Value Analysis of the Traditional Chinese Medicine Industry-Liaoning Chaohua Pharmaceutical Co., Ltd.

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Value Analysis of the Traditional Chinese Medicine Industry

Release Date:

2021-02-05

Value Analysis of the Traditional Chinese Medicine Industry

Chapter 1: Industry Overview

Medicines that are guided by traditional Chinese medical theory in their collection, processing, and formulation; that elucidate their mechanisms of action; and that inform clinical application are collectively referred to as “traditional Chinese medicines” (TCMs). In brief, TCMs are substances used under the guidance of TCM theory for disease prevention, treatment, and diagnosis, and which also confer therapeutic and health-promoting benefits. “Crude herbal materials” refer to unprocessed or unfinished TCM raw materials suitable for pharmaceutical preparation, typically derived from natural plants, animals, and minerals. “Processed herbal slices” are crude herbal materials that have undergone specific processing and preparation, and can be directly used in compounding or formulation. “Prepared patent TCMs” are TCM products made from crude herbal materials according to prescribed formulas and manufacturing processes, under the guidance of TCM theory, with the aim of disease prevention and treatment; they are commercially available TCM preparations approved by the national drug regulatory authorities. Based on the complexity of their processing, TCMs can be classified into four major categories: crude herbal materials, processed herbal slices, prepared patent TCMs, and cosmeceuticals. According to the source of the medicinal materials, TCMs can further be divided into three main categories: plant-based, animal-based, and mineral-based.

Figure: Panoramic View of the Pharmaceutical and Biotechnology Industry Chain

Source: Asset Information Network, Qianji Investment Banking

Since 2005, the growth rate of China’s traditional Chinese medicine (TCM) industry has generally remained above 20%, outpacing the average growth rate of the pharmaceutical sector. In 2019, the area under TCM herb cultivation in China reached approximately 2.6075 million hectares, and the market size of TCM in China totaled RMB 715.3 billion. The TCM industry accounted for 0.82% of China’s GDP; although its market size and share of the overall economy remain relatively modest, it is a distinctive industry in a major manufacturing country and serves as a foundational sector of the national economy, directly linked to both agricultural and industrial production.

Figure: Classification of Traditional Chinese Medicines by Source of Raw Materials

Chapter 2: Business Models and Technological Development

2.1 Industrial Chain, Value Chain, and Business Model

2.1.1 Industrial Chain and Value Chain

The traditional Chinese medicine industry chain comprises numerous links, spanning agriculture, manufacturing, and commerce. Due to historical factors and operational characteristics, many segments of the chain remain relatively fragmented; however, the manufacturing segment stands out, benefiting from robust production processes and a strong portfolio of branded products that create significant competitive moats. As a result, this segment tends to generate higher profit margins and is more conducive to the emergence of large-scale enterprises, particularly in areas such as proprietary Chinese patent medicines and processed Chinese medicinal materials—including formulated granules.

Upstream: The efficacy of traditional Chinese medicine products depends on the quality of crude herbal materials; the stability of supply and the quality level of these materials directly affect both production and end-consumer satisfaction. Consequently, midstream players in the TCM industry chain have limited bargaining power vis-à-vis upstream suppliers. Moreover, given the scarcity of cultivated substitute varieties, crude herbal materials remain heavily reliant on natural resources.

Midstream: Compared with manufacturers of proprietary Chinese medicines, Chinese medicinal herb-processing enterprises are less scaled and industrialized. Many small-scale herbal-processing firms operate as family-run workshops, often under the household-factory model, and lack standardized production practices. Coupled with weak industry oversight, this results in a lack of uniform standards for processing Chinese medicinal herbs, leading to inconsistent product quality and posing significant quality and safety risks for downstream retailers when sourcing these products.

Downstream: The downstream sales channels in the traditional Chinese medicine industry chain directly serve consumers of TCM products. Given the large number and dispersed nature of proprietary TCM manufacturers in the midstream, coupled with low market concentration and severe product homogeneity—resulting in a lack of core competitiveness and intense intra-industry competition—downstream sales channels enjoy relatively strong bargaining power due to the wide array of options available.

