Rudi's View | Jun 22 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck
Shares of former market darling ResMed (RMD) have missed out on this year’s extension of the global bull market. Compared with a local share market gain of approximately 12% so far this year, ResMed shares lost more than 6% in value since early January.
This makes the stock one of the logical candidates for investors looking for value, especially given management’s excellent track record and mostly positive broker views in the market.
Most stock brokers rate the shares a Buy with price targets suggesting upside potential of up to 64% from Tuesday’s closing share price of $5.20. So why aren’t investors jumping on the opportunity?
The developer of medical equipment for diagnosing and managing Sleep Disordered Breathing has surprised the market with some uncharacteristic flaws over the past few quarters, including a voluntary product recall.
The story of ResMed over the past decade had been one of constant technological innovations and peer outperformance. It used to be the competition that suffered from technological mishaps, and ResMed was constantly the one to benefit from it.
But what caught most observers in particular by surprise is that the company’s growth rhythm of 20% per annum came to a sudden halt this year. Some securities analysts believe it is not impossible this year’s EPS growth figure might come in single figures only.
As a result of all this, the ResMed share price fell from a peak of a little over $7 in February to $6 and again to $5 when the product recall was announced in April. The market’s skepticism towards the stock is probably best illustrated by the fact that while most shares in Australia booked solid gains over the past few trading days, ResMed shares weakened further.
The result is a large gap between the intrinsic value of the shares as calculated by securities analysts and what the shares currently are trading at. This is also why most of these analysts rate the stock a Buy.
Data provided by Thomson Financial show twelve month price targets in the market currently vary between $8.52 and $6.33, suggesting share price upside between 62%-22%. Current market consensus is for an EPS figure of 19c for FY07 which would put the shares on a PER (price earnings ratio) of 27. A consensus estimate of 22c for FY08 takes the PER at 24 for next year. These multiples are well above ASX market averages of circa 17.5 and 16, but then again ResMed is supposed to grow by 20% year after year after year.
A recent study by Citigroup into the obstructive sleep apnea (OSA) market in the US may have contributed to investors’ cautiousness towards the stock. Among other things, the survey indicates the growth rate for the important US market may have plunged to a historically low 16%. Furthermore, the amount of respondents to the survey who continue to foresee growth of 20% or more has fallen sharply: from 43% last year to 30% this year.
Citi analysts who only recently re-commenced coverage on the stock, after an absence of more than a year, believe the survey might signal that ResMed’s key US market is maturing. The fact that the top three players in the market -Respironics, ResMed and Fisher and Paykel Healthcare (FPH)- now account for 73% market share is seen as possible further proof of this. The fact that the latest market survey indicates that product price, and no longer service or technological superiority, has become the key determinant in choosing the product supplier is seen as another one.
Add the rumour that founding CEO Peter Farrell is looking to give up his role as CEO to concentrate on the chairmanship of the board and it would seem there are plenty of reasons to not jump on board of the seemingly obvious ResMed value opportunity just yet.
This may even be more the case since the internal experiment of sending Farrell’s touted successor, former CFO Adrian Smith, to Europe has painfully backfired. Under Smith ResMed consistently gave up market share to Respironics while growth figures fell short of market expectations. Some analysts had already started to describe the European businesses as “the consistently underperforming geography”. Smith recently left the company.
Analysts at Macquarie believe Kieran Gallahue, current President of the company’s global operations, would now seem the most logical candidate to succeed Farrell.
A stronger Aussie dollar is another clear negative.
Equally important is that securities analysts are still re-adjusting their models and forecasts to the new, seemingly more challenging environment for the company. This will not only lead to a likely further lowering of consensus forecasts, but also of price targets and possibly even some recommendations.
Citi analysts, for instance, recently recommenced coverage with a Neutral rating and a price target of $5.30 only.
All this, however, does not imply that ResMed’s halcyon days of successful product launches, increased market share and high growth figures have now become a thing of the past. The company can still fall back on an undisputed innovative market leadership while its key markets continue to represent high growth potential for many more years to come. The Citi survey suggested ResMed continues to win market share.
However, given the above mentioned challenges, and the fact the company is trailing some high growth figures achieved in 2006, chances are its share price recovery may become more of a 2008 story instead of the months ahead. All those Buy recommendations are likely best interpreted as “long term Buys”. Expect lower price targets later in the year as well.