CITIC Construction Investment | Review and Outlook of the Traditional Chinese Medicine Industry: From Quantity Increase to Quality Improvement, Growth and Adjustment in Parallel

CITIC Construction Investment Securities Research Written by: Yuan Qinghui, Liu Ruofei, He Juying, Yuan Quan, Shen Xingxi We believe that as the traditional Chinese medicine industry evolves from quantity growth to quality improvement, traditional Chinese medicine enterprises are also facing corresponding development pain points. In order to actively adapt to changes in the market and policy environments, future industry growth will proceed in parallel with adjustments, and the transformation and upgrading of the industry is an inevitable trend. Looking ahead to 2026, from the perspective of industry fundamentals, the pressure from the base is expected to gradually ease. Coupled with some enterprises actively promoting channel reforms and improving quality and efficiency, channel adjustments are accelerating, and most enterprises are expected to achieve improvements under low bases on a year-on-year basis. In the long term, we recommend paying attention to policy catalysts such as the essential drug catalog and the progress of industry transformation and upgrading. The industry is bottoming out and recovering, focusing on leading enterprises with stable operations. Industry Review: From Quantity Growth to Quality Improvement, Growth and Adjustment Proceed in Parallel Policy catalysts have led to a rebound in market prosperity, and transformation and upgrading have brought new opportunities to the industry. Since 2005, driven by rising household incomes and the expansion of health insurance, branded traditional Chinese medicine has flourished. Since the pilot program for health insurance cost control began in 2013, the growth rate of traditional Chinese medicine prescription drugs has slowed, and traditional Chinese medicine injections have come under pressure, leading to gradual revenue pressure in the industry. By the end of 2021, policy catalysts have led to a rebound in industry prosperity, coupled with the release of demand driven by the easing of the pandemic. However, in 2024, growth is expected to slow due to factors such as the Four Same and centralized procurement, and in 2025, the industry will face weak terminal demand and channel destocking, continuing to put pressure on fundamentals. Against this backdrop, at the beginning of the year, eight departments jointly issued the "Implementation Plan for High-Quality Development of the Traditional Chinese Medicine Industry (2026-2030)," proposing to accelerate the optimization and transformation of the traditional Chinese medicine industry structure and comprehensively enhance the resilience and stability of the traditional Chinese medicine industry chain and supply chain, which is expected to bring new opportunities to the industry. From quantity growth to quality improvement, growth and adjustment proceed in parallel. From the perspective of overall industry development, policies further standardize the inheritance and innovative development of traditional Chinese medicine, while the aging population deepens the transformation of the silver economy. The traditional Chinese medicine industry is expected to gradually enter a new stage of systematic and high-quality development under the dual influence of policy-driven and market demand. We believe that as the traditional Chinese medicine industry evolves from quantity growth to quality improvement, traditional Chinese medicine enterprises are also facing corresponding development pain points. In order to actively adapt to changes in the market and policy environments, future industry growth will proceed in parallel with adjustments, and the transformation and upgrading of the industry is an inevitable trend. Industry Outlook: Short-term Focus on Improvement of Fundamentals The pressure from the base is gradually easing, and attention should be paid to the improvement of industry fundamentals. Looking ahead to 2026, from the perspective of industry fundamentals, the pressure from the base is expected to gradually ease. Coupled with some enterprises actively promoting channel reforms and improving quality and efficiency, channel adjustments are accelerating. With the arrival of the peak season for respiratory diseases at the beginning of the year, we are optimistic about the sustained recovery of demand during the peak season, and most enterprises are expected to achieve improvements under low bases on a year-on-year basis The prices of traditional Chinese medicinal materials have seen a decline, and profitability is expected to continue to recover. Overall, factors such as capital speculation, cyclical fluctuations in market prices, post-epidemic recovery of downstream consumer demand, and improvements in quality standards for medicinal materials have all had a certain impact on the price fluctuations of traditional Chinese medicinal materials in recent years. Recently, the price index of traditional Chinese medicinal materials has continued to decline at a low level, and is expected to gradually recover to pre-epidemic levels. The cost pressure on downstream industrial enterprises is expected to continue to ease, further promoting the recovery of profitability. Industry Outlook: Long-term focus on policy catalysts and progress in transformation and upgrading The adjustment of the national essential medicine list is imminent, and it is recommended to pay