Figure: Industrial Chain of China’s Traditional Chinese Medicine Industry

Source: Asset Information Network, Qianji Investment Banking

Figure: Complementary Sub-sectors in the Traditional Chinese Medicine Industry

Source: Asset Information Network, Qianji Investment Banking

Figure: Analysis of the Industrial Value Chain in the Traditional Chinese Medicine Industry

Source: Asset Information Network, Qianji Investment Banking

Figure: Analysis of the Traditional Chinese Medicine Industry

Source: Asset Information Network, Qianji Investment Banking

Figure: Flowchart of Traditional Chinese Medicine Material Processing Techniques

Source: Asset Information Network, Qianji Investment Banking

2.1.2 Business Model

Source: Asset Information Network, Qianji Investment Banking

Figure: Corporate Evaluation—A Six-Factor Assessment Model Using Huatai Pharmaceutical as a Case Study

Source: Asset Information Network, Qianji Investment Banking

2.2 Technological Development

The processing technology is the core of pharmaceutical manufacturing and determines the quality and therapeutic efficacy of traditional Chinese medicine decoction pieces.

Figure: Traditional Chinese Medicine Processing Techniques

Source: Asset Information Network, Qianji Investment Banking

The digitalization of traditional Chinese medicine permeates the entire TCM industry chain, providing IT solutions for agriculture, TCM research and development and manufacturing, and distribution. This enhances the efficiency of agricultural cultivation and operations, optimizes R&D and production processes, and enables end-to-end traceability in pharmaceutical quality management.

Figure: Information Technology Industrial Chain for Traditional Chinese Medicine

Source of Information: Asset Information Network, Qianji Investment Bank

2.3 Policy Regulation

Chinese medicinal decoction pieces are classified as part of the pharmaceutical industry, subject to stringent regulation by relevant government authorities and coordinated and guided in their development by industry self-regulatory associations. The pertinent government regulatory bodies include the National Health and Family Planning Commission, the National Medical Products Administration, the State Administration of Traditional Chinese Medicine, and the Ministry of Human Resources and Social Security, among others; industry self-regulatory organizations comprise the China Association of Traditional Chinese Medicine, the China Chamber of Commerce for Import & Export of Medicines & Health Products, and the Strategic Alliance for Technological Innovation in the Chinese Medicinal Decoction Pieces Industry, among others. Enterprises engaged in the production and operation of Chinese medicinal decoction pieces are governed by all applicable laws and regulations pertaining to pharmaceutical enterprises, including certification standards such as GMP and GSP.

Figure: Policy Analysis of the Traditional Chinese Medicine and Pharmaceutical Industries

Source: Asset Information Network, Qianji Investment Banking

Chapter 3: Industry Valuation, Pricing Mechanisms, and Global Industry Leaders

3.1 Comprehensive Financial Analysis and Valuation Methods for the Industry

Figure: Comprehensive Financial Analysis

Source: Asset Information Network, Qianji Investment Banking

Figure: Industry Valuation and Historical Comparison

Source: Asset Information Network, Qianji Investment Banking

Valuation methods for the traditional Chinese medicine industry include the price-to-earnings ratio method, the PEG ratio method, the price-to-book ratio method, the price-to-cash-flow ratio, the price-to-sales ratio method, the enterprise value-to-sales ratio method, the RNAV revaluation of net asset value method, the enterprise value-to-EBITDA ratio method, the dividend discount model (DDM), the discounted cash flow (DCF) valuation method, and the net asset value (NAV) valuation method, among others.

