How Long Will ResMed’s Suffering Continue?

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

-Unclear re extent of price disruption
-Margin strength a key positive
-New product should spark sales growth

 

By Eva Brocklehurst

Sleep disorder specialist ResMed ((RMD)) suffered from weak revenue growth in the second quarter as the US competitive bidding processes continue to disrupt the customer base. Brokers vary over the degree to which they're prepared to look through this disruption, which has persisted for some time.

The second quarter weakness follows a soft outcome in the first quarter and CIMB questions whether the worst is now behind the company. The broker remains confident in the long term but just doesn't like the short to medium-term trajectory for the stock. With the US system in flux amid competition risks, CIMB has decided to reduce the rating to Hold from Add pending greater visibility on the dynamics. A lack of clarity surrounds whether US competitive bidding is a mere distraction, as management contends, or whether it reflects a more sustained change in the pricing/volume of the business, as distributors review their business models. CIMB still thinks the company is well placed, with multiple levers to offset such pressures, but expects the stock will be volatile. The broker adds a proviso that, should any considerable weakness develop, the rating would be reviewed as the multiples do not appear overly extended.

Citi is more confident growth will return, particularly as home sleep testing is increasing the rate of new diagnoses. The broker observes ResMed is losing market share in masks and new product launches over the next six months need to address this loss, although it will take time to gain traction. Gross margin remains a key factor in ResMed's favour, according to Citi. Moreover, while foreign exchange contributed, margins were underpinned by manufacturing gains and a favourable product mix. The broker assumes ResMed will invest this gain back into lower US customer pricing in the second half to stem the market share decline.

Another broker that is prepared to dismiss the current softness is JP Morgan, convinced that once US pricing has been re-based the company will regain its strong position in the healthcare sector. The broker considers an FY15 price/earnings forecast of 15 times, adjusted for cash, represents a good point of entry for a stock that will benefit from reinvestment in R&D and the increasing awareness of sleep apnea via home sleep testing. The broker also expects some easing of the disruption as distributors and medical centres in the US come to terms with the subcontracting arrangement and re-supply documentation.

UBS, while expecting competitive bidding will overhang the stock for some time, thinks the new platform that's due by the end of FY14 will herald a new growth phase in FY15. UBS rates the launch of the new flow generator platform in the fourth quarter as extremely likely. History suggests sales growth of 16-43% follows a new product launch. The broker notes consensus forecasts for just 8.5% sales growth in FY15 do not factor in a launch response. The broker has based forecasts on modest launch success, with growth of 15%. Credit Suisse also considers it important that ResMed launches an array of new products, priced effectively to ensure a stemming of market share losses. The broker considers the impending launch of a new respiratory care platform and a falling Australian dollar will be beneficial, but remains concerned about how quickly the US market pressure will abate. Until Credit Suisse is convinced about the growth trajectory a Neutral rating is retained.

The company has little choice but to cut prices to shore up the market position and the risk that such a strategy leads to a price war cannot be ignored, in Deutsche Bank's view. What stands the company in good stead is its gross margins are at a 10-year high and it continues to refresh the product base. The broker is confident the drag from competitive bidding will disappear. The Hold rating is retained because of limited upside to the broker's price target. Deutsche Bank expects pricing to be more aggressive this year, limiting further market share losses, and expects US sales could contract slightly in the second half.

Until top line earnings growth returns, Macquarie considers a re-rating unlikely. This could be some way off and the broker finds it hard to foresee when the disruptions will peter out. What concerns Macquarie is that management said ResMed will re-evaluate price premiums given the state of the current market. This suggests to the broker the company has been surprised by the extent of competitor price reductions and that prices will get worse in the third quarter. Macquarie suspects that price headwinds could continue until mid FY15. Still, the broker is confident that, in the longer term, revenue headwinds will ease and ResMed will retain a strong position in its market.

There are four that retain Buy ratings on the FNArena database. The other four have Hold ratings. The consensus price target of $5.95 suggests 18% upside to the last share price. Price targets range from $5.40 to $6.74.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms