Opportunity For ResMed Following Philips Recall

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ResMed has reported increased engagement with potential CPAP customers as a result of the Philips recall, although the opportunity could be limited by supply constraints

-Supply constraints may limit upside for ResMed from the Philips recall
-Possible that some of the customer transfer may be permanent
-Launch of AirSense 11 could have a positive impact on market share
 

By Eva Brocklehurst

An opportunity beckons for ResMed ((RMD)) as competitor Philips has issued a recall notice for the majority of devices affected by sound abatement foam degradation among its first generation DreamStation products.

Philips is advising patients to discontinue the use of the affected devices having determined that, based on testing, there will possible risks related to the type of foam being used. This is despite a low complaint rate, and the company plans to increase production of its new DreamStation 2 CPAP (continuous positive airway pressure) device which is not affected by the problem.

Both ResMed and Fisher & Paykel Healthcare ((FPH)) have reported increased engagement with customers as a result of this issue, although Citi notes the impact on the latter will be minimal given it only sells CPAP devices in the private pay market in the US.

In a normal year, ResMed's revenue is split around 50% to devices, 40% to masks and 10% to software-as-a-service. CPAP and Bi-Level products make up nearly all of the device sales. Goldman Sachs expects both companies will use the opportunity to overcome at least some of the deficit in sales persisting from a lower rate of new patient diagnoses.

Nevertheless, global supply pressures relating to component shortages may limit the upside. ResMed has indicated any allocation to filling enquiries associated with the Philips recall will be directed to the highest acuity needs, signalling ventilators would be at the top of the list.

Ord Minnett acknowledges gains in sales for ResMed will be countered by supply constraints but the opportunity is potentially worth more than US$500m. It is also fairly weighted between the US and other markets. While the US market may be larger, the benefit to ResMed is offset by competition from the new DreamStation 2 device and gains from the recall are likely to peak in the first half of FY22.

Positive Sentiment

Goldman Sachs retains a Neutral rating on ResMed because recovery in new patient diagnoses has lagged other elective demand. Consequently, momentum in masks has been affected by the loss of cumulative diagnoses and it may be several quarters yet before growth returns to the 3-year quarterly average of around 14%.

Still, market share gains stemming from the Philips recall could bridge the gap until diagnoses recover to pre-pandemic levels. Costs are also growing ahead of revenue, which Goldman Sachs asserts is an unusual dynamic for ResMed and one that may persist through to the end of FY22.

The stock has materially outperformed, despite an uncertain recovery in both sales and margins, and valuation continues to set all-time highs, so the broker currently envisages more attractive risk/reward elsewhere in the sector.

Longer term Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, remains positive and notes ResMed is a clear leader in an attractive market, retaining a target of $28.40.

The recall is positive for sentiment and Citi highlights the June quarter will mark the largest comparable period since the outbreak of the pandemic in terms of ventilators sold. After this the ventilator impact should be minimal and the company will start to cycle lower base comparables.

Citi expects new patients will buy disproportionately more ResMed devices, providing a much higher market share and it is possible some of this may become permanent. Still, it is premature to allow for this until there is a full response from Philips, which could take six months.

Ord Minnett is more assertive about the opportunity to expand ResMed's leading position in the sleep apnoea market as Philips faces a potential impact on reputation, given patients have been exposed to possible carcinogenic particles.

Based on inventory at the end of the March quarter and allowing for a month of production in transit, Ord Minnett estimates ResMed has US$130-150m in devices on hand, equivalent to US$170-200m in sales.

The broker believes the roll-out of the AirSense 11 CPAP device commencing in the second half can be managed with a view to maximising share, although ResMed will face some soft sales ahead of the full launch.

FNArena's database has three Buy ratings and three Hold. The consensus target is $28.92, signalling -4.6% downside to the last share price. Targets range from $27.40 (Morgan Stanley) to $32.00 (Ord Minnett).

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