Can faster innovative drug growth offset the decline in generics?

  • Hengrui’s innovative drug sales rose 24% year over year in the third quarter of 2026, accelerating significantly from 8% in the second quarter. Growth was 16% in the first half and 17% cumulatively in the first three quarters, when innovative drugs accounted for 65% of pharmaceutical sales.
  • The other side is pressure on generics: sales fell 22% year over year in the third quarter, the same rate of decline as in the second quarter, as a result of continued volume-based procurement pressure and the company’s strategic decision to lower their priority. Generics accounted for 35% of pharmaceutical sales in the first three quarters.
  • Morgan Stanley is watching whether domestic innovative drug sales can reach or exceed the 2026 target of 19.2 billion yuan implied by the employee share ownership plan, corresponding to year-over-year growth of 17.5%.

How did collaboration revenue affect third-quarter results?

  • Third-quarter business development (BD) revenue was 1.36 billion yuan, mainly from the recognition of part of the upfront payments under collaborations with GSK and Bristol Myers Squibb. Hengrui has received the full upfront payment of 600 million US dollars from Bristol Myers Squibb.
  • Morgan Stanley believes third-quarter revenue and profit were both slightly above market consensus and expects a modest upward revision to consensus earnings per share estimates over the next 12 months. The bank will monitor the execution of announced collaborations and the timing of revenue recognition.

Why did product operating margin rise despite a decline in gross margin?

  • Third-quarter gross margin on product sales fell 2 percentage points year over year to 83%, but the selling, general and administrative expense ratio fell 5.8 percentage points and the research and development expense ratio rose 1.8 percentage points. As a result, the operating margin on product sales increased 1.9 percentage points year over year to 18.4%.
  • Recurring net profit was 2.5 billion yuan, up 91% year over year and 13% above Morgan Stanley’s forecast. The third-quarter change in fair value was a loss of 40 million yuan: gains from BraveHeart were offset by losses from Kailera.

What will Morgan Stanley watch in its assessment going forward?

  • The bank is watching for further policy effects on the generic and mature patented drug portfolio and trends in product gross and operating margins. For external collaborations, it is monitoring transaction execution and revenue recognition involving GSK, Bristol Myers Squibb and two new companies.
  • Morgan Stanley rates Hengrui’s Hong Kong shares Overweight with a target price of 82 Hong Kong dollars. Upside factors listed by the bank include licensing deals and collaboration revenue exceeding expectations; downside factors include a greater-than-expected impact of volume-based procurement on some drugs and major setbacks in the research and development pipeline.