Kangji Medical is the largest domestic MISIA producer in China
The Chinese MISIA industry is rapidly expanding, with expected 19.1% sales CAGR from 2020-24
Positive industry tailwinds include improving competitiveness of local brands, increasing demand for disposable products and heightened adoption of MIS
Kangji has displayed high growth, margins and ROE for the past few years
Owner-operator business with founding team having a significant stake of ~51%
Plans in place to reinvest in capacity growth and make strategic acquisitions, backed by net cash of HK$2.76/share or 23% of market cap.
Current product suite could be sheltered from healthcare reform measures, which points to a potentially undervalued business
Kangji Medical (Kangji) is a dominant player in the minimally invasive surgical instruments and accessories (MISIA) space in China, providing solutions to four key surgical specialties of OBGYN, general surgery, urology, and thoracic surgery. As of 2019, it was the largest domestic player by sales, commanding a 2.7% market share. Their product portfolio includes trocars, polymer ligation clips and electrocoagulation forceps, which are used in minimally invasive surgeries and procedures.
1. Leading domestic player in a fast-growing industry
Minimally invasive surgeries are increasingly gaining buy-in from physicians and patients due to their advantages over traditional open surgeries. These include reduced size of incision, lowered associated pain, scarring and complication, lower infection risk and shorter hospital stays and recovery time. Resultantly, this has spurred demand for MISIA products which are used in these operations. According to CIC research, the MISIA market is expected to grow at a 19.1% CAGR from 2020-24.
The Chinese MISIA market has traditionally been dominated by large international players, mainly because these large MNCs are stronger in developing higher-end products which command a higher ASP. In terms of overall market share in 2019, Kangji was the fourth largest MISIA producer in China.
Meanwhile, amongst the local players, Kangji was the leading local MISIA producer, holding a 2.7% market share in 2019.
We expect Kangji to be a beneficiary of a confluence of industry tailwinds, namely a) Improving competitiveness of local brands b) Increasing demand for disposable MISIA and c) Rising adoption of MIS.
a) Improving competitiveness of local brands
From 2015-19, Kangji’s key markets have seen domestic players grab market share from international brands due to improving technological capabilities and greater cost efficiencies. Research from CIC also indicates that this trend will continue into 2024. Kangji’s pole position in the local MISIA space puts it in good stead to benefit from this industry-wide shift.
b) Increasing demand for disposable MISIA products
Given that Kangji’s sales mix is skewed towards disposable MISIA, they are well-poised to serve the growing demand for these products. The benefits of disposable medical products over reusable ones are clear – they decrease infection risk for patients and the reduces the sterilization workload for hospitals. As such, the disposable MISIA market is expected to grow at a much faster 2020-24 CAGR of 21.2% compared to the 5.8% CAGR of the reusable market. This trend is already playing out in Kangji’s 1H20 print, which saw disposable product sales growing by 1.7% while sale of reusable products fell by 20%.
Moreover, disposable products command a far higher gross margin than reusable products. Should Kangji’s product portfolio continue to shift towards a higher proportion of disposables, it should benefit from margin expansion.
c) Rising adoption of MIS
MIS is expected to grow in tandem with the broader rise in surgical demand in China, driven by an ageing population and increasing disposable income. Furthermore, MIS is still underpenetrated in China (38.1%) compared to the US (80.1%). This is partly driven by a lower proportion of Chinese hospitals being capable of performing MIS. We believe that substitution of open surgeries and improved capabilities of hospitals will continue to drive MIS adoption.
2. High growth and margins
Based on historical figures, Kangji has experienced healthy top-line growth over the past three years. In 1H20, sales growth dipped to -1.6% y/y mainly because of COVID-19, which hampered demand for MISIA as elective surgeries were being rescheduled.
It is also noteworthy that Kangji’s business experiences some seasonality and tends to be the slowest in 1Q20 due to the Chinese New Year holidays when fewer surgeries are being scheduled. On a positive note, Kangji’s sales re-accelerated in 2Q20, growing 19.3% y/y as the COVID-19 situation in China improved.
