CITIC Construction Investment: The pharmacy industry is currently recovering moderately, and transformation is expected to catalyze valuation enhancement

According to the Zhitong Finance APP, CITIC Construction Investment has released a research report stating that in recent years, the economic environment, industry policies, and consumer habits have continuously changed. Leading pharmacies are actively adapting to these changes. From a medium to long-term perspective, traditional pharmacy formats may face many development pain points, and differentiated transformation is imperative. Chinese pharmacies may differentiate into two categories: 1) Specialized pharmacies essentially meet the specialized medication needs of patients discharged from hospitals, such as outpatient coordinated pharmacies, dual-channel pharmacies, commercial insurance pharmacies, in-hospital pharmacies, specialty pharmacies, etc.; 2) Diversified pharmacies essentially meet the daily health needs of the public, such as drugstores, maternal and child stores, pet stores, sports stores, convenience stores, experience stores, elderly-friendly stores, and hot commodity stores.

The main viewpoints of CITIC Construction Investment are as follows:

Strategic layout, transformation of the pharmacy industry is imperative

In recent years, the economic environment, industry policies, and consumer habits have continuously changed. Leading pharmacies are actively adapting to these changes. From a medium to long-term perspective, traditional pharmacy formats may face many development pain points: 1) The growth rate of the industry scale is slowing down, and the number of stores has reached a high level; 2) Due to multiple factors, there is an urgent need to target the younger demographic; 3) The trend of controlling medical insurance costs is evident, and the profitability of medical insurance drug sales may weaken. Therefore, the pharmacy industry urgently needs to break through homogeneous development, and differentiated transformation is imperative.

Benchmarking Japan: Gradual advancement of the separation of medicine and pharmacy, diversified formats to gain additional increments

In Japan's pharmaceutical retail industry: the separation of medicine and pharmacy is gradually advancing, and pharmacy companies are developing in a differentiated manner. Benefiting from policy support, Japan's prescription outflow rate has increased from 11.3% in 1989 to about 80% in 2023, with the proportion of outpatient medication continuously rising. The main sales categories of Japanese pharmacy companies include health care (drugs + dispensing), cosmetics, daily necessities, and food. Each pharmacy develops differently based on its own endowments and store locations. For example, Welcia and Matsumoto Kiyoshi focus on specialized drugs, dispensing, and cosmetics; Kanagawa Pharmaceuticals and Yakukodo expand their sales areas, primarily selling convenience goods; and San Holdings focuses on dispensing prescriptions, enhancing external prescription service capabilities. However, these companies do not engage in a single business; they often have diversified business structures.

A thousand stores with a thousand faces, differentiated development reconstructs the Chinese pharmacy ecosystem. The current economic environment in China is quite similar to Japan's past situation, both being in the stage of separation of medicine and pharmacy, and pharmacies are seeking transformation and upgrading. Therefore, Chinese pharmacies may differentiate into specialized pharmacies and diversified pharmacies: 1) Specialized pharmacies essentially meet the specialized medication needs of patients discharged from hospitals and provide channels for specialized products; 2) Diversified pharmacies essentially meet the daily health needs of the public and continuously introduce a diversified non-drug product mix with synergistic effects. In this process, the channel attributes of pharmacies are expected to be further strengthened, while pharmacies may enhance customer traffic and data value through digital transformation and high-value service integration, achieving a transformation and upgrading from traditional retail formats to higher-value service formats Specialized Transformation: Embracing Medical Insurance and Commercial Insurance, Focusing on Professional Capability Building

Specialized Pharmacies: Responding to policy guidance, actively undertaking prescription outflow. Standardizing pharmacy sales behavior will remain a short-term policy focus. As the industry gradually standardizes, the combination of online electronic prescriptions and offline outpatient coordination policies is expected to accelerate implementation. Pharmacy channels will continue to be the main channel for undertaking prescription outflow, and specialized pharmacies may enter a phase of accelerated development.

Outpatient Coordinated Pharmacies: Improving Utilization of Coordinated Funds, Accelerating Prescription Outflow

The sales categories of coordinated pharmacies mainly focus on prescription drugs, which have relatively low gross margins but higher customer traffic and transaction frequency, making the overall net profit margin expected to remain at a reasonable level. Future attention should be paid to the acceptance of internet hospital prescriptions by outpatient coordination policies in various regions and the implementation of electronic prescription circulation platforms.

Dual Channels Assist Prescription Outflow, Continuously Accelerating the Expansion of the Out-of-Hospital Market. Due to reasons such as drug proportion assessments and procurement restrictions in hospitals, it is not possible to promptly equip some high-priced medical insurance negotiated drugs. Therefore, the promotion of dual channel policies essentially guides patients to retail pharmacies, enhancing the accessibility of medications. Currently, leading enterprises are laying out dual channel pharmacies, with the number of qualifications continuously increasing, but the core focus should be on the implementation of prescription outflow platforms and the acquisition of advantageous varieties.

