DBS: The wave of domestic innovative drugs going overseas continues; short-term adjustment pressure may be faced, while the medium- to long-term outlook is positive.

The "15th Five-Year Plan" for the development of the pharmaceutical industry in Mainland China proposes a target for China's first-in-class (FIC) drugs to account for more than 25% of the global total by 2030. Jiang Weiming, Executive Director of Equity Research at DBS Hong Kong, believes that due to the continued emergence of first-in-class drugs, the sales CAGR (compound annual growth rate) of China's innovative drug industry will accelerate to 20% over the next five years, and he holds a positive view on the medium- to long-term outlook. However, affected by new regulations on pharmaceutical representatives and the interest rate hike environment, the industry may face adjustment pressure in the fourth quarter. BeOne Medicines Ltd. (06160) is the bank's top pick. Overseas licensing deals for innovative drugs in the mainland have increased. Jiang Weiming pointed out that, benefiting from multinational pharmaceutical companies (MNCs) facing a "patent cliff" and policy support in Mainland China, the trend of domestic innovative drugs going overseas will be sustainable. However, in the short term, due to interest rate hike pressure and the impact of new regulations on pharmaceutical sales representatives in the mainland on pharmaceutical companies' performance, the sector may see adjustments in the fourth quarter. Jiang Weiming mentioned that the biotechnology industry has historically been negatively correlated with interest rates. These companies need financing to advance research and development, and high interest rates intensify their funding pressure. If the Federal Reserve raises interest rates further, it may continue to put pressure on the sector. On the other hand, the new regulations on pharmaceutical sales representatives that took effect in the mainland in August have forced companies to adjust their marketing strategies, which may drag down third-quarter sales performance. He suggested that investors pay attention to pharmaceutical companies' announced third-quarter results and fourth-quarter guidance. In the long run, however, he believes that China's innovative drug industry is ushering in structural positives. Overseas licensing of mainland innovative drugs has become an irreversible trend. The rising share of first-in-class drugs in the future will continue to provide candidate drugs for overseas licensing, and the profit margin of such deals exceeds 90%, which is expected to drive a re-rating of the industry. Supported by strong research and development, the value of overseas licensing deals for mainland innovative drugs in the first half of this year has almost caught up with the full year last year. He explained that major international pharmaceutical companies are facing a patent expiration crisis caused by patents expiring, and need to replenish their product portfolios by buying licenses. The imbalance between supply and demand gives domestically developed high-quality targeted drugs pricing and bargaining power. At the same time, the mainland government has introduced a series of policies to address the industry's "pain points," including allowing innovative drug prices to remain stable for a period of time (free from price-cut pressure), facilitating inclusion in the National Reimbursement Drug List (NRDL), and providing funding support for small and medium-sized enterprises, among others, to encourage the development of innovative drugs. In terms of stock selection strategy, DBS's top pick is BeOne Medicines Ltd. Jiang Weiming noted that BeOne Medicines Ltd. has its own manufacturing facilities and a large sales team in the United States, which can effectively avoid tariff risks, and the U.S. market accounts for a fairly high proportion of its revenue. During the past biotechnology stock frenzy, as long as a pharmaceutical company announced an overseas licensing deal with a high total value, including upfront payments, milestone payments, and sales royalties, its share price would soar accordingly. However, Jiang Weiming said bluntly that institutional investors have become smarter and are no longer easily swayed by the amount. He admitted that the capital market's attitude toward valuing innovative drugs is now "rigorous." In the past, the market would factor unrealized milestones and royalties into valuations, but now buy-side investors only look at the actual upfront payment amount, that is, how much cash is in hand. In addition, regarding whether "preclinical licensing deals will become mainstream," which the market is watching closely, Jiang Weiming believes that because drugs in the preclinical stage are still being tested "on mice and white rabbits" and are still far from human trials and commercialization, unless it is an extremely rare hot target with very little competition, the market mainstream will still focus on projects that have already entered the clinical stage and have higher certainty.