Brokers Breathe Easier Over ResMed

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

-US revenue growth seen strong
-Many options to offset price pressure
-Further upside to share price seen
-Generous margin buffer
 

By Eva Brocklehurst

Sleep disorder equipment specialist, ResMed ((RMD)),  provided a number of inducements to look favourably on the outlook after a strong fourth quarter finished off FY13. This was the first full quarter since the announcement in January of round two of the US Medicare competitive bidding pricing. Pricing was seen by brokers as the most contentious issue in the latest results, and for FY14.

Management does not think the US competitive bidding issue will be a problem. US industry revenue growth is 6-8% and there's not much change expected either to price or volume. Moreover, ResMed has grown market share. CIMB's confidence has increased as a result, despite the challenging industry dynamics. Margin stability was seen in the result and this should enable management to offset pressures via such things as manufacturing efficiencies, shifting the mix of products and more volume-based deals. There are also benefits from the fall in the Australian dollar. Although the shares are up more than 10% from lows last month the broker sees further upside potential as trading levels are not too demanding. CIMB upgraded the rating to Outperform from Neutral.

It was a solid set of numbers, in most broker opinions. Fourth quarter earnings per share was up 18% year on year and 7.2% quarter on quarter. Revenue was up 11% year on year. US sales were up 11% and the rest of the world up 12%. Earnings margin at the EBITDA level improved by 40 basis points to 31.5%, while a tax rate of 20.7% (excluding the University of Sydney payment) was better than CIMB expected (21.2%).

Deutsche Bank's confidence was also boosted. The broker noted the accelerating trend to home sleep testing (boosting market growth and mix), the impending benefits from new mask launches, the growing importance of the ventilation range and the tailwind from the falling Australian dollar. The first quarter of FY14 will contain the acid test but the results do allow for revision to earlier cautious assumptions with regard to competitive bidding round two. Deutsche Bank lifted earnings forecasts by 6% for FY14. Given the growing upside risk to earnings the broker moved the recommendation to Buy from Hold.

For Credit Suisse, operating cash flow generation stood out, with a reduction in the days inventory a key contributor. While the broker suspects the full impact of round two of competitive bidding is yet to be seen, as some small durable medical equipment (DME) enterprises could struggle to remain profitable, disrupting patient flow and volumes while patient lists are absorbed within a consolidating industry. There are levers within ResMed's control which should help alleviate any impact from this aspect.

Having recently surmised that the US price erosion was on the high single digits, UBS locked the 3-year growth outlook at 13%, made possible by cost savings equivalent to around 500 basis points of earnings margin over two years  and offset by price pressure. The results have proved this thesis, with leverage in the fourth quarter seen despite elevated price tensions. ResMed reported price erosion of 4-6% across the entire business, not just in the US segment, which compares with 2-5% historically.

ResMed made specific mention of the VPAP Adapt product performance in the result. UBS observed that channel checks rarely show this up because of the low volume but at over 10 times the price of more basic equipment it does not take much volume movement to make an impact. UBS also noted that, although reimbursement for bilevel devices was reduced through competitive bidding. Home health care dealers are making a more comfortable margin on these products.

Sleep apnea product sales are the most visible portion of the business and UBS' investment thesis also centres on increased high margin mask sales. With mask sales falling to the lowest point in five years in the US the assumptions need to be revisited. Despite the concerns, the broker found that mask launches were well timed to help offset elevated price tension and ResMed may have sacrificed some growth in masks over the last six months to support FY14 growth. The broker suspects the market has focused too much on market pricing and not enough on the impact on earnings. On this point UBS is resolute. ResMed can manage costs and maintain earnings growth above the price erosion that will be experienced over FY14 and may extend into FY15.

JP Morgan also expects ResMed should surprise on the upside with pricing in the next half, considering the generous margin buffer. Going forward management has retained expectations of a 61-63% gross margin, which is comforting to the broker in light of the introduction of competitive bidding. ResMed may be forced to accept price declines from the larger DMEs but has a number of meaningful drivers that will help keep gross margin intact. The real test for JP Morgan will be whether the company continues to grow margins whilst working through the paradigm shift in US pricing.

The stock has six Buy ratings on the FNArena database and two Hold. There are no Sell ratings. The consensus target price of $5.92 suggests 10.4% upside to the last share price.
 

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