Australia | Aug 21 2006
By Chris Shaw
One problem all growth stocks eventually must face is the rate of growth must slow down at some point, as the increasing size of the company and its ever-increasing sales and earnings base makes it harder and harder for earnings to continue increasing at the same rate.
One current example is Resmed (RMD), as while the company has continued to grow earnings strongly it now appears to be struggling to exceed market forecasts. As evidence of this, the company’s fourth quarter profit of US$23.1m result fell short of market forecasts, leading to downward revisions to estimates in future periods.
Part of this is due to more aggressive pricing by its major competitor in the US, Respironics, though as the company is also facing tougher comparisons given the strong growth it achieved last year the outlook is for more subdued growth.
The most severe came from Deutsche Bank, which cut its rating to Hold from Buy and its target price to US$45.50 from US$50.00 (based on the price of the company’s American Depository Receipts) to reflect its more cautious view on the company’s margin outlook. The margin impact can be seen in the fact the company’ profit result was slightly below the broker’s forecast despite sales being a little higher than expected, so its earnings per share outlook is now not as positive as was previously the case.
The broker has cut its margin forecast by 2% for both FY07 and FY08, resulting in its earnings estimates falling 8% in each year to US152c and US190c. ABN Amro reacted in a similar way, cutting its margin estimate by 2.5% to 61%, resulting in its earnings forecasts falling 9.4% in FY07 to US141c and 9.9% in FY08 to US164c. The broker has retained its Buy rating, but cut its price target to $6.20 from $6.77 for the shares traded on the Australian market.
Unlike Deutsche the broker sees some potential for upside earnings surprise though, as it notes the company is rolling out its Swift II nasal mask product earlier than expected and industry growth is still strong.
GSJB Were is less optimistic, rating the stock as Marketperform, L/T Hold to reflect its view the upside potential in the stock is already priced in at current levels. The broker points out the stock is trading at a premium to the market of about 91% at current levels, so the combination of downgrades to earnings forecasts and tougher competition makes it difficult to see the potential for outperformance. (Readers should note however this is a view which has been expressed by GSJBW over the past two years).
The broker has lowered its earnings estimates by 5% in both FY07 and FY08 to US142.5c and US168.3c respectively to reflect an adjustment to its unit sale forecasts and lower margins, as well as the ongoing problems in the European operations, where sales growth has continued to disappoint.
The FN Arena database shows the stock is now rated as Buy twice and Hold four times, Macquarie being responsible for the other Buy rating based on its view the stock will benefit from an overall market growing faster than it had expected.
The average target price in the database is $6.60, while Thomson One Analytics shows the median price target is $6.77, with Macquarie having the most aggressive target in the market at $7.01. The market reacted to the result on Friday and pushed the stock down from levels closer to $6.00 to below $5.80, the stock today trading down 1c at $5.75 as at 12.00pm.