1H23 earnings was in line with CMBI and consensus estimates. AK Medical reported 1H23 revenue of RMB648.7mn, up 22.1% YoY, primarily driven by the significant revenue growth of knee replacement implants and non-VBP products.Gross profit was RMB338.5mn, up 9.8% YoY. Gross profit margin fell 1.8 ppts to 61.9% (vs. 63.7% in 1H22) due to the implementation of national VBP of joint implants since April 2022. Attributable net profit was RMB132.6mn, up 5.2% YoY, and the attributable net profit margin dropped by 3.3 ppts to 20.4% in 1H23 (vs. 23.7% in 1H22) mainly due to the lower GPM and increased administrative expense rate (11.6% in 1H23 vs. 10.3% in 1H22).
Robust growth in knee replacement implants. Thanks to the sustained market share gain from foreign brands after the national joint VBP and the orthopedic surgery demand recovery, sales volume of the primary knee system increased by 107% YoY. Sales of knee unicondyle replacement system, which is a new partial knee product approved in July 2022, reached RMB33.8mn in 1H23. As a result, AK Medical's revenue from knee replacement implants surged by 64.7% YoY to RMB211.0mn in 1H23.
Moreover, AK Medical continued to penetrate into higher-tier hospitals.Approximately 16% of the implant volumes occurred in provincial hospitals in 1H23, up from 10% in 1H22. We expect this trend will further drive the strong sales growth of knee replacement implants in coming years.
Improved revenue mix with increasing proportion of revenue from high-margin non-VBP products. AK Medical has a comprehensive orthopedic implants portfolios including various products that are safe from VBP such as revision and reconstruction products, 3D-printed spinal implants, partial knee products and customized products (ICOS) etc. The domestic sales of revision products grew by over 60% YoY in 1H23, contributing 26% of the Company's total domestic revenue. The ICOS products realized RMB27.8mn of sales with four NMPA-approved 3D- printing customized products and 62 customized products filings with cooperating hospitals, up 31.5% YoY in 1H23. As a result, 48% of the domestic revenue was from the non-VBP products in 1H23, compared to approximately 36% in 1H22. Besides, the overseas market continued strong growth momentum and the overseas revenue increased by 78.3% YoY to RMB113.5mn in 1H23. Thus, we think 56.8% of AK Medical's total revenue was not VBP-relevant while contributed higher margin than VBP products.
Valuation/Key risks. To factor in the challenging business environment in China, we revised our TP to HK$8.46 based on a 9-year DCF model (WACC: 11.08%, terminal growth rate: 2.0%).