fiscal policies are positive, and hospital tenders are recovering. After a low period of hospital tenders for over a year, the fourth quarter of 2024 has gradually recovered, and with encouragement for equipment updates, hospital tenders are expected to significantly recover in 2025. The health insurance bureau is actively promoting commercial insurance, and healthcare is expected to see an increase in coverage. In 2025, the health insurance bureau will improve the multi-level medical security system, explore innovative drug payment mechanisms, support the inclusion of innovative drugs in reimbursement under comprehensive commercial health insurance, and study the inclusion of Class-B drugs in the catalogue. Combined with proactive transformation by pharmaceutical companies, the prospects for innovation and overseas expansion are promising. The strong rise of Chinese innovation and manufacturing has laid a foundation for high-quality exports by domestic companies. In 2024, high-value BD transactions for innovative drugs have frequently occurred, and breakthroughs have been made in high-end medical equipment and supply chains, with Chinese companies' global competitiveness expected to accelerate. Risk warning: Increased industry competition risk: With continuous innovation and progress in China's pharmaceutical industry, the risk of increased competition from new entrants cannot be ruled out; Policy change risk: Tiered diagnosis and treatment, ongoing healthcare payment reforms, and initiatives such as volume-based procurement may put pressure on downstream revenues and profits in the pharmaceutical industry; Risk of demand falling short of expectations: If end-user demand falls short of expectations, it will have a negative impact on company performance.