Preannounced 1H24 net profit down 65-72% YoY

Kingmed Diagnostics preannounced its 1H24 results, estimating that attributable net profit dropped 65-72% YoY to Rmb80-100mn, and recurring net profit fell 69-76% YoY to Rmb65-85mn, in line with market expectations.

Trends to watch

Credit impairment provision of Rmb290mn in 1H24 dragged apparent profit; impairment losses will likely narrow in 2H24. According to corporate filings, the firm planned to make provisions for credit impairment losses of about Rmb290mn in 1H24 due to the long collection period of some accounts receivable. We estimate its credit impairment provisions at about Rmb150mn, Rmb170mn, Rmb80mn, Rmb100mn, Rmb140mn, and Rmb150mn over 1Q23-2Q24. We attribute the expansion of quarterly provisions in 2Q24 to the aging of accounts receivable related to COVID- 19. Given the firm’s provision rules, we expect its impairment losses to shrink in 2H24 as the collection of accounts receivable progresses and the structure of accounts receivable related to the COVID-19 pandemic changes.

Profitability of routine medical diagnosis services may stabilize and recover. Due to falling demand for COVID-19-related tests, the firm's revenue in 1Q23-1Q24 was about Rmb2.1bn, Rmb2.2bn, Rmb2.0bn, Rmb2.2bn, and Rmb1.8bn, implying YoY declines of 50%, 46%, 49%, 32%, and 13%. Meanwhile, we estimate the firm's attributable net profit fell 12-27% YoY to Rmb100-120mn in 2Q24. Including the credit impairment loss of Rmb150mn, we think the firm’s adjusted net profit in 2Q24 was Rmb250-270mn, implying a significant improvement from the Rmb160mn and Rmb120mn in 4Q23 and 1Q24. We think this suggests an improvement in the profitability of its routine medical diagnosis services.

Long-term growth intact despite short-term fluctuations; upbeat on rising penetration rate and leading positions. The firm's fundamentals fluctuated over a short period, because falling demand for COVID-19- related tests and tightening industry regulations weighed on demand, and competition intensified amid the growing number of independent clinical laboratories.

From a long-term perspective, hospital laboratory departments will likely gradually transform from profit generators to cost generators due to policies such as control over medical insurance spending and centralized procurement of in-vitro diagnostic reagents. We expect the overall penetration rate of test outsourcing to gradually rise, driving the steady growth of the industry. We expect leaders such as Kingmed Diagnostics to achieve sustainable revenue and profit growth on the back of substantial economies of scale.

Financials and valuation

Considering potential short-term disruptions to demand growth of routine medical diagnosis and potential large credit impairment losses in 2024 and 2025, we lower our 2024 and 2025 net profit forecasts 33% and 19% to Rmb697mn and Rmb1.05bn. The stock is trading at 18.5x 2024e and 12.3x 2025e P/E. Considering the company has a competitive advantage as the industry leader, we maintain an OUTPERFORM rating, and cut our target price 33% to Rmb35.38, implying 23.8x 2024e and 15.9x 2025e P/E, offering 28.6% upside.

Risks

Risks related to cost control for diagnosis services; fiercer-than-expected competition.