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Is the Medical Developments investment thesis broken? (ASX: MVP)

Claude Walker — Mon, 09 Dec 2013 02:55:35 +0000

Well today I sold my shares in Medical Developments International. It was a borderline call, as the thesis is still mostly there. However, the new piece of information was that the company gave the following guidance:

"We expect profit after tax for the six months ending 31 December 2013 will be approximately $500,000,
which includes a one-off tax adjustment of $360,000."

However, the company also said:

"We are confident volumes of our respiratory devices will return to forecast levels during the last six months of FY14."

If there is one thing I can't stand it's an ambiguous market sensitive earnings guidance. What does that even mean? What's the tax adjustment for? Is the tax adjustment a credit or a debit? I assume it's a debit, but seriously, it wouldn't kill them to make it clear.

For my own sake, I'm just going to record the unsuccessful investment in MVP here.

My Portfolio

Buy prices: $1.35 and $1.16

Average Dividend adjusted buy price: $1.27

Sell prices: $1.50 and $1.158

Average Sell Price: $1.47

Return: 19.8% in less than 6 months (a mild outperformance of the market at best)

Musings on Medical Developments International

I either made a mistake buying or made a mistake selling. It is not clear which is the case. However, I have now sold because there are, quite frankly, better places for my money. The latest announcement confirms my increasing frustration with the ambiguity of what is going on. I have spent a large amount of energy trying to value this company; it's simply very difficult. The conclusion is that when it is very difficult to value a company, you need to get a really great margin of safety.

The core business - supplying Penthrox - is still working, and the company still has plenty of irons in the fire. It has suffered a setback, that we knew. However, the more annoying thing is the manner in which guidance was announced today. Mercifully, I don't have to make that decision. Keep in mind the Directors bought at above $1.20 quite recently. It seems like there is a still interest in the shares at around that price and those buyers have a decent point... the investment thesis isn't shattered, it's just taken a few hits. It is certainly good news for the company that the Penthrox sales are on budget for this half.

Main Reason for selling

Analysing this holding is simply too difficult because of the ambiguous announcements. There are other companies that have a stronger investment thesis. I don't like how they took on debt but paid a dividend - it just makes it even more difficult to value the business, and it adds additional interest expense. It is a mechanism to allow the Chairman to buy more shares through the dividend reinvestment plan (and release franking credits). However, I do think that the Chairman has a lot of faith in the company and is a good man (he reinvested right at the top of the market, which is a benefit to all the other shareholders). Still, the interest expense seems a bit unnecessary.

The Author does not own Shares in any of the companies mentioned in this post. Nothing on this website is advice, ever.

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Medical Developments International receives FDA approval for Space Chamber asthma spacers (ASX: MVP)

Claude Walker — Sun, 17 Nov 2013 23:25:19 +0000

It has been announced this morning that Medical Developments International has received FDA approval for its Space Chamber asthma spacers. Since I bought shares, the company has moved forward with a number of its initiatives (selling asthma devices into the USA is just one of them). Importantly, the application for marketing approval of Penthrox in Europe has been accepted for consideration. These are both positives. However, the company has also reported reduced sales of Penthrox in Australia, meaning that the shares are no more attractive now than when I bought them, in my opinion. The current price is $1.38 (only slightly above my average entry price).

Medical Developments has been an under-performing holding, although I still believe in this company for the long term. The main reason for the sluggish share price is the bad news conveyed in the Preliminary Annual Report: sales of Penthrox to two Australian ambulance customers declined (leading to a 7% reduction in sales to Australian customers). The company attributes the decline in sales to cost-cutting in the ambulance services.

Since the Liberals formed the various state governments, there have been various cuts to ambulance services and public health spending. These simply aren't the priorities for conservative governments. Most recently, the NSW government decided they would squeeze the NSW Ambulance Service. The bottom line is that despite a rise in sales of Penthrox to non-ambulance customers, the company has reported a reduction in revenue from Penthrox sales of $356,000 for FY2013.

It's quite possible that these cuts could have a greater (or equal) impact in FY 2014, because we don't know whether the full impact of reduced demand from those two customers is reflected in the FY2013 figures. The company also took on about $1.4 million of debt during the year but paid a 2c final dividend. It wasn't necessary to do this, in my opinion, as now shareholders will just end up needlessly paying interest on the debt.

In my last post on Medical Developments I wrote:

By FY 2015, any or all of the following might be occurring:
- Sales of Penthrox to the UK
- Sales of Penthrox to Japan
- Sales of Space Chambers to the USA
- Reduced cost of manufacturing Penthrox
- (Increased) sales of Penthrox into other jurisdictions

The company is on track to sell Penthrox into the UK (and Europe). The company is on track to sell Space Chambers into the USA. When I spoke to the company after the release of the preliminary annual report, it was confirmed that they continue to work on new manufacturing processes.

