ResMed Proves It Deserves Market Premium

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

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

Sleep disorder group ResMed ((RMD)) beat the market with its March quarter earnings result, delivering net profit of US$48.8 million against a consensus forecast of US$43.4 million. The result was struck on better than expected revenue of US$278 million, which beat the consensus estimate of US$271.3 million.

Revenue growth was 22% and Citi notes this was split between the US market and ResMed's operations in the rest of the world, while also being split across the company's various product categories.

According to UBS, the result was helped by the launch of new products from ResMed including some masks and its S9 flow generator product, which appears to be delivering very good sales results. UBS notes the new products are delivering some market share gains for ResMed, while the company enjoyed an overall positive shift in product mix in the period in the US market in particular towards its higher end flow generators.

The other key for Citi was ResMed was able to hold gross margins at around 60% in the period, a result seen as impressive given currency headwinds. Citi sees this as evidence of some ongoing manufacturing efficiency improvements, as well as a favourable geographic and product mix.

A falling cost base also contributed to the result as Citi notes SG&A, which is ResMed's net level of stock-based compensation, improved. As a percentage of revenue this measure declined to around 30% from 34% previously, which the broker suggests also reflects the improvement in operating performance.

In the view of UBS, the company's combination of a lower cost of goods sold, its Singapore manufacturing facility and more stable foreign exchange margins should see gross margins sustainable at around 60% this year. This implies a solid earnings growth outlook, UBS forecasting earnings per share (EPS) of US27.6c in FY10, US36.1c in FY11 and US46c in FY12.

Citi is forecasting EPS growth of 28% this year, 17% in FY11 and 15% in FY12 based on respective EPS forecasts of US24.6c, US28.8c, US33.2c, while Macquarie is forecasting EPS of US28.8c, US32.7c and US37.5c respectively.

For Citi this suggests ResMed shares remain attractively priced, as despite the good earnings growth outlook the stock is trading on around 20 times 12-month forward earnings. To reflect this Citi retains its Buy rating.

The rest of the market sees value as well, the FNArena database showing ResMed overall is rated at Buy eight times, Hold once and Reduce once. The quarterly prompted one change in rating, GSJB Were (soon to be renamed Goldman Sachs and Partners) upgrading to a Buy from Hold previously.

As Were notes, there is a strong correlation between revenue growth and ResMed's P/E or Price to Earnings rating. With the revenue outlook being supported by new product releases, market share gains and solid margins the broker expects the stock should continue to trade at a significant premium to the market.

The other positive in Macquarie's view is the level of home sleep testing in the key US market continues to increase, which underpins the growth outlook for ResMed longer-term. At the same time, the broker notes the company has a conservative balance sheet and some options with respect to capital management, which Macquarie regards as something of a free option at present.

In terms of possible issues for the company going forward, GS JB Were sees a potential risk from price declines from more competitive bidding in ResMed's markets as a potential threat. This is forecast to commence progressively from January 2011 and could see greater than usual price declines as more US states move away from the current Medicare fee schedule payment methodology.

On the flip side of this, UBS suggests there is the possibility of additional financial incentives in the sleep disorder sector that would increase the level of home sleep testing. This should prove beneficial for ResMed in UBS's view, as could the possible 2011 launch in the US market of Saime, a ventilation business bought several years ago and currently not factored into market estimates.

Overall, UBS expects market forecasts for FY11 for ResMed are likely to be upgraded in coming months to closer to its own numbers. Its forecasts are currently 16% above consensus for next year.

Post Resmed's quarterly, price targets have also been adjusted, the FNArena database showing an average target now of $7.64, up from $7.33 previously. Credit Suisse was one to lift its target, increasing it to $8.70 from $7.80 given 3-4% increases to its earnings estimates. Macquarie was similarly positive, its target rising to $8.39 from $7.50.

The average price target compares to a current share price of $7.43, the stock trading almost 5% higher today in an overall subdued share market. This implies upside to the average price target in the database of a little less than 4.0%.

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