Summary of Key Points
2026 marks a turning point for China's pharmaceutical industry: the underlying logic has shifted from "low-price competition under domestic cost control" to "global innovation collaboration (earning money from patients worldwide)," and performance is beginning to reflect this change. The current situation resembles the pharmaceutical industry's turnaround in Japan during the 1990s, but China's approach to globalization is more advanced, as it integrates into the global innovation ecosystem rather than merely exporting products. The market presents structural opportunities, with only the leading innovative companies and those with strong overseas capabilities benefiting, rather than an overall sector-wide rise in prices. Public funds' holdings in the pharmaceutical sector have reached a 10-year low, but valuations have recovered, indicating a potential gap between market expectations and reality that deserves attention.
I. The Underlying Logic Has Changed: From "Earning Money from Domestic Patients" to "Sharing in Global Innovation"
In the past, Chinese pharmaceutical companies relied primarily on the domestic market, such as through price cuts to gain market share with generic drugs. However, the trend has shifted—now, the basis for pricing pharmaceutical companies is no longer whether they can survive under domestic cost controls but whether they can participate in global innovation.
For example, BeiGene's drug Baiyueze (an anti-cancer medication) generated $1.2 billion in sales in the second quarter of 2026, with the U.S. market accounting for 74% of that figure. In the first half of the year, Chinese innovative drugs earned $99.7 billion through licensing their technologies to foreign companies (including upfront fees and sales royalties), which is nearly 73% of the total for the entire previous year. In other words, the focus has shifted from domestic price competition to global innovation revenue, and this change is no longer just an expectation but is reflected in actual financial data.
II. Comparing with Japan's Experience: China's Pharmaceutical Industry at a Turning Point
China's current pharmaceutical industry is very similar to Japan's in the 1990s, but it is progressing faster and has a higher potential for growth:
- Japan's Path: In the late 1980s, due to aging and healthcare cost controls, the government continuously reduced drug prices (up to 18.6% per adjustment), leading to the elimination of four-fifths of pharmaceutical companies. The surviving leading firms were forced to focus on innovation and globalization (for instance, Takeda Pharmaceutical's overseas revenue increased from 10% to 30%). The industry reached a turning point between 1995 and 1997.
- China's Current Situation: Drug centralized procurement has been in place for eight years, resulting in the elimination of many generic drug companies. The rules have shifted from focusing solely on low prices to balancing quality and price (for example, the twelfth round of procurement specified a price range that was 1-2 standard deviations below the average to avoid extreme discounts). Similar changes are occurring in medical device procurement, with a shift from aggressive price cuts to maintaining stable prices and volumes. Leading companies like Mindray and United Imaging have seen their overseas revenue exceed 50% or 25%, respectively, while innovative drug companies are earning money globally.
- China's Advantages: While Japan focused on selling mature products internationally, China aims to become a part of the global innovation ecosystem. For instance, Innovent Biologics collaborates with Pfizer, where Innovent handles early research and development while Pfizer is responsible for global development, sharing the profits. This indicates that China's pharmaceutical industry is not just replicating Japan's model but is ascending from being a "worker in the global supply chain" to a "participant in innovation."
III. Structural Market Trends: Not an Overall Rise, Only Leading Companies with Global Capabilities
The turning point does not mean a sector-wide increase in prices. After 1997, only the leading innovative companies in Japan saw multiple-fold gains, while the weaker generic drug firms continued to decline. The same pattern is likely to apply in China:
1. Main Portfolio Allocation (60%-70%): Innovative Drugs + CXOs (Contract Research Organizations)
- Innovative Drugs: Leading companies like BeiGene and Hengrui have stable sales and licensing revenues, offering higher certainty. Biotech firms (such as Frontier Biosciences and Rongchang Biosciences) rely on licensing fees for greater performance flexibility. Themes such as GLP-1 weight loss drugs and AI-driven drug design also offer higher potential.
- CXOs: These companies provide essential services for global drug development, and pharmaceutical companies must pay them regardless of the success of their drugs (e.g., WuXi AppTec and Kelun Pharmaceutical). With increased global investment and financing, CXO orders are on the rise, and the profit realization period is approaching. However, valuations have recovered to the 60th percentile in the past five years; it is recommended to hold these positions at lower levels and increase them during market corrections.
2. Secondary Portfolio Allocation (20%-30%): Medical Devices + Traditional Chinese Medicine
- Medical Devices: Companies like Mindray and United Imaging have strong overseas revenue, but domestic healthcare reforms and slow implementation of equipment renewal policies are affecting performance. Valuations are at the 10th percentile in the past five years, making them suitable for early investment with the potential to increase positions as profit growth stabilizes.
- Traditional Chinese Medicine: The cost curve has turned (e.g., high-priced bezoar inventory is being depleted), but these effects will only be reflected in financial reports in Q3. Policy support (such as exemptions for clinical trials based on traditional usage) will also take effect in Q3. Current valuations are low (4.31% in the past five years), making them suitable for light positions with the potential to increase holdings after Q3 data is available.
3. Wait and See: Pharmacies: Recent gains in pharmacy stocks are due to the outflow of prescriptions, but slow penetration and weak consumer demand limit their role as a main market driver, offering only short-term trading opportunities.
IV. Current Expectation Gaps: Positions Have Not Keeping Up with Market Trends
Public funds held only 6.5% of their portfolios in pharmaceuticals in the second quarter of 2026, the lowest level since 2010, despite the sector's valuation having recovered to the 54th percentile in the past five years. In other words, the market has begun to recognize the new logic of global innovation, but most funds have not yet shifted their investment focus. This gap between valuations and actual market participation is what makes the pharmaceutical sector particularly interesting at present.
Conclusion
The transformation of the pharmaceutical industry is real, but it's not about making blind investments. Only the leading companies that can participate in global innovation—whether in innovative drugs or CXOs—will continue to benefit. Ordinary investors can allocate their portfolios according to a combination of main and secondary sectors, avoiding those firms without overseas capabilities, and seize these structural opportunities.
(Note: This analysis is for reference only and does not constitute investment advice.)