Meanwhile, gross and EBIT margins have been at elevated levels and expanding from 2017-19 as Kangji continued to refocus their product mix towards disposables. EBIT margins took a hit in 1H20 mainly due to one-off listing expenses.
3. Owner-operator with solid reinvestment track record
Kangji is managed by the husband-and-wife founding team of Zhong Ming and Shentu Yinguang, who hold a combined 51% of the company.
We like that the management generally takes a demand-driven approach to product development and R&D, opting to allocate resources to products that have greater market potential. We think that this is a key contributor to Kangji’s efficient capital allocation track record, as evidenced by its elevated ROE over the past few years.
As of 1H20, Kangji boasts a strong war chest for investments and acquisitions, with net cash per share of Rmb 2.30/share (HK$2.76/share) or 23% of market cap. Out of its IPO proceeds, Kangji has earmarked HK$273.5m (9.8% of IPO proceeds) to ramping up production capabilities for current products. This is expected to expand production capacity of their current product suite by a CAGR of 30-40% from 2019-24. On top of this, HK$284.7m (10.2%) is being allocated to building up capacity for pipeline products like absorbable ligation clips, laparoscopic staplers and disposable ultrasonic scalpels over the next six years. Moreover, HK$697.8m (25%) is being set aside for strategic investments and acquisitions which could further shore up Kangji’s market leadership.
A big reason why Kangji and other Chinese medical device stocks traded down over the past few months was due to concerns over ASP compression owing to China’s centralised procurement of high-value medical consumables. These procurement exercises are part of China’s ongoing healthcare reforms to rein in inflated prices of pharmaceutical drugs and medical devices. For instance, the average price of coronary stents nosedived by >90% from Rmb 13,000 to Rmb 700 in the latest national tender in Nov ‘20.
Judging from past tenders, the program seems to disproportionately affect higher-ASP products, which we think may accelerate the growth of more cost-efficient domestic players as international players re-evaluate the financial viability of participating in these tenders. Moreover, we think that Kangji’s current product suite might remain largely sheltered from ASP compression given that ASP is on the low-end in both absolute terms and relative to ex-factory prices* of competitor products on the market.
*Ex-factory price: Price of a product sold to a buyer, with transportation costs borne by the buyer.
That said, Kangji’s new and pipeline products include high-ASP items like ultrasonic scalpels and laparoscopic staplers, which might be subject to price competition in future tenders. If this plays out, it would cap future revenue growth and is a risk that needs to be closely monitored.
At current levels, Kangji is trading ~65% below its peak of HK$34.45 and ~14% lower than its IPO price of HK$13.88, with NTM P/E at 28.8x. Meanwhile, we are presented with a company that has a solid set of financial metrics in terms of growth, margin profile and ROE. While the company saw short-term growth pressures due to COVID-19, it has since benefitted from China’s tight control of the pandemic and the resultant rebound in sales volume as elective surgeries resumed.
In our longer-term base case, we believe Kangji will continue to experience volume-driven sales growth for its current product suite, supported by secular tailwinds and capacity expansion. This scenario completely ignores any incremental upside from higher-ASP pipeline products. The key assumption here would be that sales growth for its lower-ASP products will remain unencumbered by price competition in future procurement exercises. In such a scenario, we see Kangji’s business as potentially undervalued.
This is notwithstanding that there is still a non-zero chance that Kangji's pipeline products will not be subjected to price pressures. This would contribute positively to growth and be accretive to shareholder value if it plays out.
Kangji first appeared on our radar as a potential non-consensus re-opening proxy as the pandemic situation gradually improves and more people return to hospitals to undergo elective surgeries. Based on the aforementioned investment merits, we then proceeded to open a starter position via The Snowball Portfolio a couple of weeks ago.
While the centralised procurement exercises would pose a threat should Kangji's products fall under their purview, we believe that their current products remain largely protected from price competition. Moreover, there is still the probability that their higher-ASP pipeline products might not be subject to the centralised purchasing program.
Given Kangji high-quality financial metrics and long-term growth runway, we believe this space is worth monitoring.
Thanks for reading,
Disclaimer: We are long Kangji Medical at an average price of HK$14.03. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such.