Preview of US stocks | With large fluctuations in performance and high debt levels, how will Henghong Technology (HCPC.US) tell a new story of pharmaceutical distribution?

In recent years, China has highly valued the inheritance and innovative development of the traditional Chinese medicine industry. A series of encouraging policies have injected new vitality into the development of the Chinese medicine industry. From optimizing the approval process, strengthening intellectual property protection, to promoting in-depth integration of production, education, and research, and promoting the modernization and internationalization of Chinese medicine, policy dividends continue to be released, paving the way for high-quality development of the Chinese medicine industry and enabling a group of Chinese medicine enterprises to thrive, including Henghong Technology, which has begun the journey to be listed in the United States. It is understood that Hengcheng Health Industry Co., Ltd. (hereinafter referred to as "Hengcheng Health"), the holding company of Henghong Technology Inc. (hereinafter referred to as "Henghong Technology"), first submitted a public version of the prospectus (F-1) to the SEC on March 27, applying to be listed on Nasdaq with the code "HCPC". It plans to issue 2 million common shares at a price of $4-6 per share, potentially raising up to $12 million. In terms of performance, Henghong Technology has experienced significant fluctuations. In 2023, its revenue increased by 13.79% to 264 million yuan, with a net profit of 22.3876 million yuan, a significant increase of 38.87% compared to the previous year, achieving impressive results of steady revenue growth and high net profit growth. However, in the first half of 2024, its revenue was 116 million yuan, a decrease of 17.73% compared to the previous year, with a corresponding net profit of 11.086 million yuan, a significant decrease of 35.2%. Why has Henghong Technology's performance fluctuated so significantly? Can the company return to a growth trajectory in the future? More importantly, how will a business model rooted in traditional Chinese medicine tell the story of modern Chinese medicine to Wall Street capital that values "quantitative verification"? Decreased market demand leads to significant performance fluctuations The development history of Henghong Technology can be traced back to the end of December 2008. Since its establishment, the company has been continuously focusing on the distribution of pharmaceutical products. Currently, Henghong Technology has formed two main business segments, namely drug sales and promotion, and marketing services. In 2023, the revenue share of the two main businesses was 95.2% and 4.8%, respectively, with drug sales being the core of Henghong Technology's revenue. Specifically, Henghong Technology's drug sales are divided into three main categories: traditional Chinese medicine sales, chemical drug sales, and traditional Chinese medicine raw material sales. The revenue shares of the first two categories in 2023 were 84% and 11.2%, respectively, while the sales of traditional Chinese medicine raw materials started only in the first half of 2024, with a revenue share of 1.7%, still relatively small. Traditional Chinese medicine products are the flagship products in Henghong Technology's drug sales business. According to the prospectus, Henghong Technology's drug sales business mainly purchases traditional Chinese medicine, related nutritional supplements and health products, as well as some chemical drugs, from its affiliate Guangdong Hengcheng Pharmaceutical Co., Ltd. Henghong Technology sells 34 popular products with a total of 106 specifications, covering multiple treatment areas such as respiratory, cardiovascular, and digestive health. The treatment and tonics traditional Chinese medicine are the focus of the company's sales. Most of the treatment traditional Chinese medicine is used to treat colds and coughs, such as cold-clearing granules, wind-cold cold granules, and honeysuckle detoxification granules. Tonic medicines mainly include spleen-boosting granules for nourishing blood and calming the mind, pulse-activating granules for nourishing yin, supplementing qi, tonifying blood, and kidney-tonifying dodder tonic, as well as loin-strengthening kidney-tonifying pills. In terms of distribution channels, Henghong Technology has established a multi-channel sales system, including offline distribution of products and distribution to online pharmacies and their platforms. Currently, offline distribution and marketing contribute the majority of revenue to the company. In terms of offline distribution, Henghong Technology has distribution networks in 22 provinces and autonomous regions in China, and has established business relationships with well-known large chain pharmacies in China such as Yifeng Da Pharmacy Chain Co., Ltd. In 2023, Henghong Technology's total revenue grew by 13.6% to 264 million yuan mainly