attention to major traditional Chinese medicine varieties with clinical value and product foundation. On January 27, 2026, the National Health Commission and 11 other departments jointly issued the "Management Measures for the National Essential Medicine List." The management measures for the national essential medicine list have been finalized, revising and adjusting six aspects including legal policy basis, list structure, and management mechanism, and a new round of adjustments to the essential medicine list is expected. With the country's strong support for the inheritance and innovative development of traditional Chinese medicine, innovative traditional Chinese medicines and exclusive major varieties with clinical value and product foundation are expected to enter the new version of the essential medicine list through this adjustment. It is anticipated that the varieties of traditional Chinese medicine in this essential medicine list will see further expansion, but there are still relatively strict assessment requirements for the newly added traditional Chinese medicine varieties in the new version of the essential medicine list, and the final results remain uncertain. Transformation and Upgrading Direction: Consumer attributes bring brand extension space, innovation leads high-quality growth in the industry. Judging from the current internal and external environment of the traditional Chinese medicine industry, we believe that most enterprises will actively pursue transformation and upgrading to create a second growth curve. The transformation direction of both the hospital and non-hospital markets will also show differentiation: 1) Non-hospital market: Brand traditional Chinese medicine enterprises will continue to strengthen brand building, maintain brand moats, and extend towards consumer goods through mergers and acquisitions and overseas expansion, continuously increasing market share and seizing market opportunities brought by the aging trend; 2) Hospital market: Prescription drug enterprises will actively promote innovative transformation, strengthen innovation and the ability to convert scientific research results, and construct a second growth curve through secondary development, independent research and development, mergers and acquisitions, and strategic cooperation for variety introduction, shifting from policy-driven to innovation-driven. Transformation Path 1: "Consumer-like" attributes bring broad brand extension space The upgrade of healthcare consumption and "consumer-like" attributes bring broad brand extension space. Rapid economic growth, increased health awareness, and aging lead to an upgrade in healthcare consumption, and the market for traditional Chinese medicinal products continues to expand. In recent years, with changes in the industry and market environment, the dual-drive of both hospital and non-hospital markets has gradually become a new ecosystem in the industry. Many prescription drug products are gradually converting to over-the-counter drugs, actively exploring the non-hospital retail market. The main consumption scenarios for traditional Chinese medicine OTC varieties are in the non-hospital market, possessing certain consumer product attributes, which also provide broad brand extension space for the transformation and upgrading of traditional Chinese medicine enterprises. Transformation Path 2: Actively layout innovative transformation to build a second growth curve Traditional Chinese medicine companies are actively laying out innovative transformations. In recent years, traditional Chinese medicine companies have been actively innovating and transforming into chemical and biological medicine fields to expand growth space, achieving significant progress through independent research and development, mergers and acquisitions, and strategic cooperation for variety introduction, thereby creating a future second growth curve Investment Logic Analysis of the Traditional Chinese Medicine Sector Dividend Assets: Favorable towards undervalued, high-dividend, and stable operating leading enterprises. With market fluctuations and adjustments, the attention on high-dividend, low-volatility related assets has increased. Among pharmaceutical companies, traditional Chinese medicine enterprises have relatively low valuations, ample cash reserves, and high dividend rates. We are optimistic about leading traditional Chinese medicine enterprises that are undervalued, offer high dividends, and have stable operations. Brand extension, channel expansion, and strong pricing power will gradually lead brand traditional Chinese medicine enterprises into a high-quality development stage. Against the backdrop of further concentration of brand enterprises in the traditional Chinese medicine consumer market, we believe that brand traditional Chinese medicine enterprises with strong brand extension, channel expansion, pricing power, and actively promoting state-owned enterprise reform will gradually enter a high-quality development stage. Although some OTC companies are still in an adjustment phase, leading enterprises are operating steadily. After the growing pains, focusing on innovation and academic leadership, the recovery of traditional Chinese medicine prescription drugs is expected. Overall, the state strongly supports the inheritance and innovative development of traditional Chinese medicine, with a moderate decline in exclusive varieties; coupled with the imminent adjustment of the basic drug catalog, selected varieties