Brokers Warm To ResMed As Price Disruptions Abate

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

-Lull in US price reforms
-New products on launch pad
-Earnings growth upside
 

By Eva Brocklehurst

Brokers have renewed confidence in sleep disorder specialist ResMed ((RMD)) after the company's March quarter results, with two taking the opportunity to upgrade recommendations. Most of the disruption from the US competitive bidding process seems to have passed and brokers, generally, have a more upbeat outlook on future prospects.

BA-Merrill Lynch believes, while growth in the quarter was achieved through discounting, the effect was immediate and this highlights the fact there are still plenty of opportunities for the taking, although large volume discounts could make further growth more difficult. Credit Suisse thinks a series of new mask launches offers the opportunity for ResMed to stem market share losses, but concedes a decision to price at the level of existing models may hinder distributor take-up. JP Morgan is encouraged by the fact ResMed is using its ample gross margin to capture lost market share but remains mindful that distributors could pull forward inventory to capitalise on discounted product. If such be the case, this is not a sign of sustained improvement in underlying demand. Still, the broker is prepared to give the company the benefit of the doubt and assumes similar volume growth in the fourth quarter.

Merrills thinks investors lacked confidence in the stock in the recent past because of the challenges in the industry but with new products, easier comparables and a lull in pricing reforms in the US, confidence should improve. The broker notes the Astral Ventilator, and "10" masks are to be launched soon and the market is expected to look ahead from these launches for what's in store in FY15. The biggest surprise for Merrills in the March quarter was the weak Flow Generator growth in the rest of the world, largely affected by the largest Japanese customer delaying the renewal of orders. The broker is comforted by the evidence that there remains strong underlying growth for masks in Japan. All up, Merrills sees the company at an inflection point and the risk/reward as attractive.

On the FNArena database the consensus target is $6.05, suggesting 16% upside to the last share price. This compares with $5.98 ahead of the quarterly update. Targets range from $5.49 to $7.07. Both CIMB and Deutsche Bank upgraded ratings. There are now five Buy ratings and three Hold.

CIMB thinks the operating environment may be challenging but price erosion is subsiding and there are new products to be launched so sales growth and momentum should be restored. The broker has upgraded to Add from Hold. The broker acknowledges gross margin guidance of 61-63% compared with the previous 63-65% suggests there may be more price erosion to come, but takes comfort from the likelihood that the bulk of price adjustments have already occurred and market stability is starting to emerge.

The US market retains some pricing issues and remains highly competitive so Credit Suisse suspects the most effective tool for manufacturers to shift market share is via pricing. A further concern centres on the shift to bundled payments as the distributor payment methodology, in lieu of nationalising the current competitive bidding. If so, Credit Suisse maintains it would radically change the way the product is sold in the US. The broker does not envisage reimbursement would be allowed to grow excessively. On this basis, JP Morgan finds it difficult to recommend the stock (Neutral rating) whilst the US Medicare decision on implementing a bundling system remains a possibility.

To Citi the US may still be challenging because of competitive bidding issues but these headwinds are abating. Moreover, the growth in the rest of the world should stay strong, aided by the controlled launch of the Astral respiratory care platform in Europe and the AirFit P10 pillows masks at the beginning of the March quarter. The broker likes the stock, particularly with core earnings growth forecast at 11% in FY14 and 19% in FY15.

Deutsche Bank expects a return to more normal pricing and demand will present in FY15, boosted by the new product range and the move into the non-invasive ventilation market in the US. While the broker acknowledges the risk of further funding reforms, such as bundling, this would take a number of years to introduce and the market should continue to grow in the interim. Deutsche Bank hails the company's success in winning back share in the US and the broker no longer expects a contraction in FY14. Rest-of-world sales forecasts are reduced following the weakness in Japan and, combined with lower average pricing, the broker has reduced earnings forecasts in FY15 by 3.5%, but this impact eases in the outer years as the benefit of non-invasive ventilation sales increases. Deutsche Bank upgrades to Buy from Hold.

A fourth quarter launch for the new FG platform at the major "sleep" conference is likely, in UBS' opinion, and there has been a strong precedent for strong growth after prior launches. The broker expects FY15 growth of 15% could prove conservative and will review sales estimates if new devices offer relevant innovation. UBS believes the key metrics are robust, there's a net cash balance of $543m and buy-backs in place for 14% of shares. Moreover, the stock is trading at 16.4 times FY15 estimates, a historical low against the five-year average. It's worth a Buy rating in this broker's book.
 

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