due to the company raising product prices. Despite a slight decrease in sales volume of traditional Chinese medicine and chemical drugs, after raising product prices, the revenues of these two businesses grew by 14.7% and 13.4% respectively in the reporting period. After raising product prices, Henghong Technology's gross profit margin increased from 19.81% to 23.21% in 2023, strengthening its profitability. Coupled with efficient control of operating expenses, the company achieved a significant increase in net profit by 38.87% in the reporting period. However, the 17.73% decrease in revenue in the first half of 2024 was mainly due to a decrease in demand for traditional Chinese medicine products after the epidemic, resulting in a decline in both sales volume and prices of traditional Chinese medicine products during the reporting period, leading to a 26.8% decrease in revenue from traditional Chinese medicine products. Even though sales volume growth in chemical drugs led to a 26% increase in revenue, it was not enough to offset the overall revenue decline of the company. With a decrease in revenue, Henghong Technology's operating expenses did not significantly decrease in the first half of 2024, coupled with a reduction in government subsidies and an increase in interest expenses, leading to a significant drop of 35.2% in net profit in the first half of 2024. Stable market environment, high competition difficulty, high asset-liability ratio and high accounts receivable As a typical pharmaceutical distributor, Henghong Technology's business model is relatively simple, and its performance is the result of a combination of channel expansion, market demand, and product pricing. The essence of the performance decline in the first half of 2024 lies in the fact that the incremental volume brought by channel expansion is far less than the decrease in market demand, leading to a weakening of product prices after the decrease in market demand. In the prospectus, Henghong Technology provided detailed explanations of its future development in terms of controllable dimensions such as channels and products. The company stated that it will continue to focus on the external hospital market, establish strategic partnerships with chain pharmacies and online e-commerce platforms, continuously optimize marketing channels, promote balanced development with full product coverage, and increase the development of the online market. In terms of products, Henghong Technology stated that the company plans to increase the promotion and marketing efforts of tonics products, explore the market potential of tonics products such as loin-strengthening kidney-tonifying pills, fresh-locking kidney tonic oral liquid, and seven-son celestial essence oral liquid, and create a series of medicinal liquor products including dodder-tonifying wine, epimedium tonifying wine, chicken blood-tonifying wine, and rejuvenation tonifying wine. For pharmaceutical distributorsIn fact, products cannot make significant differentiation. They are only used to complement the growth path through a diversified product matrix. The key to establishing competitive barriers lies in the development of channels or expansion to other links in the industry chain. Although Henghong Technology has made detailed plans for future development in terms of products and channels, its growth path may not be easy because the pharmaceutical distribution industry has been guided by policies and market integration for many years, forming a pattern of "one super, many strong" dominated by state-owned leading enterprises, with regional leading enterprises and emerging platforms coexisting. The difficulty for small and medium-sized enterprises to expand and grow is relatively large.In addition, the relatively high debt-to-asset ratio of Henghong Technology will also limit the company's expansion speed. According to the prospectus, as of June 30, 2024, Henghong Technology's total assets were 72.1379 million yuan, total liabilities were 66.989 million yuan, and the debt-to-asset ratio was as high as 92.86%. Moreover, there are risks hidden in the asset structure. According to the prospectus, as of June 30, 2024, Henghong Technology's accounts receivable and notes receivable were 35.8022 million yuan and 20.6824 million yuan respectively, totaling 56.4846 million yuan, accounting for 82.6% of current assets. Such a high level of accounts receivable may not only lead to bad debt risks affecting the company's profitability, but also hinder the company's capital turnover, further impeding the company's expansion. This also indirectly indicates that Henghong Technology does not have a strong bargaining power with downstream customers. The company may be enhancing customer loyalty by extending payment terms, which is not a healthy customer expansion model. Coupled with the flaw of high debt, the valuation level of Henghong Technology may be subject to a certain degree of suppression after going public.