• Attractive valuation at 6.8x blended FY21/22F P/E with FY21F cash holdings at 35% of Medtecs market cap.
• Margins to remain high post-pandemic led by higher sales of self-branded products.
• M&A or new dividend policy may be in the works due to large cash holdings.
• Initiate coverage on Medtecs with BUY.

Medtecs International - Company Background

• Medtecs International Corporation (SGX:546) is a leading personal protective equipment (PPE) and hospital service provider based in Taiwan. Medtecs was listed on the SGX in 1999 and employs over 7,500 employees worldwide with key business interests in Europe and Asia Pacific.
• Medtecs has three business segments -
  • Manufacturing,
  • Hospital Services and
  • Trading & Distribution.
• In recent months, the Manufacturing segment has grown to 89% of Medtecs’s total revenue (FY19: 77%) as PPE demand surged following the outbreak of COVID-19.

Manufacturing segment produces medical consumables.

• A wide range of medical consumables including surgical masks, PPE and bed linens are produced or sub-contracted by Medtecs before being supplied to large distributors or directly to hospitals. The COVID-19 pandemic has driven two major changes in manufacturing.
  • Firstly, Medtecs is seeing a large rise in sales volume, driven by medical consumable needs as a result of the pandemic.
  • Secondly, sales of Medtecs’s own label (e.g. CoverU) has risen from 3% in 2019 to 68% of the Group’s total sales for 9M20.
• Medtecs has 14 factories across Asia with over 100 production lines.

The Trading & Distribution segment primarily deals with the e-commerce and pharmaceutical store channels.

• The segment primarily markets Medtecs-branded products and has grown its contribution to Medtecs’s revenue from 2% in FY19 to 7% as of 9M20. Medtecs’s products can be found in over 3,400 pharmaceutical stores, 6,000 convenience stores and 2,000 chainstores in Taiwan and the Philippines. The segment also sells through e-commerce platforms such as Alibaba, Amazon and Lazada.

Hospital Services segment provides hospitals in Philippines and Taiwan with non-core hospital services.

• The segment fulfils non-core hospital functions such as laundry services, lease of linen and logistics support (3L services). Medtecs is currently the dominant provider for such services in Taiwan and now provides 3L services to 56 hospitals in Taiwan and the Philippines.

COVID-19 has improved Medtecs’s geographical diversity but increased Manufacturing’s share of revenue.

• Prior to COVID-19, contributions from the Manufacturing and Hospital Services segments were stable at 75% and 21% respectively. However, the Manufacturing business has surged as COVID-19 boosted demand for medical consumables. As a result, the Manufacturing segment now contributes 89% of Medtecs’s total business (as of 9M20). That said, Medtecs has diversified its revenue with Australia now contributing 6% of Medtecs’s 9M20 revenue.

Medtecs International's Management Team

• Founder and Executive Chairman: Mr Clement Yang Ker-Cheng.
• Chief Executive Officer and Executive Director: Mr William Yang Weiyuan.
• Chief Financial Officer: Mr Wilfrido Candelaria Rodriguez.

Board of Directors shuffle.

• Medtecs’ board shrank in 2020 due to the resignations of Mr Wilfrido Candelaria Rodriguez (Executive Director) and Mr Xia Junwei (Non-Executive Director). Nevertheless, Mr Wilfrido remains Medtecs’ Chief Financial Officer (CFO).

Familial relationships.

• Mr William Yang is the son of Mr Clement Yang and took over from his father in 2018. Ms Wan Chien Yang, daughter of Mr Clement Yang, was recently appointed non-executive director of Medtecs USA.

Medtecs International - Investment Summary

Initiate with BUY and target price representing 40% upside.

• Medtecs offers compelling value at 6.8x blended FY21/22F P/E. Post-pandemic, the Group could sustain gross margins of 33% led by a higher share of Medtecs-branded product sales.
• Sales volumes are also expected to be 60% higher in FY22F compared to FY19 supported by new customers acquired during the pandemic. Medtecs’s extensive customer relationships and ability to cross sell products through its Hospital Services segment could also provide a steady stream of revenue in the post-pandemic world.
• In the medium-term, investors may also look forward to M&A activity or a sustained dividend policy given Medtecs’ large cash pile of over US$100m generated by FY21F.

Attractive valuation at 6.8x blended FY21/22F P/E or 2.7x FY21F cash holdings.

• We believe our base case valuation of S$1.30 per share or 9.5x blended FY21/22F P/E is conservative from multiple angles. The multiple of 9.5x was based on Medtecs’ lowest pre-COVID P/E in the past 5 years. In addition, Medtecs could hold 35% or 50% of its current market capitalisation in cash by FY21F and FY22F.
• At 9.5x P/E, it is still valued below both the 5-year average forward P/E of 10.8x and the pre-COVID 2-year mean P/E of 19.2x.
• Our valuation also represents a discount to the five-year peer average forward P/E of 16x that includes other PPE producers such as Riverstone (SGX:AP4) (c.12x), Top Glove (SGX:BVA) (c.18x) and Hartalega (c.28x).
• Still, given the volatile COVID-19 situation, our bear case values Medtecs at S$0.80, assuming countries stockpile 2 months’ worth of PPE and 22% gross margin for FY22F (vs 3 months and 33% gross margin in our base case).
• Click "view full report" button below for complete analysis on Medtecs' financials and valuations.

