China Medical Technologies, Inc. (CMED) has rallied sharply in the last month after reporting earnings for its fiscal third quarter (ending Dec 31).  While the results were a bit complicated due to some strategic changes to the business, it appears that core operations are not only profitable, but growing very impressively.

ChinaMed has recently made the decision to focus exclusively on the diagnostic side of its business.  Part of this decision included selling its HIFU (High Intensive Focused Ultrasound) business line.  The HIFU has long been a staple for CMED, but in recent years, the revenue from this business became stale while diagnostic revenues have picked up tremendously.  The decision to sell this portion of the business points to management’s commitment to growth and cutting edge technology.

In addition to the divestiture, ChinaMed also made a strategic acquisition which gives the company a new technology to offer customers.  Surface Plasmon Resonance (or SPR Technology) is a cutting edge approach to the analysis of proteins, nucleic acids and viruses.  The process allows scientists to more accurately diagnose specific maladies which gives CMED a competitive edge when selling to hospitals.

On March 25, the company announced that the State Food and Drug Administration (similar to the FDA in the US) issued the Quality Testing Certificate for the company’s SPR Based analysis system.  This means that the system has passed the safety and performance parameters and is now much more marketable to the top tier hospitals.  In fact, the company has set a goal to penetrate more than 400 Tier-1 hospitals by the end of March 2009.  It will be interesting to see if they reached that goal when the company announces earnings in the next few weeks.

The beauty of ChinaMed’s model is that the vast majority of their revenue is now a result of selling consumable products.  This sets them up with a recurring revenue stream which should grow as a result of more SPR systems being placed in hospitals.  As the installed base grows, so will the recurring revenue, but the existing base will offer a very predictable level of income.

CMED executives must feel relatively comfortable with the business model as they are committing personal capital into the stock.  On March 6, ChinaMed issued a press release stating that the top three executives, (Mr. Xiaodong Wu – CEO; Mr. Sam Tsang – CFO; and Dr. Zhong Chen – Chief Technology Officer) have purchased additional shares in the company.  Now the total amount is roughly 160,000 shares at a price near $13 so that represents just over $2 million in purchases.  I understand that these executives have deeper pockets than I do and $2 mil may not be such a stretch for three executives, but it is still an important endorsement of CMED’s value.

Currently analysts are expecting the company to earn $1.88 per ADS for the year just completed (remember the fiscal year end is March 31), and $2.08 for the coming year.  At a current price near 18, the stock is just about 8.5 times next year’s earnings which is quite an attractive price considering the growth prospects.  While the stock is up more than 50% from its low, the potential for another 50% run is actually quite good.  In fact, ChinaMed was one of the four stocks I picked to outperform in 2009.  The medical diagnostic market should be firm regardless of the economic backdrop which is why ChinaMed is included in the ZachStocks Growth Model and is currently offering subscribers a profit.

FD: Author has a long position in the ZachStocks Growth Model
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