Australia | Apr 29 2013
-Strong growth in March quarter sales
-Question of how much price pressure can be curbed
-Device growth outweighs softer mask growth
By Eva Brocklehurst
The manufacturer of sleep disorder diagnostic products, ResMed ((RMD)), posted strong sales growth in the March quarter. The company markets its products globally, from headquarters in the US and Australia, but the the big market is the US, where the country's health care system and competitive bidding process complicates the outlook. Revenue grew 10% in comparative terms in the quarter, with the US up 13% and the rest of the world up 6%.
The most interesting aspect for BA-Merrill Lynch was the strong gross margin. This was achieved despite weaker mask growth, which was countered by stronger US flow generator device growth. Specifically, the growth of 21% in US flow generator sales indicates the company has captured market share in some high margin areas. This, coupled with new products and cost cutting, provides the levers to counteract the pricing pressure that will come from the Round 2 of the competitive bidding process, in the broker's view. Management acknowledged that the larger-than-expected cuts to US Medicare reimbursement, following Round 2, will lead to increased price pressure in FY14, estimated at 5-6% against the usual 3-5%. The company is banking on efficiency gains to do the work to counteract this.
Merrills observed that the timing of the volume benefit that is to come from ObamaCare, as the new US health care plan is known, will be in place before the plan's Round 3 competitive bidding gets underway. The broker maintains few in the market are factoring this in. Competitive pressure is likely to build in the next six months with price discounting beyond the confines of Round 2 fundamentals. The March quarter result has provided the company with the means to mitigate the impact of this pricing pressure but the degree of both is a matter for conjecture at this stage. Moreover, the benefit could be as late FY15, in Merrills' view. As a consequence, the broker, along with most covering the stock on FNArena's database, opts for a Hold rating.
Don't underestimate the risk that competitive bidding will make to earnings, is the warning that most of the brokers make. Deutsche Bank believes this threat is the reason for maintaining a Hold rating. The Round 2 competitive bidding will start July 1. Citi believes ResMed has more bargaining power than its durable medical equipment (DME) customers and is less concerned about the process, while JP Morgan thinks improving margins and tax rates will allow ResMed to absorb the impact as DME suppliers attempt to pass on the reimbursement impact to manufacturers.
Interestingly the latter two brokers have the only Buy ratings on the FNArena database. Citi and JP Morgan have each focused on the capital management potential. JP Morgan noes that there is $672 million on the balance sheet. ResMed bought back 1.5 million shares in the quarter and has committed to buy at least one million in the September quarter. Should the board redouble efforts on the buy-back or dividend the broker expects it to be well received, despite limited tax effectiveness. Citi views the earnings profile as solid and notes the cash on the balance sheet, believing the company has capacity to increase the buy-back or dividend. The remaining six ratings on the database are Hold. The consensus price target is $4.76, suggesting upside of 3.8% to the last share price.
Home sleep testing has been considered the catalyst for future volumes of flow generators as it provides an alternative and more convenient method of diagnosis. This has always supported growth but the size of the rise in the latest quarter suggests to brokers it's about to get a lot more significant. JP Morgan notes home sleep testing is offered by 38% of US laboratories as an alternative. Why this is attractive is because home sleep testing funnels patients onto higher margin APAP flow generators in order to avoid the inconvenience and expense of titration, which is performed by a sleep lab. This underpins margin improvement and, for JP Morgan, there's some way to go. ResMed is also viewed as much stronger than competitors in this area.
Citi understands that reimbursement among private insurers is sufficiently attractive to make home sleep testing profitable for the sleep labs. The labs have been fighting the reimbursement since 2008 but adoption of pre-authorisation by the majority of private insurers means home sleep testing is now inevitable. US Medicare does not have pre-authorisation and reimbursement is relatively lower. Citi expects the majority of Medicare patients will, therefore, be diagnosed in-laboratory.
Device sales may have grown, and the trend is to higher value devices, but US mask sales growth in the quarter was the lowest in 10 years. Most brokers consider ResMed, in this instance, was a victim of increased competition. Indeed, management attributed the competition to Philips Respironic and F&P Healthcare. JP Morgan suspects that mask sales also suffered as distributors held off buying ResMed masks in anticipation of imminent new releases. The company is launching two new masks in the current quarter which should be smaller, quieter and more comfortable. Deutsche Bank also expects September quarter mask sales will be subdued before a pick up to start the company's new year (FY14) in the December quarter.
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