Brokers Mull ResMed’s Growth Prospects

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

-Gross margin still strong
-Waning impact of CB introduction
-But questions over sales growth
 

By Eva Brocklehurst

Changing purchasing patterns in the US meant ResMed's ((RMD)) FY14 results ended up below broker expectations, particularly for mask sales. The sleep disorder specialist's operating environment was challenged by timing issues, with the usual seasonal strength of the fourth quarter absent because of price cuts in the third quarter, which meant some large customers brought forward their bulk purchases.

Despite the price reductions, ResMed maintained a strong gross margin of 62.9%, ahead of most broker forecasts. The weak fourth quarter was tolerable for UBS because of the FY15 outlook – easier comparables and a new flow generator coming to market. The key metrics remain robust and UBS considers any weakness as a buying opportunity ahead of the launch of the flow generator.

Discounting had an impact on margins but this was mitigated by cost control, in JP Morgan's view. A suite of new products in masks, flow generators and ventilators is expected to address the decline in US market share and restore growth. That said, JP Morgan finds little evidence that market share decline in masks has been turned around yet. Considering the new product releases, the broker believes it is imperative there is an improvement in mask volumes over the next six months. Flow generator sales also disappointed but the broker accepts the explanation that customers are holding off until the next generation of products. JP Morgan expects, as the fourth quarter of FY14 was robbed by a pulling forward of inventory to the third quarter, this should make sales in the first quarter of FY15 a more reliable indicator.

Morgan Stanley remains comfortable regarding long-term volume and ResMed's dominant market position. The broker's investigations suggest mask growth may be positively affected by the launch of the AirFit range but the company disappointed in the June quarter in this area, reflecting price pressure and market share loss. Moreover, Morgan Stanley is not sure that future pricing will not be affected by round three of the US competitive bidding process.

Competitive bidding remains disruptive to the company's volumes, in Credit Suisse's opinion. Reduced Medicare reimbursement appears to have caused the durable medical equipment (DME) entities to sustain lower inventory levels. As is the case with other healthcare sub-sectors that have moved to a just-in-time pattern for orders, Credit Suisse does not envisage a purchase "catch up" in FY15. The speculated launch of the next flow generator platform, which did not eventuate in the June quarter, may also have played role in reducing sales, Credit Suisse suspects. The broker has reduced earnings forecasts by 5%, because of lower US sales growth rates, and considers the stock fairly valued.

Even allowing for the changed sales pattern, Deutsche Bank remains concerned about the decline in US masks sales. Rest-of-the-world sales were up 5% on an FX-adjusted basis. Gross margins also surprised the broker on the positive side and this is attributed to a lack of price discounting in end-of-quarter deals. Cash flow was strong but was largely driven by a large increase in payables, supporting a working capital uplift. This eventuated despite inventory and receivables also rising and Deutsche Bank suspects this situation is unsustainable.

CIMB found gross margins held up well, product mix was supportive and so were manufacturing efficiencies and FX. The slight margin decline reflected a more stable pricing environment and, with a product portfolio that is stronger than ever, sales weakness is not overly worrying CIMB at this point in time. Citi expects growth to improve in FY15 as the impacts from introduction of competitive bidding in the US start to wane and new products gain traction. Citi believes underlying market demand for flow generators is still growing and a return to double digit revenue growth in the second half of FY15 is likely.

On the FNArena database there are six Buy ratings and two Hold for ResMed. The consensus target is $6.03, which suggests 13.9% upside to the last share price. Targets range from $5.50 to $6.97.
 

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