JOINN: A profit warning becomes a market indicator, is "rate cut" the key to valuation rebound?

On July 10, JOINN (06127) closed at a record low of HKD 6.62, injecting a shot in the arm for this CRO company with a "profit warning" announcement that same evening.

According to the Securities Times APP, on the evening of July 10, JOINN issued a profit warning: it is expected to achieve operating income of approximately RMB 719 million to 973 million in the first half of 2024, a decrease of about RMB 38.6417 million to 293 million compared to the same period last year, a year-on-year decrease of about 3.8% to 28.9%. It is expected to achieve a net loss attributable to shareholders of the listed company of approximately -184 million to -136 million in the first half of 2024, compared to the same period last year, resulting in a loss.

However, it was this profit warning that led to a significant increase in JOINN's stock price the next day, rising by 10.12%, with an intraday increase reaching 12.08%. On July 12, JOINN continued to rise, with the highest intraday increase in stock price reaching 6.45%, resulting in a cumulative increase of 12.24% over two days.

Although the reverse trend of JOINN's stock price after the profit warning is somewhat related to the generally low market expectations, from the company's perspective, behind the declining trends in revenue and net profit in this performance forecast, the business side has shown a turning point, with an improvement in order intake and consultations on a month-on-month basis. The market's sentiment towards JOINN and even the entire CRO market's subsequent rebound is all condensed in this 10% increase.

Monkey Price Decline Continues

In the latest performance forecast released by JOINN, the company has analyzed the factors affecting its own losses, with a net loss of 2.24-2.47 billion yuan caused directly by changes in the fair value of biological assets. Ultimately, JOINN is still suffering from the negative aftermath of the drop in experimental monkey prices.

According to the Securities Times APP, the average purchase price of crab-eating monkeys in China surged 6 times between 2020 and 2022, and the aggressive JOINN, in addition to hoarding monkeys, also changed the measurement method of experimental monkey biological assets in the 2020 annual report from the previous "cost method" to the "fair value method".

The result of this accounting policy change is that when the fair value of biological assets continues to rise, the price gains are released in the current period's financial statements. However, as a double-edged sword, once the period of soaring monkey prices ends, the company's net profit will also be negatively affected. This is the main reason why JOINN has been incurring losses for several quarters in the past.

On the other hand, in the first quarter of this year, JOINN recorded a net loss attributable to the parent company of 2.72 billion yuan, while in the second quarter, the company achieved a net profit attributable to the parent company of 0.88 billion to 1.36 billion yuan, showing a significant improvement on a quarter-on-quarter basis In other words, the appearance of a short-term turning point in the operation of JOINN can be clearly judged from the 2024H1 performance forecast.

Firstly, referring to JOINN's 2023 annual report data, the reasons for the decline in net profit given by the company at that time are basically the same as this performance forecast, both mentioning a decrease in industry prosperity and intensified competition leading to the company making concessions on order prices, squeezing profit margins.

However, the difference in order numbers between the 23 annual report and Q1 and Q1 of 24 shows an overall market recovery. In the 2023 annual report, JOINN stated that it signed new orders of 2.3 billion yuan, a year-on-year decrease of 39%, but the number of new customers increased by 30% year-on-year. At the same time, the company's backlog orders reached 3.3 billion yuan, providing a stable backlog of orders and customer numbers to support future performance.

Subsequently, in the 2024Q1 period, the number of new projects signed by JOINN increased by 20% year-on-year, overseas project orders increased by 30%, and the growth in backlog orders or the increase in new project numbers may be the main factors leading to the company's performance recovery in 2024Q2.

Upward forecast of the CXO cycle?

Since mid-January 2023, JOINN's stock price has been in a continuous decline, coupled with the dismal performance disclosed in the 2023 interim report and the first three quarters' financial reports, with net profit declining by 75.58% and 48.17% year-on-year respectively. JOINN's stock price went through the entire 2023 in accelerated decline, and there are no clear signs of a bottoming out in 2024.

Starting from the high point of 35.07 Hong Kong dollars on January 16, 2023, even with the stock price rebound on July 11 and 12 this year, JOINN's stock price has accumulated a decline of nearly 80%. The reason for this is that there is still a divergence in the market's judgment on the downstream prosperity of the CXO sector. In this context, the traditional valuation model for CXO companies is almost ineffective, and the cyclical nature of CXO companies is becoming more apparent.

In fact, since the third quarter of 2023, JOINN's performance has shown significant improvement on a quarter-on-quarter basis. For example, in the second and third quarters of 2023, key financial indicators of JOINN showed a significant year-on-year decline, but the quarter-on-quarter growth data of the laboratory's core business, excluding the impact of biological assets, indicates that its profitability has not been lost. This also indicates that JOINN's industry moat built on scarce and comprehensive international certification qualifications is still effective.

However, in the face of the downturn in the CXO industry cycle, the weight of performance in valuation judgment has dropped to a new low, and the company's stock price continues to decline without support, which is a typical characteristic of cyclical stocks.

In this logic, in response to JOINN's 2024H1 performance forecast, the market reaction seems to be somewhat beyond imagination. In other words, if JOINN were to experience a valuation reversal in the future, the impact of its own performance fluctuations would not be so significant, to some extent, it would require an improvement in the biopharmaceutical investment and financing environment to drive a rebound in the overall domestic CXO sector On July 9th local time, Federal Reserve Chairman Powell attended the Senate Banking Committee hearing, delivered testimony on semi-annual monetary policy, and answered questions on monetary policy and bank regulation. Powell stated in his prepared remarks that although inflation has eased, it remains above the 2% target, and policymakers remain committed to bringing the inflation rate down to 2%. Analysts believe that Powell's testimony indicates a shift in the balance between stabilizing prices and maximizing sustainable employment, bringing the Fed closer to a rate cut.

On July 3rd, the U.S. released the ISM Non-Manufacturing PMI for June, which came in at 48.8, below the expected 52.6 and lower than the previous value of 53.8. As the PMI index uses 50 as the dividing line between expansion and contraction, the actual value of 48.8 falling below this threshold and well below expectations has increased market expectations of a Fed rate cut, leading to a drop in the U.S. dollar index on that day.

On July 5th, the U.S. Department of Labor released the June non-farm payrolls data: the number of new jobs added was 206,000, significantly lower than the previous 272,000; the unemployment rate rose to 4.1%, the highest since 2021. This has raised expectations of a Fed rate cut starting in September. According to the "Fed Watch Tool" data from the Chicago Mercantile Exchange, the market currently expects a 73% probability of a cumulative 25 basis point rate cut by the Fed by September.

These data to some extent indicate that the U.S. interest rate hike cycle is coming to an end, the biopharmaceutical investment and financing environment is expected to improve, transmitting to the upstream market, and the CXO sector may usher in a new upward cycle. Only in an industry upswing cycle can JOINN Pharmaceuticals hope to increase its valuation based on its leading position in drug evaluation and scarce qualifications. To some extent, the market's anticipation of JOINN Pharmaceuticals' future performance based on new orders can be seen as a prediction of the arrival of an upward cycle in the CXO sector