Table: Analysis of the Main Business Structure Using Yunnan Baiyao as an Example

Source: Asset Information Network, Qianji Investment Bank

3.2 Industry Development, Driving Mechanisms, and Risk Management

3.2.1 Industry Development and Driving Factors

In 2019, China’s output of traditional Chinese medicinal materials reached 4.505 million tonnes, with imports totaling 63,000 tonnes and exports 128,000 tonnes, resulting in an apparent domestic consumption of 4.440 million tonnes. The area under cultivation for these materials stood at approximately 52.5 million mu. Meanwhile, the market size for traditional Chinese medicinal materials expanded from RMB 23.2 billion in 2010 to RMB 68.5 billion in 2019.

The output of traditional Chinese patent medicines reached 2.464 million tonnes, with a market size of RMB 546.3 billion. Driven by the growing consumer preference for natural, eco-friendly products and the preventive health-care philosophy of “treating disease before it manifests,” traditional Chinese patent medicines are increasingly popular and are now entering a golden period of development.

In 2012, the Chinese medicinal decoction piece industry recorded sales revenue of RMB 201.261 billion, with imports totaling approximately RMB 1.029 billion and exports approximately RMB 6.202 billion, bringing the total domestic market size to about RMB 196.088 billion. The industry’s output reached 3.8 million tonnes, with imports of 63,000 tonnes and exports of 128,000 tonnes, while domestic demand stood at 3.735 million tonnes.

Sales revenue in the plant-extract industry has grown to RMB 25.05 billion. Cosmeceuticals represent the future direction of development for the global cosmetics industry. China boasts a history of over a thousand years in the practice of cosmeceuticals; as people’s income levels rise and their understanding of these products deepens, substantial latent demand is emerging, indicating enormous growth potential for the Chinese cosmeceutical market. In 2019, the size of China’s traditional Chinese medicine–based health-food market reached RMB 97.45 billion, yet overall, such products account for less than 30% of China’s broader health-food industry.

On the one hand, China’s national income has been steadily rising, leading to increasing expenditures on healthcare; on the other hand, driven by factors such as advancements in cultivation techniques and a range of favorable government policies, both the quantity and quality of traditional Chinese medicine (TCM) supplies have improved. Consequently, consumer spending on TCM has continued to grow. Against this backdrop, the number of TCM enterprises has gradually increased, with branded TCM firms currently exhibiting strong operational performance and robust profitability—between 2014 and 2018, revenue growth for branded TCM products consistently remained above 10%. By contrast, non-branded TCM products have seen a slowdown in revenue growth since 2017, accompanied by declining profit margins. At present, the TCM industry in China has already attained a considerable scale, with a large number of manufacturers; leading companies are generally performing well, yet a substantial number of small enterprises still remain. In the short term, market concentration is expected to continue rising.

Figure: Number of IND Applications for Innovative Drugs in China, 2010–2019

Source: Asset Information Network, Qianji Investment Banking

Figure: Medical Insurance Fund Expenditure

Source: Asset Information Network, Qianji Investment Banking

Figure: Market Size of Traditional Chinese Medicinal Preparations

Source: Asset Information Network, Qianji Investment Banking

Figure: Changes in Domestic Production and Growth Rate of Traditional Chinese Patent Medicines, 2011–2018

Source: Asset Information Network, Qianji Investment Banking

Figure: Market Size and Growth Rate of Traditional Chinese Medicine Decoction Pieces, 2011–2019

Source: Asset Information Network, Qianji Investment Banking

Figure: Number of Drugs Included in the National Medical Insurance Reimbursement List Over the Years (Number of Items)

Source: Asset Information Network, Qianji Investment Banking

Figure: Proportion of Sales Revenue for Various Traditional Chinese Medicine Injections in China’s Public Hospitals in 2018

Source: Asset Information Network, Qianji Investment Bank

Figure: Sales of Xueshuantong Capsules and Injection in Sample Hospitals in Recent Years

Source: Asset Information Network, Qianji Investment Banking

Driving factors

▷ Expansion of the national medical insurance drug list enhances residents’ purchasing power and willingness; this expansion reduces the financial burden of purchasing proprietary Chinese medicines, thereby boosting consumers’ demand. Traditional Chinese medicines offer both therapeutic and health-promoting benefits and are generally milder in nature than Western pharmaceuticals, making them more readily accepted by the public. Consequently, as residents’ ability and willingness to pay for healthcare continue to strengthen, the market for traditional Chinese medicines is poised for sustained growth.

