Neautus Looks Outward To Boost Its Traditional Medicine Story

The maker of traditional Chinese medicines has applied for a Hong Kong IPO after abandoning two listing attempts on China's domestic A-share market

Key Takeaways:

• Neautus has applied to list in Hong Kong, reporting its revenue rose about 9% in 2024, even as its profit fell 14% on surging R&D expenses
• China's highly fragmented traditional medicine market is ripe for consolidation, with the top five players holding less than 3% of the market

With a history spanning thousands of years, traditional Chinese medicine (TCM) is gaining global traction as interest in alternative natural therapies grows. But the industry is highly fragmented, with the top five players controlling less than 3% of the market. Now, Sichuan Neautus Traditional Chinese Medicine Co. Ltd., one of many players in the field, is hoping to bolster its own position using new funds from a planned Hong Kong IPO.

Founded in 2001 in Chengdu, capital of Southwest China's Sichuan province, Neautus is no newcomer to capital markets. The company attempted to list on China's domestic A-share market twice, first in 2011, and then 12 years later in 2023. But it never completed either of those attempts, leading it to seek the Hong Kong listing that typically attracts a more international group of investors.

High fragmentation

China's TCM market is vast and means big business, accounting for a sizable 27.9% of the country's total healthcare spending in 2023. And while many patients and doctors embrace Western medicines, TCM is still quite popular in China, growing from 17.9% of average public hospital pharmaceutical sales in 2019 to 20.5% in 2022.

Driven by an aging population, many of whom grew up using such medicines, as well as rising acceptance among younger people, government support, and international expansion, the TCM market was worth 451.6 billion yuan ($61.6 billion) in 2023 and is expected to grow to 599.3 billion yuan by 2030, according to third-party market data in Neautus' listing document filed earlier this month.

Such products fall into several major categories, including patent medicines, decoction-ready products, formula granules, injections, and health supplements. Decoction-ready products that are Neautus' mainstay include herbal medicines that are processed using sophisticated machinery in accordance with strict TCM modern standards, and then directly transformed into medicines that can be easily used by patients.

Such decoction-ready products offer greater convenience than traditional brewing methods, making the category a major business opportunity. Market research firm Frost & Sullivan projects the decoction-ready market will expand from 278.8 billion yuan in 2023 to 409.7 billion yuan by 2030, according to the listing document.

Despite the big potential for such products, the market remains highly fragmented. In 2024, China had 2,334 licensed decoction-ready product manufacturers, mostly smaller companies, and only a handful generated annual revenue exceeding 1 billion yuan. The top five players held a combined market share of just 2.7%. Neautus was one of those, with its small 0.4% market share enough to rank it second in the industry. The largest player holds a larger but still relatively small 1.3%, showing there's plenty of room for consolidation.

Drag from R&D

Neautus sells both toxic and non-toxic decoction products, accounting for 13.8% and 86.2%, respectively, of its revenue last year. Its gross margin for toxic products was 19.1%, while the non-toxic ones were less profitable at 16.7%. Toxic products demand specialized methods to reduce or control their toxicity, requiring precise control of conditions like temperature and duration of the distillation process.

Benefiting from gains in both businesses, Neautus' overall revenue rose by 9.1% year-on-year to 1.25 billion yuan in 2024. But its profit fell by 14.3% that year to 89.1 million yuan, which the company blamed on increased donations and a 48.9% spike in R&D spending. That higher spending came as Neautus added three new R&D projects last year, and used higher-value raw materials for its research.

We should also note that Neautus' overall gross margin dropped by 1.4 percentage points to 17.1% in 2024. The company explained that in addition to feeling effects from higher R&D spending, the overall margin decline owed partly to its growth in sales to medical trading companies, which accounted for 35.5% of revenue last year and generally carries lower margins. It also cited intensifying competition and higher raw material costs.

Fluctuations in raw material prices are of particular concern for TCM companies, accounting for 94% of Neautus' cost of sales. Because they are mostly derived from nature, the cost of such materials can vary from year to year based on factors like weather, planting patterns and supply and demand imbalances. Neautus has also pointed out that such fluctuations have directly affected its margins in the last few years. To minimize such effects, Neautus says it plans to use funds from the IPO on strategic investments to globally diversify its upstream chain of raw material suppliers.

In terms of sales, Neautus' overseas business is still small, accounting for just 4.5% of its revenue last year. That said, the overseas business is also growing quickly, rising from 26.1 million yuan in 2022 to 56.2 million yuan last year. Neautus already operates outside the Chinese Mainland in Hong Kong, Taiwan, Vietnam and Malaysia, and plans to further develop its overseas business after the listing. It says part of the funds from the IPO will be used to establish overseas sales channels in Vietnam and Malaysia.

Hong Kong's stock exchange is currently home to a number of TCM concept stocks, including China Traditional Chinese Medicine (0570.HK), the largest player by market capitalization, and other well-known names like Beijing Tong Ren Tang Chinese Medicine (3613.HK). But such companies aren't generally valued very highly. These two listed companies currently trade at forward price-to-earnings (P/E) ratios of just 10 and 12 times, respectively, meaning Neautus will also likely need to settle for a similar, less-than-premium valuation.

At the end of the day, China's TCM industry is a crowded, highly fragmented space without any dominant players, making the market fertile for mergers and acquisitions to consolidate the sector. As a leading player, Neautus could be positioned to become such a consolidator, using both organic and acquisitive expansion and cost controls to reignite its profit growth.