Not all readers will know Medical Developments International Ltd (ASX: MVP) directly, but many will have used its products.
In Australia, the defence force, ambulance officers, and even surf lifesavers on Bondi beach have safely used its inhaled pain-management product Penthrox for decades. Asthmatics may have required its space chambers, and you'll find its various other medical devices throughout hospitals and veterinary practices around Australia.
Medical Developments International's (MDI) aim for global expansion is gathering speed and it has recently announced numerous international regulatory approvals for Penthrox and asthma products. Over the past 12 months, its share price has surged 250%, breaking through the $4 barrier.
Net profit for the 2015 financial year was $1.5 million resulting in 2.6 cents earnings per share.
Traditional value investors may reach for the Penthrox inhaler when confronted with the sky-high trailing price to earnings ratio (P/E ratio) of 150, but is MDI worth the price for those chasing growth?
The business
MDI operates predominately in Australia and New Zealand and reports three main divisions: pharmaceuticals, medical devices and veterinary, which contributed $7.1 million (60%), $4.1 million (35%) and $0.4 million (5%), respectively, to FY15 revenue of $11.6 million.
Pharmaceuticals
Penthrox, also known as "the green whistle", is a pen-shaped device that delivers rapid pain relief after inhaling the vapours of the active drug, methoxyflurane. It controls around 10% of the Australian trauma market, which is MDI's target in other international countries.
Methoxyflurane was once commonly used in high doses as a general anaesthetic until safety concerns reduced its use and resulted in the United States FDA removing it from their register of drugs in 2005. While high doses of methoxyflurane did cause toxicity issues in the kidneys, lower doses for pain relief have been proven to be perfectly safe.
This might sound alarming, but it is the source of several competitive advantages for MDI.
As use declined around the world, MDI continued producing the drug and has now built up extensive clinical research proving the safety of Penthrox and has developed intellectual property for the methoxyflurane production process. MDI is now the only global producer and supplier of methoxyflurane for analgesia.
Penthrox has a long list of advantages over its competitors, including morphine and nitrous oxide, some of which are listed below:
- Penthrox has a rapid onset of pain relief and no risk of overdose
- Does not impact vital signs; no clinical depression of respiration or circulation at low doses
- Non-addictive unlike opioids (e.g. morphine) and doesn't require strict storage protocols
- Inhaled self-administration in a portable, single-use container reduces the need for nurses and supervision. A wide range of the community can safely administer the drug
- A recent study showed that patients can operate vehicles and machinery only 20 minutes after use, which could make it the drug of choice in many clinical settings.
Growth
Penthrox is on the verge of global expansion following recent approval for sale in South Africa, Singapore, Ireland and the UK. Approvals in France and Belgium should be announced shortly, with applications pending for numerous other countries.
MDI has signed some significant agreements with pharmaceutical companies including Galen, covering the Ireland and UK markets, and more recently, a deal with Mundipharma worth up to US$54.5 million, giving it exclusive product rights in 39 European countries, excluding those already covered by Galen.
Galen recently submitted its first forecast orders for Ireland and the UK, a total of $2.2 million, to be delivered during the second half of FY16. The large initial orders indicate Galen is confident that Penthrox will quickly penetrate these markets.
Mundipharma is a global pharmaceutical company specialising in pain management and will take control of the regulatory approval process in Europe and support the development of additional Penthrox products and clinical uses which will drive sales much harder that MDI could do by itself. It estimates that peak annual sales in its licenced markets could reach 10 million units, compared to MDI's current annual sales of around 250,000 to 300,000 units.
MDI has concluded licencing deals for Mexico, Suadi Arabia, Taiwan, United Arab Emirates and Hong Kong while they are in discussion with other companies to licence the markets of Turkey, Israel, Canada, Russia, Japan, Malaysia, South Korea, Bahrain & Latin America.
United States
The potential Penthrox market depends more on the size of the population than overall wealth within the country, however, the US is a lucrative market and it is now receiving full attention from management.
MDI is working with one of the US's best regulatory advisory firms who are providing guidance during the US Food and Drug Administration (FDA) approval process for Penthrox, which it expects to be successful although an additional Stage 3 trial may be required to satisfy the FDA's ethnicity requirements.
Speaking with MDI Chairman David Williams, he mentioned they will be meeting with the FDA before the end of the year and that there is a 50 percent chance they won't require a Stage 3 trial. If they do require a Stage 3 trial, it will take 2-3 years to get to market. If not, the regulatory approval process will still take at least one year.
Expanding the addressable market
MDI has spent almost $10 million on Penthrox clinical trials to open up its addressable market and cover pain relief for various biopsies, colonoscopies, a psychomotor function for driving, and burn management.
