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Should you buy Medical Developments?

The vast majority of ASX companies with a market cap of under $100 million either fail to turn a profit or are leveraged to mining in one way or another. Medical Developments International (ASX: MVP) is a veritable breath of fresh air — it lacks any dependence on mining, and has a long history of turning a profit. Even better, it boasts a 5.3% trailing dividend yield.

The company manufactures asthma spacers, the emergency analgesic Penthrox and an assortment of other medical equipment such as the Oxy-Life Oxygen Resuscitation Kit. It is currently running clinical trials for its high margin product, Penthrox, in the UK, and plans to submit its application for marketing authorisation in October 2013. The UK is a much bigger market than Australia, and sales in that jurisdiction could significantly grow profits, especially if current efforts to reduce manufacturing costs are successful.

Since John Sharman took over as CEO of the company in 2010, Medical Developments has seen a dramatic increase in market capitalisation on the back of significant increases to revenue and gross profit. However, the company has recently given guidance that NPAT will be down 10-15% for the full year. At the current share price, that gives a whopping estimated P/E of about 28.2 for FY 2013, and it is likely that the dividend will be cut or stopped because the company is reinvesting most of its free cash flow into opening up new markets.

If the market reacts negatively to this foreseeable move, it may offer us a very attractive price for the stock. I recommend patience, however, as the market for this stock is not particularly liquid, partly because Chairman David Williams owns just over 50% of the stock on issue.

Management is concentrating on breaking into new markets with the company’s new range of asthma spacers and with Penthrox. In particular, the company has just started selling asthma spacers into Canada, and more recently has hired 40 people to market the equipment in the UK, where it qualified for government subsidy in April. The company has also begun to improve the manufacturing process for Penthrox with a view to increasing the already considerable margin it makes on that product. In my opinion, management is honest and competent, and its interests are reasonable aligned with shareholders. The company does not carry debt, and balance sheet risk is minimal.

Foolish takeaway

Time will tell if the company’s investment in marketing and more efficient manufacturing will pay off, but in my opinion management is going about growing profits in a sensible manner. Medical Developments International deserves a spot on your watch list because the market may solely reflect the fact that net profit is dropping, without recognising that this is due to the fact that the company is investing in its own future. If growth plans come to fruition, considerable gains are very likely within the next five years.

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Motley Fool contributor Claude Walker owns shares in Medical Developments International.

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