AK Medical cut its FY23 sales and net profit guidance, primarily due to the declined orthopaedic surgery volumes amid the challenging business environment in China. The Company now expects 2023E revenue to remain flat, down from its previous guidance of 30% YoY revenue growth for 2023E. NPM may slightly drop because the anti-corruption activities hurt the sales of high- margin non-VBP products in 2H23. AK medical expects the business to recover in 2024E and forecasts at least 30% YoY revenue growth and above 20% NPM in 2024E.
　　High-margin non-VBP products have been disproportionately affected since Aug with slight turnaround of surgery volumes in Oct. In 1H23, 48% of AK Medical’s domestic revenue was from the high-margin non-VBP products such as revision and reconstruction joints, 3D-printed spinal implants, partial knee products and customized products (ICOS), etc. However, the management noted that clinicians preferred to use VBP products rather than the non-VBP products since Aug due to the anti- corruption campaign. Thus, the Company’s revenue and NPM were both negatively impacted from 3Q23. AK Medical has seen slight recovery of surgery volumes in Oct as it was flat YoY compared to a 10% YoY drop in Sep. Academic conferences have gradually resumed while the marketing events led by the Company are still suspended. AK Medical expects surgery volumes to be back on track after the Spring Festival.
　　Expect moderate price recovery in the upcoming VBP renewal. AK Medical believes the joint VBP renewal will be initiated by the end of the year and be implemented in 2Q24E. We expect the VBP renewal of joints to follow the rules of coronary stents and trauma products which led to the convergence of the bidding prices. AK Medical has relatively low bidding prices in the previous VBP with hip joint price of ~ RMB5,900/unit (vs. average price of ~ RMB7,000/unit), and knee joint price of ~ RMB 3,400/unit (vs. average price of ~ RMB5,000/unit). AK Medical lose market share in hip joints because distributors received less margins from AK Medical than other domestic brands and were less motivated to promote AK’s products. We expect AK Medical’s bidding prices to increase during the VBP renewal, which will allow the Company to offer higher margins to its distributors while maintain relatively stable out-of-factory prices. Therefore, we believe AK Medical will regain market share in the hip joint market in 2024E, leveraging its high product quality and wide distribution network.
　　Maintain BUY. To factor in the lower-than-expected sales in 2023E and our expectation on the surgery volume recovery in 2024E, we revised our TP to HK$8.44 based on a 9-year DCF model (WACC: 11.08%, terminal growth rate: 2.5%), implying 31x 24E P/E.