ResMed Re-Awakens

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

-New product demand ahead of supply
-Margin adjustment eases
-Discounting stabilising
 

By Eva Brocklehurst

Sleep disorder specialist ResMed ((RMD)) provided some relief for brokers in its first quarter trading update. Flow generator sales surpassed expectations and while masks growth contracted slightly, the company noted prices were stable, volumes are growing and the company was gaining back market share in masks.

Growth rates for masks should improve in the third quarter, on the anniversary of price cuts, in Citi's view. The broker believes momentum will build in FY15, supported by the launch of the bi-level range of products. The mix of benefits from new products and a declining Australian dollar is expected to drive gross margins to the top end of guidance. ResMed forecasts gross margins of 61-63% in FY15. Citi does not expect further large price discounts in the US market and believes the effects of competitive bidding round 2 are now well embedded. Price erosion is likely to return to more historical norms in FY15 and beyond. The first quarter result and management commentary supports this conclusion, in the broker's view.

CIMB believes the evidence of price stabilisation, improved market share and volume, as well as the reception for new products, signals ResMed will more than offset concerns about provider pressure stemming from lower payments, bureaucracy and rising operational costs. To the broker, a modest sequential decline year on year in gross margins, to 62.4% in the quarter, underscores the probability that the bulk of price adjustments have already occurred.

Outside of the US, sales growth was up 11% in the quarter and this was a very positive signal for brokers, especially as the AirSense-10 was only launched in a few countries outside of the US late in the quarter. Management pointed to strength in Astral ventilator sales and a recovery in Japan, although Deutsche Bank points out Japan is a "notoriously lumpy" market.

Meanwhile, sales of AirSense-10 are ahead of supply, leaving the company with back orders to fill. Macquarie expects strong sales growth will continue with the broader geographical rollout of the product and the bi-level AirCurve being launched in the current quarter. ResMed will also start to cycle weak periods that were affected by price cutting and market share losses. Macquarie forecasts 7.1% sales growth in the second quarter. If the company exceeds this then concerns around its ability to grow will become more difficult to justify, in the broker's opinion.

JP Morgan also considers momentum is now on the company's side. Moreover, there is upside from currency movements if the Australian dollar continues to weaken. Masks are a concern but the flow generator success has bought some time, in the broker's opinion, as masks pricing re-bases. JP Morgan previously flagged the discounting that was rife in the US, with volume discounts as high as 20%, but margins now suggest this is stabilising. A weak euro will act as a further headwind in the current quarter but this should reverse in the third quarter as the weaker Australian dollar helps the cost of goods sold. The most disappointing aspect for JP Morgan was the lack of traction in the Airfit range and the 1% contraction in US mask revenue.

The first quarter may have been unrepresentative in many aspects, UBS suspects, in that mask/flow generator bundling was held up until the AirSense-10 launch. The broker also suspects some promotional market "seeding" of new Airfit-10 masks as well as the effect of ongoing discounts played a part in mask weakness. Hence, the new AirCurve-10 bi-level and respiratory range due this quarter should fuel further growth. UBS expects round 3 of the US competitive bidding system will continue to carry pricing risk for manufacturers but the national players with a regional presence have already achieved lower wholesale prices. The broker suspects the market has been reasonably efficient in extracting lower prices already.

Goldman Sachs is concerned that mask sales are still soft and suspects it will take a further couple of quarters before this improves. If the company can build on the momentum from product launches then the outlook is likely to improve, with a clearing of the back log of orders likely to assist in the second quarter, the bi-level launch assist in the third quarter and the anniversary of the price cuts for masks assist in the fourth quarter. Goldman retains a Buy rating and $6.00 target at this point in the new product cycle.

On FNArena's database there are five Buy and three Hold ratings. The consensus target is $6.52, which suggests 10.6% upside to the last share price.
 

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