▷ The National Essential Medicines List now includes a greater variety of traditional Chinese medicines, and a catalog of time-honored classic prescriptions has been released. The National Essential Medicines List serves as the basis for medical institutions in procuring and using pharmaceuticals; drugs included on the list are subject to unified, stringent state regulation across all stages—production, procurement, distribution, and sales—thereby effectively ensuring reasonable drug prices and stable supply and helping to meet the basic medication needs of the population.

▷ Favorable Policies Support and Guide the Healthy, Rapid Development of the Traditional Chinese Medicine Industry The Chinese government has implemented a series of policies to provide macro-level guidance on the direction of TCM industry development and to offer support and guidance in areas such as innovative R&D, production, and marketing, thereby effectively promoting the healthy and rapid growth of the TCM sector.

3.2.2 Industry Risk Analysis and Risk Management

At present, proprietary Chinese medicines have evolved into one of the few systematic, modern economic industries in China that enjoy a distinct advantage in terms of independent intellectual property rights, forming a complete industrial value chain that encompasses the cultivation of medicinal herbs (agriculture), the manufacturing of proprietary Chinese medicines, and the distribution of such products (commerce). With the rising incidence of iatrogenic and drug-induced diseases, coupled with evolving health awareness and a shift in the medical paradigm, proprietary Chinese medicines—owing to their natural origins, minimal adverse effects, proven therapeutic efficacy, and relatively affordable prices—are attracting increasing attention. As a result, the strengths of traditional Chinese medicine are becoming more pronounced, and the sector is experiencing rapid growth. At the same time, the industry faces certain associated risks.

▷ Risks in New Drug Development

New drug development is among the most knowledge- and capital-intensive industries in the world, requiring not only a large pool of highly skilled technical talent but also substantial financial investment. Particularly once a project enters the clinical research phase, pharmaceutical companies must possess robust financial strength to fully support the conduct of these trials. China’s pharmaceutical industry started relatively late and generally suffers from insufficient R&D investment. Given the high risks associated with new drug development and the limited overall revenue scale, domestic pharmaceutical firms tend to adopt a cautious approach when allocating resources to new drug R&D.

▷ Pharmaceutical Quality Risk

Medicines are a vital health resource for treating illness and saving lives; the authenticity and quality of medicines directly affect patients’ physical health and even their safety. In China, food and drug-related incidents occur frequently, making risk prevention and control a top priority in food and drug supervision. Pharmaceutical production involves numerous stages—raw materials, excipients, manufacturing, storage, transportation, and sales—and any one of these stages can give rise to issues that compromise product quality, potentially leading to pharmaceutical safety incidents. Consequently, risks to medicine quality and safety represent a critical concern that cannot be overlooked in the pharmaceutical industry.

Figure: Existing Problems

Source: Asset Information Network, Qianji Investment Bank

3.3 Competitive Analysis

The Chinese traditional medicine industry features a relatively balanced distribution of company types, with product-oriented firms accounting for the largest share.

Figure: Market Share of the Traditional Chinese Medicine Industry

Source: Asset Information Network, Qianji Investment Bank

SWOT Analysis

I. Industry Advantage Analysis

▷ China boasts abundant traditional Chinese medicinal resources.

▷ Traditional Chinese medicine is a time-honored tradition in China, with a history spanning thousands of years and continuing to play an irreplaceable role in healthcare today. More than 8,000 classical works on TCM are currently extant in China, documenting the theoretical foundations and practical experience accumulated over millennia in the use of medicinal herbs. In addition, TCM has been integrated into the urban medical insurance system, and specialized TCM hospitals can be found in regions across the country, which has provided a significant boost to the development of the TCM industry.

▷ Policy support is driving the development of China’s traditional Chinese medicine industry; as a branch of Chinese culture, TCM has also received increasing policy support in recent years.

