ResMed Keeps The Good News Coming

This story features RESMED INC. For more info SHARE ANALYSIS: RMD

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

Sleep disorder group ResMed ((RMD)) recorded earnings per share (EPS) growth of 33% in the September quarter, a result better than most in the market had anticipated. Revenues in the period rose 14% compared to the previous corresponding quarter, with management indicating much of the sales growth was due to the release of the S9 flow generator series.

Citi viewed the quarterly result as "impressive" as it comes at a time of weakness in the US market, which means ResMed's new products are generating a significant increase in market share. The result showed both an increase in gross margins and lower costs thanks to the new products on offer and Citi expects these cost improvements will continue.

Net profit for the three months came in at US$56.7 million, which Citi notes was about 15% above market consensus. Given the better than expected performance in the quarter, a number of market forecasts have been lifted, Citi increasing its earnings per share (EPS) estimates by 2-3%. BA Merrill Lynch and Deutsche Bank have also lifted EPS estimates, but Goldman Sachs has gone the other way, trimming its EPS forecasts by around 3%. GS predicts the benefit of higher margins will be more than offset by lower revenue growth assumptions. Goldman Sachs is forecasting FY11 EPS of US14.9c, rising to US16.3c in FY12.

While market share gains are expected to continue thanks to the S9 product range, another key for ResMed's outlook in Citi's view is growth in Home Sleep Testing. Now that Home Sleep Testing is better covered by medical insurance in the US, the level of market penetration should increase. Significant cost advantages in home testing support this expectation.

The pace of growth in Home Sleep Testing has to date been slow, but as Macquarie notes there are some early signs suggesting home testing could eventually become the industry standard. As well, stockbroker Moelis points out there is additional upside if CPAP (continuous positive airway pressure) masks gain traction as a treatment for issues such as heart disease and diabetes given ResMed's strong market position.

A share buyback program should offer some price support for ResMed, suggests Deutsche Bank. The stockbroker it notes there are a further 13.8 million shares available to be bought-back under the current program. Any periods of share price weakness should see management enter the market via this program, in the broker's view.

Despite this potential support, valuation remains an issue for Goldman Sachs, as it notes ResMed at current levels is trading on an earnings multiple of more than 20 times, which is “growth stock” level in the broker's view. While the company is generating growth from its new products, this is not at the growth of previous product launches.

This leads Goldman Sachs to suggest better than 20% revenue growth rates are unrealistic in the shorter-term. This is especially the case given a stronger Australian dollar is a negative for ResMed with respect to translating its operational earnings.

Emerging markets offer some blue sky given these markets in generally have low market penetration levels at present. But Goldman Sachs is cautious here as well, in part because of challenging reimbursement and intellectual property protection conditions in these markets.

Given valuation looks stretched at current share price levels, Goldman Sachs has downgraded ResMed to Hold from Buy previously, while retaining its $4.00 price target on the stock. This puts the broker at odds with most of those in the FNArena database. ResMed is rated as Buy seven times and Hold once. (Goldman Sachs is not included in this).

The database shows a consensus price target for ResMed of $3.92, which compares to a consensus target of $4.00 prior to the quarterly result. Macquarie leads the way in target terms at $4.35, while RBS Australia is the low mark at $3.35.

Shares in ResMed today are weaker and as at 11.30am the stock was down 14c or a little more than 4.0% at $3.27. The current share price implies upside of around 20% to the consensus price target in the FNArena database.

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