How Much Upside Is There For ResMed?

By Eva Brocklehurst | More Articles by Eva Brocklehurst

Breathing disorder therapist ResMed ((RMD)) is increasing its dominance of the US sleep apnoea devices segment, reporting a robust December quarter result. This market dominance, Ord Minnett suggests, implies distributors are increasingly standardising on the company’s connected offering.

If this superior position can be replicated in other markets, the broker believes it will entail economies of scale that should allow the company to develop potentially higher-margin revenue streams. Yet, while optimistic on the outlook, Ord Minnett remains conscious that much of the potential is already in the current share price.

December quarter results were driven by stronger revenue growth and lower expenses. Gross margin fell to 58.2%, down 10 basis points year-on-year, with management attributing the reduction to average selling price declines that were partly offset by manufacturing and procurement efficiencies. Morgan Stanley envisages gross margins will improve to 59.4% by FY19.

UBS upgrades estimates for FY18 and FY19 earnings per share by 11% and 3% respectively. The upgrades are primarily on the back of stronger assumed mask sales, amid higher recurring replenishment revenue. The broker was impressed with the growth across both masks and devices and the increasing traction of the re-supply platform.

Operating Leverage

The only blemishes Morgans found in an otherwise solid December quarter result were lower average selling prices and one-off tax adjustments. Although the share price rallied strongly, the broker is comfortable with a positive stance, expecting earnings growth will come via further manufacturing and operating efficiencies and an increased contribution from the Brightree business.

The main risks the broker envisages are pricing pressures that end up greater than forecast as well as foreign exchange headwinds. Morgans believes the leverage from the improved cost base and further market share gains will grow earnings.

UBS was pleased the company was able to co-ordinate top-line growth with operating leverage, although acknowledges it had expected the stronger mask growth would deliver an upgrade to gross margins. Instead disciplined management of costs reduced the leverage.

The broker suggests that once the foreign exchange headwind and ongoing strength in lower-margin device sales are accounted for, the company’s flat gross margin becomes a more positive outcome.

Gross Margin

Net profit was substantially higher than the prior corresponding period, supported by a lower tax rate. In line with the strong growth recorded for devices in recent years masks/accessories have accounted for a reduced proportion of total revenue. Macquarie’s analysis shows a correlation between gross margin decline and a lower contribution from masks to total revenue. This is explained by the high-margin nature of consumables relative to flow generators.

Macquarie acknowledges the strength of the result and the opportunity for the company to increase its penetration of obstructive sleep apnoea (OSA) populations but asserts there is a limit to operating leverage with ongoing price declines. The broker believes the current risk/reward profile is skewed to the downside. Along with limited appeal relative to domestic healthcare peers, Macquarie believes these factors support a downgrade to Underperform from Neutral.

Morgan Stanley acknowledges its Overweight thesis is a little hampered by strength in the Australian dollar and this is likely to continue over the rest of FY18. Nevertheless, the broker remains confident upside will be driven by improved operating leverage, emanating through R&D along with a one-off benefit from US tax reforms. The broker prefers the stock versus other Australian peers earning offshore income such as CSL ((CSL)) and Cochlear ((COH)).

Citi increases estimates for FY18-20 earnings per share by 6-11%. The broker believes further upside is possible from expanding gross margins amid a range of inputs such as continued growth in masks, further leverage on costs, sales increases in respiratory care, Brightree, acquisitions and/or capital management.

Credit Suisse considers the stock fairly priced, despite strong execution, and remains wary of the potential for irrational discounting if key competitors struggle to maintain their share of OSA masks.

FNArena’s database has four Buy ratings, two Hold and one Sell (Macquarie). The consensus target is $12.01, signalling -2.3% downside to the last share price. Targets range from $11.25 (Ord Minnett) to $13.60 (Citi).

Eva Brocklehurst

About Eva Brocklehurst

Eva Brocklehurst started her journalistic career in 1993 as a financial reporter with RWE Australian Business News covering money markets and economic reports. She moved to Australian Associated Press (AAP) in 1998 as a senior financial journalist to cover money markets, economic analysis, Reserve Bank and Treasury. Eva became deputy finance editor at AAP in 2003. Started working online as a reporter on ASX-listed companies for RWE Australian Business News in 2005. Eva joined FNArena in 2012 and has been covering stockbroker analysis of ASX-listed companies since, as well as writing general news stories.

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