II. Analysis of Industry Disadvantages

▷ Weak scientific foundation. From a market perspective, pharmacological research on traditional Chinese medicine in China lags behind, with more than 90% of its significant toxicities remaining scientifically uncharacterized. Moreover, influenced by conventional medical paradigms, China still lacks a robust clinical efficacy evaluation system for TCM, which hinders the rapid advancement of the overall level of TCM in the country.

▷ Biopharmaceuticals are vying for a foothold in the traditional Chinese medicine market. With global advances in science and technology, biopharmaceuticals have emerged as the cutting edge of capital investment and technological research in the pharmaceutical industry. Should breakthroughs be achieved in biopharmaceutical technologies, they will not only drive technological progress in the traditional Chinese medicine sector but also exert substantial pressure on it.

III. Industry Opportunity Analysis

▷ The pharmaceutical industry is experiencing rapid growth. In recent years, driven by steady economic development, China’s pharmaceutical sector has continued to expand. As an important component of the national pharmaceutical industry, traditional Chinese medicine has also witnessed swift growth in response to increasing market demand.

▷ China’s aging population and prevailing social attitudes have fostered a high level of acceptance of traditional Chinese medicine. As older adults enter a phase of declining physical function, their risk of contracting various diseases rises substantially compared with younger and middle-aged individuals, thereby significantly boosting market demand for pharmaceutical products. Rooted in and originating from China, traditional Chinese medicine has, over the course of China’s millennia-long historical development, earned widespread recognition at home thanks to its distinctive diagnostic and therapeutic approaches, proven efficacy, and comprehensive theoretical system, making it an especially attractive option for the elderly.

IV. Industry Threat Analysis

▷ Foreign enterprises entering China’s traditional Chinese medicine market. With the increasing exchange brought about by economic globalization, China’s pharmaceutical market has continued to open up, attracting a large influx of foreign pharmaceutical companies. Several major overseas pharmaceutical giants have begun to enter the traditional Chinese medicine market. Given their strong financial resources, cutting-edge technology, and extensive management expertise, these multinational firms will exert considerable pressure on domestic players.

▷ The efficiency of developing and utilizing traditional Chinese medicinal resources in China is low. Despite the country’s abundant supply of such resources, most remain underutilized, and some rare and valuable medicinal materials are even beginning to dwindle.

3.4 Ranking of Chinese Enterprises

Figure: Top 5 Ranking of Traditional Chinese Medicine R&D Strength in China, 2020

Figure: A-share and Hong Kong-listed Companies

▷ Yunnan Baiyao [000538.SZ]: The company is a well-known Chinese patent medicine manufacturer in China, currently operating 18 wholly owned, controlling, and equity-participated subsidiaries. It is a large-scale industrial and commercial pharmaceutical enterprise based in Yunnan Province. Its principal business activities include the production and sale of chemical APIs, chemical pharmaceutical preparations, Chinese patent medicines, traditional Chinese medicinal materials, and biological products. The company’s product portfolio is primarily centered on the Yunnan Baiyao series, the Sanqi series, and a range of ethnic-minority–themed medicines unique to Yunnan, encompassing more than 200 products across 17 dosage forms. These products enjoy strong sales in the domestic market and throughout Southeast Asia, while the company is gradually expanding into developed markets such as Japan, Europe, and North America.

▷ Baiyunshan [600332.SH]: The company is a large, holding-company–based enterprise that has long been dedicated to the pharmaceutical and health industries. Over many years of development, its scale and profitability have continued to expand. Currently, the Group’s principal business activities include: (1) the research, development, manufacturing, and sales of traditional Chinese medicines, Western patent medicines, chemical APIs, natural medicines, biopharmaceuticals, and intermediates for chemical APIs; (2) the wholesale, retail, and import–export of Western medicines, traditional Chinese medicines, and medical devices; (3) the R&D, production, and sales of greater-health products; and (4) investments in health-related sectors such as medical services, health management, wellness, and elderly care. After years of development, the Group has achieved full industrial-chain coverage and has established a relatively comprehensive product portfolio in areas such as antibacterial and anti-inflammatory drugs, diabetes treatments, cardiovascular and cerebrovascular therapies, gastrointestinal medications, heat-clearing and detoxifying agents, urological medicines, and pediatric drugs. Moreover, the Group holds a significant market position in niche segments including traditional Chinese medicine, chemical APIs, and chemical pharmaceutical preparations.

