The good news is that a new round of restocking has begun. The bad news is that manufacturers cannot remain trapped in the ' reliance on luck' cycle forever.

Emerging from the Inventory Cycle, Bulk Raw Materials See Both Volume and Price Increases

In the recently concluded half-year report disclosure season,many raw material pharmaceutical companies have recovered from their downturn, delivering results that exceeded market expectations. Statistics show that a total of 43 raw material companies achieved revenues of 59.18 billion yuan and a net profit of 6.85 billion yuan in the first half of the year. Notably, in Q2 2024, both revenue and net profit saw year-on-year increases of 11.2% and 22.6%, respectively, indicating a significant recovery in profitability. According to another statistic, in H1 2024, publicly listed companies in the raw material sector achieved a combined revenue of 57.068 billion yuan, a year-on-year increase of 5.32%, and a combined net profit of 6.501 billion yuan, a year-on-year increase of 8.23%.

2020Q1-2024Q2 Revenue and year-on-year growth rate of API companies will be at their lowest in 2022 and 2023, and will bottom out and rebound in 2024. Image source: Huayuan Securities Research Institute

Looking back over the past few years, the raw material sector has experienced a volatile cycle marked by price increases,stabilization during the pandemic, andpost-pandemic declines. In mid-2018, the industry faced a toxic gene issue with sartans, prompting some companies to achieve qualitative leaps due to their technical capabilities and responsiveness. This led to a rise in both volume and price, successfully achieving a "Davis Double Play."

By the end of 2020, as leading suppliers restored their output, market competition intensified, leading to price declines and a turning point in the industry’s prosperity. However, due to successful expansions in CDMO businesses among leading companies and a steady demand for pandemic-related drug orders, the trend continued.

Since 2022, as the global economic order gradually normalized, downstream customers began to reduce inventory while industry capacity expanded, putting pressure on both supply and demand, resulting in persistently low gross margins. Particularly in 2023, prices for various specialty raw materials were largely at low levels, reflected in minimal revenue growth and even profit declines on financial statements.

It can be said that the raw material sector has been stuck in the inventory reduction cycle for two years, but now there are signs of recovery. Since H1 2023, inventory levels in the SW raw material sector have been decreasing, and a new round of restocking is expected to begin. In the future, with inventory cycle adjustments and new patent cliffs expanding demand, the supply-demand relationship in the industry is likely to be reshaped.

For example, in the vitamin sector, A-share companies Xinhecheng and Zhejiang Medicine account for nearly half of the global capacity for two key products. Meanwhile, major foreign competitor BASF has faced production halts due to an explosion at its plant, leading to a golden price period for domestic manufacturers. According to the H1 financial reports of various companies, Xinhecheng's revenue and net profit grew by 32.7% and 48.62%, respectively, while Zhejiang Medicine's year-on-year growth rates were 11.87% and 15.82%.

With both price and inventory factors boosting the market, the outlook for bulk raw materials like vitamins remains positive. Additionally, prices for antibioticsand certain other raw materials have seen significant increases, while companies like Aurobindo and Strides have benefited from early transformations into formulation businesses, resulting in rising revenues and profits.

Secondly, medium to long-term attention should be paid to patent cliffs and opportunities in specialty raw materials. From 2023 to 2030, approximately 236 billion dollars worth of pharmaceuticals will face patent cliffs, with increased generic drug production corresponding to heightened API demand. Looking ahead, patent cliffs will present opportunities for specialty raw material companies.

First Half Price Trends in the Raw Material Market

As mentioned earlier, the raw material pharmaceutical industry underwent adjustments in 2023. According to data from the China Pharmaceutical Enterprises Management Association, the revenue of the chemical raw material drug industry decreased by 5.9% in 2023, and profits fell by 13.2%. Based on statistics from the National Bureau of Statistics, China's production of chemical raw materials was 3.949 million tons in 2023, a year-on-year decline of 7%.

Entering 2024, from the reports of publicly listed companies, inventory metrics and inventory turnover days have continued to improve, and prices for most raw materials are gradually bottoming out, with downstream clients nearing the end of their inventory reduction. According to the National Bureau of Statistics, the production of chemical raw materials from January to May 2024 reached 1.459 million tons, a year-on-year increase of 5%, indicating a gradual recovery in industry demand and increased upstream production driven by downstream restocking.