It's also good news that the company is planning to sell Penthrox into the USA, although I think they have to be careful how much they spend on trying to get FDA approval.

Two different directors have bought shares at about $1.26, in recent weeks, suggesting that current prices are attractive. All things considered, the good news from Medical Developments balances out the bad news, and I will continue to hold my shares in the company. However, I did sell some of my holding in August 2013, because of the poor Penthrox sales in Australia. The company is about 8% of my personal portfolio, which is highly concentrated - my top 3 holdings are almost 50%. Edit: I also have capital in August Investments, which adds diversification (separate to my own portfolio).

I didn't see the point in opportunistically buying shares this morning because I have enough already. The share price is probably bouncing as I write this. I wouldn't be surprised if it comes back down to around $1.40 at least, as it has traded below that for a few weeks now, and this news is not that surprising.

The Author owns shares in Medical Developments International. Nothing on this website is advice, ever. This post is for entertainment (and for my own reference!)

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Update on Medical Developments: negative profit guidance, as expected (ASX:MVP)

Claude Walker — Thu, 13 Jun 2013 01:34:54 +0000

Medical Developments (MVP) recently updated the market as to its operations and expected profits for FY13. As expected, net profit is expected to be down on 2012, by up to 15%. The market immediately reacted to this, and what followed was two days of savage selling... to a low of $1.06. Since then, the share price come back up to about $1.30, albeit on low volume.

I myself was just a little bit too greedy, and was hoping the selling would push prices down to $1. My low order was not filled. However, there will probably be plenty more opportunities to buy MVP at a good price. With the market a little jittery, poor results, or better yet the announcement that the dividend will be reduced or suspended, could potentially result in further selling.

It makes little sense for me to summarize the update in detail, but I will point out that they obviously only mentioned areas in which they had some progress to report. For example, Japanese distribution of Penthrox was not mentioned. As much for myself as anybody else, I'll record some of the predictions they made (rather than the progress).

- Management expects to see the effect of marketing spend in FY14.
- MVP expects to complete two Penthrox trials in August 2013, and submit an application for marketing authorisation in October 2013.
- They expect to be able to further penetrate the NZ market for Penthrox (time frame not given).
- They expect to receive approval to sell their their Asthma Space Chambers in the USA by October 2013 and to launch the range there by the end of 2013, or "shortly thereafter."

So this gives us something to measure them against. Meanwhile, it's also worth noting that they reported some respectable achievements regarding their manufacturing process. To me, the announcement further signifies that reinvestment in the business proceeds at a cracking pace. This means that NPAT (and free cash flow) will almost certainly be subdued right into 2014, as well as this year. Currently, I'd say that we won't really see the benefits to the bottom line until 2015. My reasoning is as follows. MVP will be selling Asthma Space Chambers into the UK for all of FY2014, but during that time, they'll still be funding Penthrox trials and regulatory approval for Europe and the UK. (I hope) They will also be funding the product launch for the Asthma Space Chambers in the USA. These will be reasonably expensive activities, and the investment will not generate profits immediately. It's difficult to predict how much will be spent on developing on the new manufacturing process for Penthrox, and this is a key risk, in my view. It's also worth noting that, given their international expansion plans, the weaker Australian dollar works against them for the time being.

Any one of these occurring will have a positive impact on the company, and the impact on Gross Profits (and NPAT) of all of these occurring would be quite extreme, especially increased sales of Penthrox plus an improved margin. Before the company started ramping up marketing and R&D spend, free cash flow was over $1.4 million a half. Were the company to achieve increased sales, increased margins, and then reduce marketing and R&D spend, then the free cash flow would really jump.

Historical and Projected Profits for Medical Developments International

The Author has a direct interest in shares of Medical Developments International. The Author is not aware of any indirect interest in MVP.

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An Introduction to Medical Developments International (ASX:MVP)

Claude Walker — Thu, 16 May 2013 06:21:46 +0000

Share Price: $1.40
Market Capitalisation: Approximately $81 Million

Medical Developments International (ASX:MVP) is a company with a variety of business segments. Their main two product lines are Penthrox® an inhaled analgesic known colloquially as the “green whistle” and a range of asthma equipment, such as face masks and spacers. In addition to this, they also sell other medical equipment such as oxygen resuscitation equipment, defibrillators and veterinary anaesthetic machines. In recent times, the company has been successful at selling Penthrox and the Space Chamber Plus® range, which are a new design of the spacers that have been used in conjunction with asthma inhalers for decades. Penthrox, by the way, is methoxyflurane, and it would be very difficult to sell it in the USA, because there has been a determination by the FDA that it was withdrawn from sale for reasons of health and safety. According to that determination, approval for methoxyflurane was withdrawn in the USA after the company that sold it there advised the FDA that it “was no longer being marketed under NDA 13-056 and requested withdrawal of that application.” It seems to me that methoxyflurane is safe for its current applications, despite very rare cases of adverse effects. To share a personal anecdote, I was very grateful for methoxyflurane when I broke my collarbone!