▷ Tong Ren Tang [600085.SH]: The company is a renowned time-honored brand in the traditional Chinese medicine industry, operating as an integrated enterprise that covers production, sales, research and development, and distribution. Its main dosage forms include honey pills, water-honey pills, water pills, hard capsules, oral liquids, alcoholic preparations, granules, and powders. The company boasts 22 production lines that have been certified for quality both domestically and internationally, serving as a key showcase of Tong Ren Tang’s capabilities on the global stage.

3.5 Global Key Competitors

As the therapeutic efficacy of traditional Chinese medicine and its role in healthcare are increasingly recognized and affirmed, Chinese herbal medicine is continuously evolving.

▷ Entered foreign healthcare systems;

▷ The scale of medical services continues to expand.

Currently, Japan holds a 90% share of the global traditional Chinese medicine market, making it a formidable competitor for Chinese TCM enterprises.

Tsumura & Co., Ltd. of Japan is the country’s largest manufacturer of traditional Chinese medicines, accounting for approximately 80% of Japan’s total production of Kampo medicines. As the world’s leading Kampo pharmaceutical company, it produces nearly 150 different Kampo formulations and recorded sales of about RMB 8.1 billion in 2020.

Chapter 4: Future Prospects

The following development trends are expected in key industries of the future:

▷ Innovation in pharmaceutical product R&D

The research and development of new drugs requires substantial investment and a lengthy development cycle; consequently, most companies opt to manufacture generic drugs in order to quickly achieve economic returns, and generics currently account for more than 90% of China’s pharmaceutical production. In contrast to generics are innovative, patent-protected new drugs—commonly referred to as originator products. As the financial strength and R&D innovation capabilities of some domestic firms continue to improve, these companies are actively pursuing the research and development of innovative new drugs, either through independent R&D or in collaboration with external specialized institutions. Several such products have undergone extensive validation through clinical trials and have subsequently gained broad market acceptance upon launch. Looking ahead, as the technological capabilities of domestic pharmaceutical manufacturers continue to advance, the number and variety of innovative new drugs in China will further increase, driving the industry toward greater innovation in product R&D.

▷ Standardization of Pharmaceutical Marketing

Pharmacies and hospital pharmacies serve as the final points of sale for pharmaceutical products and, to a certain extent, influence consumers’ purchasing decisions. The implementation of the “two-invoice system,” volume-based drug procurement, and the gradual nationwide rollout of DRGs (diagnosis-related groups) will collectively promote the standardization of pharmaceutical marketing practices.

▷ Industry regulatory framework is becoming increasingly stringent

With China’s drug regulatory authority having become a full member of the International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use (ICH) and with the revision and implementation of a series of drug registration and management measures, the pharmaceutical industry is now subject to increasingly stringent regulatory requirements. Standards for pharmaceutical manufacturers in areas such as drug research and development, manufacturing, and quality control have been further raised, which will help enhance the safety and quality of medicines, promote orderly competition and natural selection within the industry, and raise the industry’s entry barriers.

[Major Announcement] The General Office of the State Council Has Issued the “Several Policy Measures for Accelerating the Distinctive Development of Traditional Chinese Medicine”

Seven Nationally Classified Confidential Traditional Chinese Medicines

[Major Announcement] The General Office of the State Council Has Issued the “Several Policy Measures for Accelerating the Distinctive Development of Traditional Chinese Medicine”

Seven Nationally Classified Confidential Traditional Chinese Medicines

Value Analysis of the Traditional Chinese Medicine Industry

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