China Galaxy Securities has released a research report indicating that after a significant pullback in the pharmaceutical sector during the first half of the year, valuations for both innovative and non-innovative drugs have retreated to historic lows. The firm highlights that investors should focus on medical insurance policy changes and the clinical data readouts of innovative drugs in the second half. The recommended investment strategy centers on identifying hardcore medical technology and factoring in corporate cash value, with a preference for innovative drug developers with BIC and FIC pipeline leaders, the innovative drug supply chain covering CDMOs and life science upstream sectors, innovative medical device players expanding overseas in imaging and high-value consumables, and the medical AI theme. The report also notes potential opportunities in the recovery of medical services and third-party ICL providers.
The sector has entered a recovery cycle, characterized by the coexistence of high prosperity in the innovation chain and the ongoing clearing of traditional segments. In the first half of 2026, listed pharmaceutical companies recorded a 3.3% year-on-year increase in revenue and an 8.8% rise in net profit attributable to shareholders, while non-recurring deducted net profit surged by 29.2%. The modest top-line growth coupled with improving bottom-line performance was primarily driven by stronger-than-expected order growth for CDMO and life science upstream R&D services, the recognition of overseas BD licensing revenues, and the commercial ramp-up of new products following their launch and inclusion in medical insurance. Meanwhile, in vitro diagnostics and commercial retail segments saw marginal recovery from a low base last year, whereas traditional pharmaceuticals, traditional Chinese medicine, vaccines, and blood products continued to face earnings pressure, underscoring pronounced divergence within the industry. The profit growth outpacing revenue gains can be attributed to a larger share of high-margin innovative drug commercialization and out-licensing revenues, alongside the high prosperity in CDMO and research services, where rising orders fully utilized earlier capacity expansion and headcount investments, thereby diluting fixed costs and boosting profitability.
Industry profitability is showing structural repair, although overall operational quality remains in a low range. In the first half of 2026, the average gross margin and net margin across the pharmaceutical sector stood at 51.6% and 9.4%, respectively, reflecting a solid product margin foundation. Sales expense ratio and R&D expense ratio were 19.0% and 14.2%, respectively, signaling a shift from a traditional sales-driven model to an R&D-driven approach; however, heavy commercialization spending and R&D outlays continue to cap profit conversion rates. On operational quality, the industry's return on equity was 2.5% in the first half, down 0.5 percentage points year-on-year, remaining at historical lows. Accounts receivable turnover days extended to 116.6 days and inventory turnover days to 229.9 days, both up from the prior-year period, reflecting slower payment cycles from hospitals and distributors, weak demand in traditional segments causing channel inventory buildup, and generally subdued operational efficiency.
The commercialization and out-licensing monetization of innovative drugs are unlocking long-term growth potential. In the first half of 2026, several innovative drug companies saw accelerated commercial sales of their core products, with blockbuster drugs including zanubrutinib, furmonertinib, and mazdutide consistently exceeding expectations. During the period, the total value of out-licensing BD deals from Chinese innovative drug developers approached $100 billion, with upfront payments and milestone revenues being recognized, significantly amplifying revenue and profit growth rates. Among representative innovative drug companies selected by the brokerage across A-shares and H-shares, combined revenue for the first half increased by 50.11% and 40.71%, respectively, with multiple firms achieving profitability ahead of schedule while maintaining positive growth in R&D investment. Looking at the medium-to-long-term horizon, supportive policies for the innovative drug supply chain are expected to be further refined, with the industry's positioning as an "emerging pillar industry" broadening its upside potential. The steady rise in BD out-licensing activity, combined with multiple favorable catalysts, is driving a value restructuring for innovative drug companies, paving the way for sustained long-term growth.
Risk warnings: The report highlights risks including insufficient medical consumption growth due to increased macroeconomic pressure, policy shortfalls in medical insurance reimbursement for innovative drugs, the potential shift of global orders amid geopolitical tensions, and the possibility of centralized procurement or fee reductions exceeding market expectations.
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