Looking at the PPI index for raw materials, as of May 2024, the index has stabilized around 96.00, with the PPI index for the manufacturing of chemical raw materials showing signs of bottoming out. Considering the factors of downstream restocking and China's ongoing advantages in scale, production processes, and costs, some raw materials with favorable competitive dynamics, such as VD3 and steroid products, may see slight price rebounds in the next 2-3 quarters, reflecting a trend of increasing volume and prices.

In terms of categories, the specific price trends for raw materials in the first half of 2024 are as follows:

Since August, some available price data for raw materials (primarily bulk raw materials) is as follows:

Raw Material Pharmaceuticals Urgently Need to Break the Cycle Curse and Rethink Transformation Directions

The mid-year reports of raw material pharmaceutical companies reflect common challenges in the industry:

Industry Differentiation: Some Companies Need to Break Free from the "Reliance on Luck" Cycle.

On one hand, companies that have successfully navigated their transitions continue to show growth. For instance, in H1 2024, Noratech achieved a year-on-year growth of 107.5% (high growth in peptide raw materials and CDMO), Chuaning Biotech saw a 32.2% increase in antibiotic sales, Aurobindo recorded a 32.2% rise in Dydrogesterone tablets, Strides achieved a 22.7% increase in formulation sales, and Huahai Pharmaceutical experienced a 19.4% boost in both raw materials and formulations. On the other hand, some companies are still experiencing revenue declines despite the industry’s recovery. They need to break free from "cyclical dependency" and seek sustainable transformation rather than relying solely on market recovery for profit.

While Some Companies Accelerate Overseas Expansion, Overall Export Growth Faces a Bottleneck.

Regionally, in H1 2024, some raw material companies reported an average overseas growth rate of about 7%, almost matching domestic growth, with the average share of overseas revenue rising from 54.4% in H1 2023 to 55.7%. However, some companies are now more reliant on domestic markets. For example, Zhejiang Medicine's revenue from domestic sales in 2023 was 71.9%, compared to about 50% a decade ago.

Overall, in the first half of this year, raw material exports totaled $21.34 billion, a slight increase of 0.1%, indicating that while some companies are expanding their overseas business, the overall export situation remains challenging. China’s raw material industry can leverage its robust domestic industrial chain, abundant talent in chemical synthesis, and the technological and systemic advantages accumulated by leading firms to accelerate overseas generics expansion and achieve new market growth.

For the high-profile drug Sitagliptin, as of January 10, 2024, there are 46 companies in India and 38 in China that have activated Sitagliptin phosphate API, together accounting for 82% of global companies. Although China ranks second, the number of companies with international operations is limited, necessitating a faster push for overseas expansion. Among domestic firms, only three have activated Sitagliptin phosphate API products in the U.S., Europe, and China, and only three hold activation certificates in two of those regions.

Image source: Huachuang Securities

Long Transformation Cycles, High Investment, and High Risks Mean Finding the Right Path is Crucial.

As companies in the raw material sector grow, they typically expand into integrated raw materials, formulations, and CDMO areas while attempting to transition to innovative drugs. However, downstream formulation and CDMO sectors are also facing intense competition, leaving limited room for transformation. For example, Jiuzhou Pharmaceutical, which is transitioning to CDMO, reported related revenues of 1.971 billion yuan in the first half of the year, a year-on-year decrease of 20%.

Successful examples of transformation include Aurobindo, which took 25 years (1998-2023) to build its competitive moat and enter the billion-yuan annual revenue club. After laying out its Dydrogesterone formulations, sales increased rapidly, but it incurred significant costs, adding approximately 60 million yuan in new sales expenses in 2023.

Borui Pharmaceutical has ventured into both generics and innovative drugs. However, without successful commercialization of products like Elagolix, Oseltamivir, Micafungin, Argatroban, and Fondaparinux—six formulations where it has raw material advantages—it cannot support the profitability of its formulation business.

For raw material companies that have successfully expanded into CDMO, there remains a significant gap compared to established CDMO giants, making it difficult to secure orders from top pharmaceutical companies or high-end patented raw materials. Except for a few companies like Pro, most may only exist as supplementary businesses in the future.

In summary, due to the long transformation cycles, heavy investments, and high risks associated with wrong project choices in the raw material sector, industry experts recommend focusing on core products first and then expanding into related areas. It is also crucial for specialty raw material companies to seize the opportunities presented by the patent cliff to actively expand and explore overseas markets. Internally, many companies should focus on effectively reducing costs and improving quality.