2H22 results miss our forecast

HitGen announced its 1H22 results: Revenue declined 10.01% YoY to Rmb139mn and attributable net profit slumped 134.17% YoY to -Rmb7mn. In 2Q22, revenue dropped 22.03% YoY to Rmb66mn and attributable net profit decreased 99.80% YoY to Rmb0.03mn, missing our forecast, as: 1) COVID-19 resurgence impeded clients’ field visits, leading to a decline in new clients; and 2) the firm was upgrading its DNA-encoded compound library (DEL) screening services.

Trends to watch

Short-term results affected by COVID-19; businesses undergoing transformation. By segment, revenue from customized DEL library services declined 19.33% YoY to Rmb23.01mn and that from DEL screening services decreased 10.16% YoY to Rmb37.08mn in 1H22. Revenue from domestic clients increased 25.42% YoY to Rmb28.36mn in 1H22, accounting for 20.44% of the total. Revenue at subsidiary Vernalis came to Rmb48.04mn, accounting for 34.63% of total revenue of 1H22. The firm expanded its service coverage. In June, it launched OpenDEL?3.0, which features a greater range of DEL libraries and compounds with better drug-likeness, lowering the threshold for its applications and providing more screening samples. Meanwhile, the firm also rolled out new DEL-related services such as DEL screening of matrix materials and reagent synthesis, among others. The firm continued to strengthen its advantages in DEL technology. As of end-June, its DEL libraries had 1.2trn of molecules and selected 51 projects on different types of targets from clients. The firm had about 20 R&D projects for new drugs with proprietary intellectual property rights, with four of them undergoing phase I clinical trials.

Continues to improve core technological platform and invest in new drug pipelines. In 1H22, the firm invested Rmb42.58mn in R&D, up 27.02% YoY and accounting for 30.69% of total revenue (up 8.94ppt YoY). The firm increased R&D personnel by 40 in 1H22 bringing the total to 419. Underpinned by a drug discovery platform based on four major technologies[1], the firm has established a one-stop system supporting drug optimization ranging from target gene to application for clinical trials.

In 1H22, gross margin declined 15.05ppt YoY to 37.15%. We think it is mainly because: 1) R&D projects of new drugs are still at preliminary stages; 2) progress in implementation and difficulty in development of projects affected gross margin; and 3) raw material prices increased.

Financials and valuation

We maintain our 2022 and 2023 earnings forecasts and an OUTPERFORM rating. However, considering that policies increasingly encouraging innovative original research in China will increase the asset value of drug discoveries, we raise our DCF-based TP by 18.1% to Rmb18.90, offering 10.1% upside.

Risks

M&A disappoints; risk in drug development; loss of core employees; changes in forex rates.