Monday, September 7, 2020

Medtecs International Corporation Ltd (Part I)

Investing amidst COVID-19

Medtecs International Corporation Limited (MED) manufactures medical consumables including surgical attire, patient apparel and medical bandages. The Company also acts as agents to distribute medical devices such as digital blood pressure equipment and respiratory treatment equipment. MED manufactures and sells woven and knitted medical textile goods of similar nature.

MED has been attracting a lot of attention from the investment community due to its outstanding performance ytd in 2020. Along with the bullish sentiment surrounding MED, there are also an equally vocal group warning that this is only a thematic play that will not last beyond the year.

What are MED’s products? What do they do?

MED produces epidemic prevention equipment such as PE gowns, protective overalls, face masks, etc. In addition, it also produces workwear, hospital textile, personal protective equipment (PPE), incontinence products and medical device directive products (isolation gowns, shoe covers, etc.).

In terms of services, MED provides hospitals in Taiwan and Philippines with integrated services including rental and laundry of linens, management of laundry facilities, hospital automation and other non-core hospital functions.

What had fueled MED’s rise from the ashes?

For budgetary and efficiency reasons, healthcare organizations adopted a “just in time” approach to ordering supplies. Nobody expected COVID-19 to happen and when it did, a PPE shortage emerged.

As an established player in the PPE industry, MED was the main beneficiary of this PPE shortage as demand rose. This had flowed down to its P/L and ballooning cash and cash equivalents on its balance sheet.

Some have pointed out that the surge in demand for PPE have coincided with low material costs (looks at oil price chart) which have fattened the margins for MED. I will beg to differ on this argument.

I refer you to a featured report in 2014 by the non-wovens industry.

Medtecs International Grows in Southeast Asia (https://www.nonwovens-industry.com/issues/2014-02-02/view_features/medtecs-international-grows-in-southeast-asia/). In the report, Yang Kexin, general manager of Jin Cheng Medical Textile, a member of Medtecs Group discusses the company’s past and future.

While raw material prices keep rising, product market demand is declining. Who can explain this with the market principles of supply and demand? In the end, this takes profits away from manufacturers.

MED’s margins basically have no correlation to commodities prices. Rather, MED’s margins are helped by rising average selling prices in PPE due to shortage in supplies and a low manufacturing cost base.

The margins for MED’s products are helped by the efficiencies and inherent regulatory environment of its various factories in Cambodia, China and Philippines. For example, in the same article it is mentioned that exports from Cambodia to Europe are duty-free, there aren’t any foreign exchange controls in Cambodia and labor costs are low.

COVID-19 has exposed the vulnerabilities of the current supply chain, and I expect the market landscape to shift considerably. As US and Europe began to wean themselves of their existing heavy reliance on China, a China Plus One Strategy may be pursued not only by manufacturers but also by government agencies when sourcing for essential products such as PPE. MED is an early-mover and will no doubt be able to capitalize on this trend and capture more contracts as other manufacturers are only just beginning to consider having manufacturing facilities in alternative locations.

Where is the meat?

The following is MED’s historical performance.

In the beginning of the pandemic, governments all over the world were fighting to secure PPE. Unsurprisingly, MED had also obtained substantial orders from SEA, Europe and US. And if you look hard enough, you will find the demand in SEA is closer than most people think.

Based on this set of results it is evident that MED had performed tremendously well in 1H2020. But will this continue?

Let us look at MED’s current capacity. I have collated MED’s capacity based on publicly available information. As demand continues to be tight while supply of good grade medical PPE are still low, these figures may be too conservative.

The sources of the capacity are from the following:

Cambodia factory capacity:

https://www.phnompenhpost.com/national/kingdom-produces-ppe-gear

Philippines factory capacity:

https://www.bworldonline.com/boi-approved-investments-plunge/

Does this figure make sense? We look back to MED’s factory description on the company website.

The production line in terms of what products are being produced where checks out.

We go on to factor in PPE prices (I think it’s easy to search for prices online so I’m leaving the links out for this one).

MED had already announced that they have orders filled up to next year. Applying gross profit margins and net profit margins of 30% and 25% respectively. I had conservatively reduced margins lower for 3Q 2020 and 4Q 2020 to factor in higher labor costs as a result of significant ramp in capacity utilization.

This means that MED’s 3Q 2020 net profit is expected to register at least 40% QoQ jump from 2Q 2020.

Again, margins may be higher because we know US and Europe actually have medical standards in place even for PPE that hospitals can purchase (this is one of the greatest strength that MED enjoys as an incumbent of the PPE industry as opposed to makeshift/ repurposed factories from clothing lines and small businesses popping up in India and China).

This point on medical standards cannot be more clear, as we read from the media as far back as February 2020 that clothing manufacturers have repurposed their factories to produce PPE/masks/gloves/ventilators in the US. However, average selling prices in April to June did not fall. This means that the supply of good grade PPE products are still in shortage.

As at the close of trading on 7 September 2020, MED is trading at S$1.44 or 4.2x FY2020 results.

So where does that leaves us? A good comparison will be medical gloves counters trading on SGX. These guys are very well publicized, please look for Top Glove, Riverstone and UG Healthcare. These guys are all trading well above 12x FY2020 PE.

MED is a cheaper stock to buy. 

Why has MED remained cheap?

1. MED is not well covered by analysts. While the glove counters have had their moment under the sun, MED’s sales continue to power on unnoticed by institutions.

2. MED’s management have also been shy to speak to media and have not been actively engaging with the investment community. That is why capacity numbers, market supply/demand and average selling prices have not been easily obtained and injects an element of uncertainty in MED’s future performance. 

Compared to the glove counters where production capacities are announced in the headlines, MED could have done better in this aspect.

But we see this 'shyness' in other Taiwan companies as well (e.g. Hotung Investment Holdings). This does not mean they are not confident of their performance or are hiding anything. 

3. MED’s meteoric rise had captured the headlines. But these headlines had created a mental block in the investment community, “Wa rise 5,000% already, still can go meh?”.

This creates an opportunity for the value investor and also the analyst (buy- and sell- side) who uncovers this gem.

MED definitely remind me of the likes of AEM and China Sunsine which had benefited so many investors.

In the next article, we talk about FY2021 and beyond. This is important as we are deep into the second half of 2020 and analysts are now basing their valuations on FY2021 numbers. 



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2 comments:

  1. Thank you for a pretty cool analysis. Looking forward to Part 2 on FY202.

    ReplyDelete
  2. HI, but given that the demand is unlikely to be sustainable in the long run (next 3-5years), what is your take on whether Medtec is a good counter to hold on for the long run? Or is it still speculative at this point?

    ReplyDelete