Fuerjia is a leader in specialized skincare patch products. Leveraging its strengths in dressings, Fuerjia has developed a range of products and expanded its product matrix, resulting in seven top-selling products, each with over Rmb100mn in sales. In terms of channel positioning, Fuerjia has undergone structural optimization by lowering the proportion of offline sales and achieving rapid growth in online sales, thus enhancing its channel visibility and pricing power. Looking ahead, Fuerjia is increasing its marketing spending to strengthen its brand while venturing into medical aesthetics and expanding into Class III dressings on the back of a substantial R&D pipeline, which will likely unlock medium-to-long-term growth opportunities. We assign 26x 2024E PE to derive a target price of Rmb56 and initiate coverage with a "BUY" rating.

A leader in the specialized skincare patch category with stable and resilient business performance: Starting as a pharmaceutical manufacturer, Fuerjia embarked on a journey of transformation from its predecessor, Huaxin Pharma ("华信药业"), in 2012.

With over a decade of transformation, it secured a dominant market position in the specialized skincare patch category with a 17.5% market share in 2021.

Fuerjia's product portfolio is highly concentrated, with seven top-selling products contributing 83% of its revenue in 2022. In terms of distribution, Fuerjia primarily relies on offline channels, which account for 60%, while online sales have seen significant growth with a well-established presence.

Fuerjia's controlling shareholder holds an 84.4% stake, resulting in a highly concentrated ownership structure. Its executive team, with long tenures and equity incentives, has helped create a cohesive and motivated organization.

Regulation-driven supply and demand dynamics are paving the way for substantial growth in the skincare segment, focusing on efficacy.

According to data from Frost & Sullivan (as cited in Fuerjia's prospectus), the skincare industry encompasses various segments, with the professional skincare product market accounting for 12% of the industry in 2021. Within this category: ① Medical device-type dressings achieved sales of nearly Rmb7bn in 2021, exhibiting a remarkable CAGR of +86% from 2017 to 2021.

This niche market, characterized by its small size and strong growth, is poised for a 2021-26 CAGR of +30.1% per Frost & Sullivan. Clear regulatory policies introduced since 2021 have refined product definitions and standardized efficacy claims, which led to a surge in the number of product registrations, intensifying competition and expanding the industry's size. ② In 2021, the professional skincare market in China reached a size of nearly Rmb37.8bn, which would grow at a 2021-26 CAGR of +18.3% per Frost & Sullivan. Fuerjia maintained its top-three position in the market in 2021. In recent years, the concept of efficacy-based skincare has gained prominence, driven by various factors. Among these, over 40% of consumers with sensitive skin have shown heightened demand for professional skincare products, propelling a five-year CAGR of +27.8% in the dermatologist-level skincare product market in China.

Additionally, regulatory compliance and the rise of social media have laid the　foundation for the promotion of professional products. Enhanced transparency in product efficacy has elevated consumer awareness, and the proportion of professional consumers, such as ingredient enthusiasts, is likely to continue to grow, fueling the demand for efficacy-based skincare.

Expanding the product matrix, exploring online channels, and intensifying marketing efforts to cultivate new growth drivers. 1) Products: The product matrix expansion has evolved through three distinct phases: laying the foundation with dressings→crafting top-selling flagship products→creating a broader product matrix.

Fuerjia has shifted from a focus on large top-selling products towards a diverse product matrix, with a strong emphasis on exploring extensions driven by innovative efficacies. The two core products ("White Dressing" and "Black Dressing") combined generated revenue of Rmb800mn in 2022 and have served as enduring cornerstones for the brand. Fuerjia has successfully ventured into the skincare market by focusing on acne treatment, repair, whitening, and anti-aging with a limited number of top-sellers, resulting in five top-sellers with annual sales exceeding Rmb1bn. Continuous innovation and a focus on ingredient efficacy have facilitated category expansion and product line extensions, enabling its transition from medical dressings to professional skincare products across various domains. We believe the Company is well-positioned to explore growth opportunities through a parallel approach to developing flagship products and extending the product matrix in the future. 2) Channels: Distribution channel optimization comes with robust growth in multi-channel online sales. i) Distribution optimization: The Company's channel partner structure has undergone optimization to enhance operational standardization and stability. Notably, a focus on the concentration of top-tier partners within the A-class category, standardized integration and management of alliance partners, and intensified efforts by channel partners in reaching end users have resulted in +50% YoY growth in revenue contributor from a single distributor, reaching Rmb3.96mn in 2022. ii) Tmall flagship stores: With nearly five years of operation, Fuerjia's Tmall flagship store has seen expansion in its customer base and an improved customer retention rate. Promotions during key sales events contributed more than half of the revenue. iii) Douyin: The Company has established a network of seven stores on Douyin, primarily focusing on official flagship stores with in-house broadcasts, with sales reaching Rmb59mn/100mn/122mn in 1Q/2Q/3Q23, respectively, to showcase gradual momentum building.