are expected to further tap into the grassroots market, bringing incremental contributions to the performance of some enterprises. In addition, as the industry order gradually recovers, the external environmental impact brought by compliance upgrades is gradually weakening. Most enterprises have established a sound compliance marketing system, and with the basic end of industry channel adjustments, traditional Chinese medicine prescription drug enterprises continue to focus on innovation and academic leadership, which is expected to gradually achieve recovery. Product promotion does not meet expectations: The company increases investment in the terminal market and brand. If product promotion does not meet expectations, it will affect sales revenue and subsequently impact the company's profits; Risk of drug price reduction: Changes in the policy environment, such as centralized procurement of traditional Chinese medicine and price comparisons, may lead to a decrease in product prices, thereby affecting the company's profit expectations; Risk of raw material price fluctuations: The prices of traditional Chinese medicinal materials can be influenced by various factors such as the macro environment, natural disasters, and planting conditions, leading to significant fluctuations. If the prices of traditional Chinese medicinal raw materials rise, the company's production costs may increase significantly, thereby affecting the company's profits; Hospital diagnosis and treatment volume recovery does not meet expectations: With home-based diagnosis and treatment gradually being promoted post-epidemic, the volume of hospital diagnoses and treatments may be affected, which in turn impacts the sales of prescription drugs and subsequently affects the company's overall profits Yuan Qinghui: CITIC Construction Investment Chief Analyst of the Pharmaceutical and Biotechnology Group. Bachelor of Science from Sun Yat-sen University, Master of Science from Georgia State University, Research Scholar at the University of North Carolina at Chapel Hill School of Medicine. Previously engaged in the research and development of new drugs related to Alzheimer's and tumors, specializing in innovative drug industry research. Joined CITIC Construction Investment Securities Research and Development Department in 2018, responsible for the pharmaceutical and biotechnology sector. Liu Ruofei: Co-Chief Analyst of Pharmaceutical Consumption and Bioproducts, Master of Biotechnology from Peking University, joined CITIC Construction Investment Securities Research and Development Department in 2017. Mainly covers traditional Chinese medicine, pharmaceutical distribution, chain pharmacies, vaccines, blood products, CRO, raw materials, gene sequencing, and other sub-sectors. Core member of the team ranked second, third, fourth, and fifth in the New Fortune Best Analyst Awards for the pharmaceutical and biotechnology industry in 2024, 2023, 2022, and 2021 respectively. Yuan Quan: Pharmaceutical Analyst at CITIC Construction Investment Securities, Master of Healthcare Management from Yale University, previously worked in the Investment Banking Department of Credit Suisse Hong Kong, joined CITIC Construction Investment Securities Research and Development Department in 2021, mainly responsible for traditional Chinese medicine, medical aesthetics, pharmaceutical commerce, and global perspective research, core member of the team ranked second and third in the New Fortune Best Analyst Awards for the pharmaceutical and biotechnology industry in 2024 and 2023. Shen Xingxi: Pharmaceutical Industry Analyst, Master of Health Economics from Wuhan University, joined the pharmaceutical team of CITIC Construction Investment Securities Research and Development Department in 2023, mainly covering gene testing, pharmacies, pharmaceutical distribution, traditional Chinese medicine, and commercial insurance sectors. He Juying: Chief Analyst of the Pharmaceutical Industry at CITIC Construction Investment Securities, Master of Management from Fudan University, over 10 years of experience in sell-side pharmaceutical research, skilled in forward-looking identification of opportunities in sub-sectors, with in-depth and detailed company research, responsible for overall investment direction judgment. Ranked seventh in the pharmaceutical industry in the 2020 Sina Finance Golden Unicorn Analyst Awards, shortlisted in the New Fortune Best Analyst Awards for the pharmaceutical industry, and ranked fourth in the pharmaceutical industry in the Wind Best Analyst Awards. Ranked first in the pharmaceutical industry in the 2019 Wind "Golden Analyst" awards. Ranked third in the pharmaceutical industry in the 2018 Wind "Golden Analyst" awards and first in the pharmaceutical industry in the 2018 First Financial Best Analyst Awards. Ranked third in the pharmaceutical industry in the 2013 New Fortune awards and fifth in the pharmaceutical industry in the Crystal Ball awards. Securities Research Report Title: "Review and Outlook of the Traditional Chinese Medicine Industry: From Quantity Increase to Quality Improvement, Growth and Adjustment Proceeding in Parallel" External Release Date: March 15, 2026 Report Issuing Institution: CITIC Construction Investment Securities Co., Ltd Analysts of this report: Yuan Qinghui SAC No.: S1440520030001 SFC No.: BPW879 Liu Ruofei SAC No.: S1440519080003 SFC No.: BVX723 He Juying SAC No.: S1440517050001 SFC No.: ASZ591 Yuan Quan SAC No.: S1440523070006 Shen Xingxi SAC No.: S1440525070009