Fisher & Paykel Healthcare Increases Opportunity And Risk

This story features FISHER & PAYKEL HEALTHCARE CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: FPH

-Competition felt in flow generators
-Some disruption in US likely
-Optiflow a key product opportunity
 

By Eva Brocklehurst

Fisher & Paykel Healthcare ((FPH)) continues to execute its strategy, delivering FY15 results which were above expectations. The numbers beat broker estimates largely because of an impressive performance in gross margins. The revenue mix was tilted towards the respiratory and acute care (RAC) division as opposed to obstructive sleep apnea (OSA), where masks growth stood out but flow generators underwhelmed.

Sales growth in constant currency terms was 13%, with accessories and consumables now comprising 81% of core revenue. High yielding masks growth stood out, up 23% in the second half. Flow generators were the area of weakness, delivering a flat outcome.

To Credit Suisse, the outcome for masks implies meaningful growth in market share. Gross profit margin also impressed, up 443 basis points. The broker was not so impressed with the news the company would undertake a new distribution arrangement in the US for its hospital respiratory (RAC) products. The US market is important and the broker believes a rapid transition to the new channel will be necessary. Fisher & Paykel Healthcare is seeking to distribute its products directly and is working with Carefusion, its current distributor, to ensure a smooth transition. The company has established an expanded centre in the US and is doubling the size of its US hospital sales team.

Credit Suisse gives the company the benefit of the doubt but maintains a cautious stance, keeping forecasts to the low end of guidance for FY16 until it is evident the company can push through the necessary changes. Upside should come late in FY16. Still, the broker is confident in the company’s ability to drive its margins higher than originally estimated. The flat outcome in flow generators did not surprise Credit Suisse, given competitor ResMed’s ((RMD)) momentum in this particular area. Credit Suisse has an Underperform rating and NZ$6.05 target for Fisher & Paykel Healthcare.

Without a new platform, growth may be elusive for some time, UBS observes. This broker also suggests the company’s flow generator sales may be struggling against ResMed’s new platform. While management did not offer a time line, UBS believes a new platform is over 12 months away. Still, momentum in RAC and OSA in terms of masks, as well as margins, continues to impress. This is now aided by FX tailwinds.

That all said, the broker believes the market is pricing in growth beyond what is currently visible. The implied RAC multiple suggests there is limited room for execution risk should challenges emerge on the transition front. Hence, UBS retains a Sell rating with a NZ$5.90 target. The company is now targeting a 70% pay-out ratio and increases its final dividend to NZ8c a share.

Citi also has a Sell rating, with a NZ$4.12 target. The broker notes underlying growth was strong, with net profit up 57% in constant currency terms, offset by decline FX hedging gains. The decision to distribute directly in the US follows a recent takeover of Carefusion. Citi believes the transition is likely to result in NZ$10-15m in additional operating costs and NZ$15m in capital expenditure. In the short term, the broker suspects lower sales as the current channel inventory is run down, with some disruption in hospital contracts as new staff are put in place.

In time, the shift in the distribution of US RAC products will allow for a more focused sales team and slightly better margins, in Macquarie’s opinion. The broker welcomes the news that Carefusion, which current represents 24% of RAC total sales, is facilitating a smooth transition, with change-over targeted for July. The broker believes the company’s significant product advantages and experience mitigates the risks in the transition. Macquarie expects the transition will have a negative impact on earnings in 2016 but maintains an Outperform rating and NZ$7.25 target. The main risk to the positive outlook stems from the NZ dollar, as valuation and future earnings estimates are very sensitive to the currency. 

Macquarie believes Optiflow is the key product which will drive growth in new applications for the RAC division. The product is important as it builds on the company’s position in invasive ventilation as well as its knowledge of flow generators in the OSA market to create a new opportunity. In the broker’s view the company’s estimate of the addressable market of 30m patients for this product is conservative, given around 10m per annum are given invasive ventilation. Another area of change is the shift to Mexican manufacturing. The company expects half its consumables will be manufactured there by the end of 2017. This will reduce costs in terms of NZ dollars.

Five FNArena database brokers cover Fisher & Paykel Healthcare and a currently split two Buys to three Sells.
 

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