Future Direction One: Embrace Commercial Insurance, Acquire New Growth Drivers. Currently, rapidly growing group insurance, million medical insurance, and benefit insurance models will be carried out by pharmacies for drug compensation, often focusing on special drugs and innovative drugs, which have a strong fit with existing pharmacy formats such as hospital-side pharmacies, DTP pharmacies, and dual channel stores. The difficulty of subsequent transformation and upgrading is relatively low, and the commercial insurance pharmacy format is expected to accelerate implementation.

Future Direction Two: Pay Attention to Policy Changes, Undertake Outpatient Pharmacy Transfers from Hospitals. In 2017, the State Council clearly proposed that regions with conditions could explore separating outpatient pharmacies from medical institutions, but the current progress is relatively slow. Future attention should be paid to changes in hospital interest compensation models and policy intensity. Improvements may lead to various formats such as out-of-hospital pharmacies managing outpatient pharmacies or directly undertaking outpatient pharmacy transfers, and this part of the format will be more closely related to hospitals, which is expected to become a major channel for prescription outflow.

Future Direction Three: Focus on Specific Groups, Create Specialized and Special Disease Pharmacies. As aging deepens and chronic disease populations become younger, the number of chronic disease patients may continue to increase. Pharmacies need to focus on specific diseases, perfecting the product line, professional services, experience, and follow-up in a particular treatment area. Future attention should be paid to the prescription outflow process, while pharmacy channels should also implement a series of supporting measures such as supply chain, products, and services to leverage their specialized advantages.

Diversified Transformation: Thousands of Stores with Unique Features, Building a Pharmacy Health Care Concept Based on Digitalization, Focusing on Category Innovation

Currently, the number of leading pharmacy stores has exceeded 10,000. Due to various factors such as layout regions, surrounding consumption environments, main customer groups, and store attributes, each store may have different transformation directions. However, the transformation concept is relatively consistent, which is that entering a pharmacy is not solely for purchasing medications. During this period, leading pharmacies need to actively promote digital construction, using digital means to classify and grade each pharmacy, and develop specific product systems, transformation paths, and display methods for specific groups, thereby ensuring a solid foundation for professional pharmaceutical services while deeply aligning with regional consumption characteristics to build a pharmacy health care concept The cost of transformation is relatively low, and the direction of transformation is diverse. CITIC Construction Investment believes that diversified transformation does not require a reduction in the number of drug SKUs; it only needs to change the original multi-column display to a single-column display, and then utilize the saved space to display new diversified categories, resulting in relatively low transformation costs. In addition, due to the change in the focus of displayed products, stores can be transformed into various types such as drugstores, mother and baby stores, pet stores, sports stores, convenience stores, experience stores, elderly-friendly stores, and hot product stores.

Digital empowerment: Focus on existing advantages and broaden the service group

Fully utilize data advantages to expand the business scope. At this stage, due to multiple factors such as centralized procurement, price comparison, and the clearing of the pharmacy industry, the pace of the outpatient market is changing relatively quickly. Many small and medium-sized pharmaceutical companies face numerous challenges and difficulties in dimensions such as actual drug demand, price maintenance, volume release pace, and outpatient pricing of centralized procurement products. Leading pharmacy companies and some digital companies with pharmacy sales data (such as Zhongkang Technology) can keenly understand changes in market demand and possess a lot of national and specific regional sales data, enabling them to reverse output some sales solutions to industrial enterprises and accelerate product volume release.

The industry is recovering moderately, focusing on quality leading enterprises

The long-term growth logic remains unchanged, and the industry is expected to recover moderately by 2025. In the long run, the logic of prescription outflow and concentration increase remains unchanged. In the short term, in 2024, affected by price comparison and medical insurance inspections, the stock prices of listed pharmacy companies have reacted relatively fully in the early stage, and the stock prices of the pharmacy sector have also rebounded at this stage. Looking forward to 2025, the trend of marginal improvement in the industry is obvious, and the industry is expected to recover moderately by 2025.

Focus on quality leading enterprises to continuously catalyze valuation improvement. 1) Yifeng Pharmacy (603939.SH): Significant professional advantages and strong operational resilience; 2) YIXINTANG (002727.SZ): Significant diversification advantages, pilot results are evident; 3) DSL (603233.SH): Continuous progress in cost control, gradually exploring diversified transformation; 4) Lao Baixing (603883.SH): Strong digital capabilities and significant professional service advantages; 5) JZJ (605266.SH): Focus on the big health category and carry out diversified transformation.

Risk Warning

Tightening of medical insurance policies, slower-than-expected store expansion progress, declining store profitability, slower-than-expected prescription outflow progress, and goodwill impairment provisions