The economics of Penthrox are also a focus area. A single 3ml dose costs around $20-$30 and will provide 20-30 minutes of pain relief (a second dose can provide up to 60 minutes), however, there are countless minor procedures performed every day by medical physicians and dentists that require shorter periods of relief.
To reduce the cost and subsequently increase sales into these markets, MDI will soon release a range of new sizes, possibly down to 0.5ml.
MDI is also working with an international defence force to make a Penthrox inhaler preloaded with the drug that would make it more suitable for high-stress combat situations. Currently, the drug is tipped from an ampoule into the inhaler before use.
Production process
MDI has almost finalised a new methoxyflurane production process, jointly developed by the CSIRO, which is expected to revolutionise the manufacturing process. Mr Williams said that the new process will reduce their production costs by around 60% and reduce wastage while at the same time the purity of the drug will increase.
A new production facility utilising the technology has been fully funded and will increase the annual production capability of MDI tenfold, up to 25 million units.
Medical Devices
The medical devices division is a significant contributor to group revenue and should report healthy growth in the future for its key product, the asthma space chamber.
MDI's new anti-static spacer is almost through the FDA approval process and should be ready for sale by the end of FY16, with the company close to signing some big North American distribution deals. An agreement with PSUK, the UK's largest GP service provider, was signed late last year to sell respiratory devices in the UK with minimum quantities for the next 3 years.
Financials
MDI's strong underlying business has produced sufficient cash flows to support its clinical trials. In FY13, it required a small amount of debt funding to progress the final stages of its Penthrox trials and also cut its dividend.
Following the licencing deals with Galen and Mundipharma, MDI has around $12 million cash in the bank which will be used to repay the final $1 million debt, fund the new manufacturing facility, and could reinstate the dividend.
Additional upfront and milestone payments will be paid in the coming year while business cash flow will continue to increase as Penthrox and its respiratory devices expand into more markets. It is likely that MDI's dividend will rapidly increase as the business builds surplus cash
Each division's EBITDA margin is shown in the chart above (EBITDA margin = earnings before interest, tax, depreciation and amortisation divided by revenue).
Pharmaceuticals' EBITDA margin is approaching a very healthy 50%. Increasing sales volumes combined with reducing production costs will improve margins in the future.
Medical devices' margin has been affected recently by its increased research and development expenditure. As its new range of spacers hit the US and European markets, its margin will improve and should climb back toward its longer-term average around 25% over the next several years.
Veterinary sales are a small contributor (5%) to group revenue but it's a profitable business with an average EBITDA margin around 35%.
How much is it worth?
Using a discounted cash flow (DCF) valuation and conservative input parameters (assuming peak sales take 10 years to build in its target markets, US sales starting FY20), my valuation for Medical Developments is around $4.60.
However, these conservative assumptions could be blown out of the water. MDI Chairman, Mr Williams, noted that market penetration might require only three years, based on previous experience. Additionally, if Mundipharma achieves its expected peak sales in Europe, this would be 10 million units per year and revenue around $200 million, compared to $11.6 million in FY15.
Using a more aggressive timeframe of five years to reach peak sales in these countries, my valuation rises to around $7.
Risks
The current share price of MDI factors in a significant amount of future growth and any regulatory setbacks or safety issues would severely affect the business. However, regulatory approval looks likely in most markets around the globe with their current dossier of clinical research (some particular markets such as the US and Japan may need an additional trial before approval).
A high-margin business like Penthrox is likely to attract attention from competitors as it gains global acceptance, but the regulatory approvals granted will provide protection for the drug and delivery system (generally a minimum of five years, although MDI has supplied no specific details).
MDI Chairman David Williams has been in the position for 10 years and owns around 32% of the company. While this is a risk, his large personal holding and long-term global vision for Penthrox aligns his interests with shareholders. John Sharman, the current CEO, has held the job for almost six years. Together, they have provided the guidance and stability that is helping MDI achieve its goals.
Foolish takeaway
Medical Developments is set to transform into a truly global pharmaceutical and medical devices company, with revenue expected to surge for the foreseeable future as new markets continue to be unlocked.
There is always a risk in buying high-growth companies sporting high PE ratios. However, I think Medical Developments is a unique company that more than justifies its price:
(1) Penthrox is a proven drug with many advantages and should become an essential part of international health care services as it is in Australia and New Zealand;
(2) MDI is the only global producer and supplier of the drug and has years of clinical data behind it; and
(3) Its advanced manufacturing process and regulatory approvals provide a monopoly within the market for at leat five years and a price advantage for long after that.
Not many companies hold such strong competitive advantages and it is highly likely that Medical Developments International will be another successful Australian pharmaceutical company on the world stage. .