Medtecs future earnings to be sustained by post-pandemic PPE stockpiling.

• Our base case estimates put post-COVID gown factory utilisation at 83.4% and 53.4% for FY21F and FY22F, driven by international stockpiling of PPE. Specifically, we believe that COVID-19 has heightened the awareness and importance of PPE stockpiling. We expect most countries could establish a reasonable stockpile of 90 days of PPE, creating medium-term demand for gowns and masks after COVID-19.
• In the longer-term, we forecast expiring PPE products to give a permanent boost to PPE demand as governments replenish their stockpiles of PPE. We also conservatively forecast Medtecs to retain half of their new customers acquired during the pandemic as customers may be reluctant to change suppliers due to quality and certification concerns.
• Overall, we think Medtecs may generate earnings of US$77.9m and US$33.2m for FY21F and FY22F respectively.

Transition to self-branded product sales to boost post-pandemic margins.

• We estimate that Medtecs’ ASPs could be 90% higher in FY22F compared to FY19. As a result, Medtecs’ gross margins could hover at 33% post-COVID, significantly above pre-COVID levels of 15%. The higher ASPs are expected to be driven by increasing self-branded product sales which have enabled the Group to record higher gross margins as it maintains a similar cost base.
• Over 68% of 9M20 sales was attributed to Medtecs-branded products, compared to just 3% in FY19, indicating that new customers are largely purchasing Medtecs’ branded products.

Synergistic Hospital Services segment offers stability.

• Medtecs provides linen leasing, laundry and logistics support services to 24 hospitals in Taiwan and 32 hospitals in the Philippines.
• While the business has low margins, Medtecs’ Manufacturing segment benefits from the business. Its products can be directly pushed to these hospitals, providing a ready customer base for Medtecs’ Manufacturing segment to tap into.

Steady customer relationships a bedrock for Manufacturing segment.

• Medtecs has been a long-time supplier for customers such as Premier Inc. and the governments of Taiwan and Singapore. We believe this relationship bodes well for the Group, enabling Medtecs to remain a choice supplier even after COVID-19. The Group had sacrificed higher sales of Medtecs-branded products to meet the needs of these customers during COVID-19.
• 47% of 9M20 manufacturing revenue was attributed to previous customers, translating to an estimated 150% rise in sales generated from these groups of customers.
• Additionally, we believe there is a level of stickiness in the relationship between Medtecs and its larger customers who may be resistant to seeking alternative PPE producers given the need for quality assessments.

Sizable cash pile leaves room for dividend and M&A.

• With a forecasted cash pile of over US$100m in FY21F, Medtecs may pursue M&A opportunities to strengthen its business. The Group was reported to be exploring plans to increase productivity potentially through M&A and may venture into other areas including lab testing or research and development. Alternatively, Medtecs may introduce a new sustained dividend policy.
• Medtecs paid an interim dividend of 0.01166 cents per share in September, the first time since 2007. From 2001 to 2006, Medtecs’ payout ratio averaged at around 25%.
• While its business has changed significantly since then, the period from 2002 to 2004 overlaps with the SARS outbreak and could provide an indicator for future dividend policy. As such, we have assumed a conservative 10% payout ratio going forward for Medtecs with FY21F dividend possibly coming in at 1.89 cents depending on PPE demand.

Post-pandemic strategy – A curated approach.

• Medtecs has been careful not to layout large sums on capital expenditure as the Group is aware of the unsustainable nature of current demand. Most of Medtecs’ output has been met by increasing round-the-clock shift workers, converting idle plants into additional production bases and boosting efficiency. Going forward, we believe Medtecs will study the viability of establishing new manufacturing bases with a possible focus on Europe.
• Some countries may turn inward to domestic producers for important medical supplies and Medtecs may expand accordingly to meet these needs. In addition, Medtecs is looking to further develop its self-branded (CoverU) line of PPE through brand franchising which we think has been well received given the high proportion of 9M20 self-brand sales of 68%.

Stock visibility and liquidity set for further boost.

• Medtecs’ inclusion in the MSCI Singapore Small Cap Index and application to transfer to the SGX Mainboard could increase stock visibility and liquidity. Generally, institutional investors are more likely to invest in stocks on the Mainboard compared to those on Catalist. Investment by institutions into Medtecs could instil confidence in the stock and boost Medtecs share price further.

Wildcard: Higher pandemic risks as climate warms.

• According to a World Bank blog, climate change was cited as a possible risk that could increase the chances of a pandemic. Amongst the possible risks mentioned were;
  1. changing weather patterns allowing temperature sensitive diseases to penetrate more regions,
  2. increased human-to-animal interaction driven by loss of wildlife habitat with an estimated 75% of new infectious diseases transmitted from animals to humans,
  3. viral mutations enabled by pathogens adapting to warmer temperatures.

More About Medtecs

• Click "view full report" button below for complete analysis on Medtecs International Corporation (SGX:546), including the post-COVID PPE demand estimates and Medtecs’ key earnings drivers post-COVID.

Source: DBS Research - 8 Dec 2020