For many years, this company was undervalued by the market, probably because it showed few signs of growth. Management, at least, had the good sense to buy back shares at that time. Since John Sharman took over as CEO of the company in 2010, it has seen a dramatic increase in market capitalisation, reflecting the fact that, since that time, revenue has grown by an average of about 9.7% per half, and gross profit has grown by an average of over 12.4% per half. In my opinion this growth could continue at this rate for some time to come, and fortunately, growth to date has been funded completely without debt. The company has simply begun to sell more products by breaking into new geographic markets, signing new distribution agreements, and expanding the uses for which Penthrox is approved. The last 5 halves have seen steady Penthrox sales in Australia plus some new sales in the Middle East. Importantly, the company has significantly increased Space Chamber sales through a partnership with Glaxo Smith Klein (GSK) to supply asthma equipment in Australia, and has begun selling Space Chambers in Germany through distribution partner Cegla. The company has also begun shipping space chambers to Canadian hospitals as part of 5 year supply agreement they won in the first half of FY2013

Net profit was down for the first half of 2013, leading to a reasonably dramatic share price drop from above $2 to current levels of around $1.40. If we look a little closer at the accounts, we can see that the likely culprit is the money spent on marketing. Marketing expenses for the last three consecutive halves were as follows: 1st Half 2012: $541,000; 2nd Half 2012: $634,000; 1st Half 2013: $971,000. That increase in marketing expenses accounts for the lion's share of the additional expenses that prevented MVP from recording increased net profit in the last half.

To quote from the most recent report, “In the first half of FY 2013, MVP made a significant investment in our Asthma business, establishing a European Head Office, appointing a European Business Development Manager, Global Asthma Co-ordinator, and additional sales staff. Time will tell if this is money well spent, but given the success the company has had growing its Asthma business to date, I think there is a good chance the increased spending will pay off.

Uncertain Upside

The company has too many irons in the fire for me to go in depth about them all. However, the main initiatives to grow profit over the medium to long term are (in no particular order):
-Sell asthma spacers into the UK
-Sell asthma spacers into European countries other than Germany and the UK
-Sell asthma spacers into the USA
- Start selling Penthrox into the UK (this would be great, given that Penthrox allows the company a higher margin than the equipment sales)
- Gain approval for use of Penthrox in colonoscopies.
- Sell Penthrox into Japan
- Distribute new and existing equipment lines more widely
- Improve the cost of making Penthrox using a new manufacturing process

There is no certainty that the company will achieve any of these goals, and some are closer to fruition than others. The worst case scenario is that MVP is unable to achieve any of these aims. In that case, the company would be able to cut back on costs a bit, but would still be extremely overvalued at current prices. On the other hand, a combination of an improved manufacturing process and opening new markets for Penthrox would multiply earnings.

Major Shareholders

Chairman David Williams owns 52.8% of the company. He recently re-invested his dividend at a price of $2 per share. According to the 2012 annual report, other top shareholders (with much smaller holdings) include Dr Russel Hancock, an anaesthetist, Mrs Erica Strong and Mr Alistair Strong, the latter two being early investors in Cryosite (ASX:CTE), which to me indicates good judgement.

Significant Valuation Risk for Investors at current price

The company has no debt, so balance sheet risk is low. Earnings are underpinned by fairly steady sales of Penthrox in Australia, and are more likely to grow than shrink, in my opinion. However, there is considerable valuation risk involved at current share prices. Unless this company grows earnings, the share price is sure to fall. Worse still, the market may currently be assuming that a dividend of 3c per half will continue to be paid. At current levels, free cash flow simply cannot support the dividend payment. Indeed, the 9c of dividends paid over the last three halves would not have been possible were it not for the Chairman (and major shareholder) re-investing his dividend. If the company does cut dividends, it’s quite likely that there will be more sellers. Given that a cut in the dividend may simply indicate that the company is reinvesting in its own businesses, this could provide an opportunity to buy a great company at a good price. As I'm writing this trading has closed at $1.40, and the buy sell spread is $1.35 - $1.49. In the last week, shares have mostly been changing hands in small volumes between $1.31 and $1.41.

Cashflow Graph

This graphs shows how the free cashflow has been eaten up by the increased cash outflows. The combined cash outflows include payments for plant and equipment, payments to supplier and employees and R&D expenditure, the latter of which is driving the growth in cash outflows. For a dividend to be sustainable in the long run, it needs to be funded by free cash flow.

Profit Graph

This graph shows that the strong growth in revenue and gross profit hasn't translated into growth in net profit, as expenses have been increasing. A key risk facing the company is that the increased marketing expenditure fails to generate increased sales.

Disclosure: The Author has bought 2500 shares in MVP at $1.35. The author feels somewhat ambivalent about whether the share price goes up or down, given that he would really like to be able to buy shares at a more reasonable PE ratio.

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