Coming into 2023, the Company has adjusted its influencer structure and actively expanded its reach to both mid-tier and top-tier influencers, leveraging the flow of users to boost the reach of individual products. 3) Marketing: Online expansion boosts promotional spending, with a focus on strengthening new media and social/private domain platforms.

Fuerjia has adapted to changes in traffic channels by adjusting expenditure allocations. In recent years, there has been an increase in online marketing investment, with the selling expense ratio of direct sales rising to 36.8%. Notably, a significant emphasis has been placed on new media and social/private domain platforms. In 2022, the expense ratio of promotions via Douyin and Weixin reached 50.4% and 48.8%,　respectively.

Strengthening R&D capabilities, empowering production & sales with IPO proceeds, and venturing into medical aesthetics to unlock medium- and long-term growth prospects. 1) R&D: Enhancing third-party collaborations and in-house R&D while consolidating material and formulation R&D expertise.

Fuerjia primarily relies on third-party collaborations for its R&D, with in-house development as a complementary approach. Key highlights include: i) Third-party R&D partnerships with leading players in various domains, encompassing the development of collagen, plant extracts, and supramolecular materials and processes. Additionally, the Company obtained approval for its first cosmetic raw material, β-nicotinamide mononucleotide (NMN), in Nov 2023, marking a progressive step in material innovation. ii) The in-house R&D team consists of seasoned employees with extensive experience and new members who have been rapidly expanding. Simultaneously, Fuerjia established a subsidiary in Shanghai, joining the so-called "1-hour global beauty R&D circle." 2) Empowering through fundraising: Increased investment to lay the foundation for production capacity and marketing momentum.

The Company's initial public offering (IPO) proceeds will primarily be channeled into production and marketing. In this regard, the Company's Northern Beauty Valley production facility commenced operations in 1H23, augmenting its medical device manufacturing capabilities. Notably, in the field of collagen filler products, the Company has accumulated expertise in cross-linking and production technologies. The Company’s production capacity now covers filler and freeze-dried fiber products, which will facilitate its entry into the medical aesthetics sector. In terms of promotional expenditure, platform promotion expenses for Tmall and Douyin have remained steady, while brand marketing expenses have focused on leveraging key opinion leaders (KOLs) and celebrity influencers to enhance the brand's momentum.

Potential risks: Intensified industry competition; stricter regulatory policy; fluctuations in offline distributor networks; underperformance in online expansion; new product development not up to expectations; fluctuations in revenue from top-selling products; underperformance in marketing effectiveness; a decline in profitability; the negative impact of production capacity transition and goodwill impairments; risks from a highly concentrated ownership structure.

Investment recommendation: Fuerjia is a leader in specialized skincare patch products. Leveraging its strengths in dressings, Fuerjia has developed a range of products and expanded its product matrix, resulting in seven top-selling products, each with over Rmb100mn in sales. In terms of channel positioning, Fuerjia has undergone structural optimization by lowering the proportion of offline sales and achieving rapid growth in online sales, thus enhancing its channel visibility and pricing power. Looking ahead, Fuerjia is increasing its marketing spending to strengthen its brand while venturing into medical aesthetics and expanding into Class III dressings on the back of a substantial R&D pipeline, which will likely unlock medium-to-long-term growth opportunities. We forecast 2023E-25E attributable net profit (ANP) of Rmb781mn/862mn/943mn,　equivalent to 2023E-25E PE of 23x/21x/19x at the current price. Considering the average valuation of 26x 2024E PE for comparable companies (all based on CITICS Research forecasts), including Botanee (300957.SZ), Bloomage Biotech (688363.SH), Proya (603605.SH), and Giant Biogene (02367.HK), and factoring in the ample growth potential for the Company's new products, we believe a certain valuation premium can still be justified given the potential growth of these new offerings, despite the declining profit margins in the short term, and therefore value Fuerjia at 26x 2024E PE. Considering the average valuation of 5x 2024E PS for comparable companies (all based on CITICS Research forecasts), including Botanee (300957.SZ), Bloomage Biotech (688363.SH), Proya (603605.SH), and Giant Biogene (02367.HK), and considering the Company's strong short-term visibility and significant growth potential in the medium to long term for new products, we value Fuerjia at 9x 2024E PS. Considering that Fuerjia has been in an adjustment phase thus far this year, profit metrics are more indicative of its operational adjustment pace and actual performance. We adopt the PE valuation method to derive a 2024 target market cap of Rmb22.4bn, corresponding to a target price of Rmb56, and initiate coverage with a "BUY" rating.