Tianfeng: The impact of tariffs on the pharmaceutical industry

Tianfeng released a research report stating that the market is confident in the long-term competitive advantage of the pharmaceutical industry, and is prepared for the twists and turns in the process. Innovative drugs and related industry chains with global competitive advantage are still favored, and the relative certainty of domestic consumption is increasing. Sticking to Chinese innovative drugs (good products have no trouble selling), in the short term, attention can be focused on domestic substitute beneficiary varieties (such as blood products) and domestic products (such as medical services). Overall, Tianfeng believes that the impact of tariffs on business can be analyzed from the perspectives of price transmission (cost transfer), supply and demand situation, and cost structure. (I) The United States imposes tariffs on China and other countries (looking at competition and price transmission) On April 2nd local time, the U.S. government announced the imposition of "reciprocal tariffs," with drugs being exempted. The main affected categories are "medical consumables, dressings, medical equipment and components, rehabilitation products," considering that some low-value consumable products were significantly tariffed earlier (by 2024). From the perspective of industrial response, Chinese enterprises have already laid out production bases in Southeast Asia or reduced their dependence on the U.S. and shifted to non-U.S. markets ahead of time. This time, other countries were also simultaneously tarriffed. Tianfeng believes that this is a positive impact for the domestic industry (the price advantage of competitors has been relatively weakened). On April 8th local time, U.S. President Trump announced in a speech that the U.S. will impose tariffs on drugs. If the U.S. imposes tariffs on drugs in the future, the potential impacts on major categories are as follows: 1) Innovative drugs: Minimal impact. Tariffs affect procurement costs. If innovative drugs only consider production costs, with an average gross profit margin of over 85%, the impact of cost changes on final profits is minimal. Commercialized varieties: If the product is self-owned, with some enterprise product formulation factories located in the U.S., the impact is relatively minimal; if the product is agented, considering the high gross profit margin of pharmaceuticals, the actual factory price is relativelyless impacted. BD business: BD business involves technology going global, not affected by tariff changes. It is worth noting that from the perspective of China's BD cooperation, the proportion of non-U.S. companies (such as Europe, Japan, etc.) is also quite high, and not affected. In addition, the value of BD (down payment + milestone + share) is calculated as a certain percentage of terminal income, less affected by tariffs. U.S. Innovative drug terminal price adjustments are relatively easy, and therefore cost increases can be transmitted to terminal prices. 2) Active pharmaceutical ingredients (APIs): Impact controllable. Considering that there is global overcapacity for some APIs, imposing tariffs may further reduce the competitive advantage of Chinese enterprises' products. However, after the tariff conflict in 2018, China's direct exports of APIs to the U.S. declined (estimated from HS code chapter 29) from 15.3% in 2018 to 13.0% in 2019. The proportion of API exports to the U.S. is expected to further decrease to 9.8% by 2024. 3) CDMO: Impact controllable. For the R (research) and D (development) parts, the core logic of the existing business model is that China has higher development efficiency, and the proportion of investment in new drug research and development is relatively low. For the M (production) part, the actual impact will be more complex. On one hand, a considerable part of the M business does not necessarily export to the U.S., and on the other hand, finding suitable alternative production capacity within a highly efficient and compliant range is also a response. Finally, domestic CDMO enterprises are also laying out global production capacity. (II) China imposes tariffs on U.S. products (considering domestic substitutes) 1) Innovative drugs: Overall positive. Some imported products are heavily affected, favoring domestic innovative drug substitutes. Pharmaceutical products have low price elasticity, so the increase in costs will directly affect products imported from the U.S., but a considerable proportion of foreign companies have made early arrangements in the industrial chain, establishing local production in China or production in non-U.S. countries. 2) Blood products: Overall positive. The U.S. is a major plasma collection country globally, and China is a large market for albumin consumption. Although as a global product, related companies can adjust capacity planning to avoid the impact of tariffs, Tianfeng predicts that in the short term, the competitiveness of directly imported blood products from the U.S. will weaken, benefitting domestic products. 3) Medical devices: Overall positive. Some directly imported U.S. medical device products will be affected by tariffs. Similar to innovative drugs, in recent years, leading overseas medical device companies like GPS have strengthened their localization layout in China and adjusted their supply chain. In addition, the Ministry of Commerce has conducted investigations on imported medical CT tube, which also helps with import substitution. (III) The relative certainty of domestic consumption is increasing Tianfeng believes that the market is confident in the long-term competitive advantage of the pharmaceutical industry, and is prepared for the twists and turns in the process. Innovative drugs and the related industry chain with global competitive advantage are still favored, and the relative certainty of domestic consumption is increasing.