ResMed’s Safety Warning Hits Sentiment

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

-Warning label on ASV needed
-Damage to market sentiment
-Earnings estimates reduced
 

By Eva Brocklehurst

The market has responded harshly to ResMed's ((RMD)) acknowledgment that its phase III SERVE-HF clinical trial missed its end point, with increased risk of mortality in a specific group of patients under study. The disappointing preliminary findings, announced six months ahead of expectations, are likely to have a material effect on sales of the Adaptive Servo-Ventilation (ASV) product and reveal a lost opportunity for growth.

The outcome was eagerly awaited, amid expectations the ASV therapy could treat patients with central sleep apnea and severe congestive heart failure (CHF). Instead, the company has to issue a safety warning, with a contra indication label, as the preliminary results signalled a statistically significant increase (2.5%) in morbidity for sufferers using the therapy. Of note, the trial did not include patients with an absence of heart failure and only related to a specific sub-set of CHF suffers, namely reduced fraction with cheyne-stockes respiration – a severe and intractable stage of the disease.

While less than 2.0% of ResMed's current sales are to patients contra-indicated in this aspect, Deutsche Bank expects the warning label will have a dampening effect on other sales of ASV. Given the high margin earned on the ASV devices reduced sales in turn reduces earnings expectations, particularly in outer years as the opportunity was expected to support medium-term growth.

Citi also notes the downward pressure on sales of this high price, high margin device. The broker was very supportive of ResMed's investment and efforts to establish a business in treating heart failure. In the short term, a recall/field notification will lead to some brand damage and a one-off charge is considered likely. Given trial success was critical to high expectations built into the stock, Citi acknowledges a significant reduction to its FY16-17 estimates and downgrades straight to Sell from Buy.

The result does not stretch to the company's core obstructive sleep apnea treatments and, as such, was not factored into many broker estimates. Still, share price weakness is likely to prevail, although most brokers remain confident in the company's outlook as new products ramp up. Morgan Stanley considers the CHF option now removed from the growth story and the stock should move down towards its new price target accordingly, reduced to US$55.39 from US$62.33. That said, the share were trading above the broker's base case valuation on the option value of SERVE-HF success.

Morgan Stanley accepts industry investigations had provided a positive bias on the outcome of this trial and, hence, the result was a nasty surprise. On the broker's numbers, ASV comprises around 7.0% of global sales and around 25% of these were to the patient population identified by the safety warning. Hence, the broker estimates a 3.0% negative impact on FY16 and FY17 earnings and considers its Equal-weight rating justified.

UBS suspects, given the results relate to a very specific area of study, that trials in the CHF condition may yet continue. ResMed was adamant that a wider impact from this adverse finding was unlikely as ASV is used for complex sleep apnea as well, and medically this does not compare with the SERVE-HF trial. Moreover, a strong association has been found for reduced hospital admissions post treatment with positive airway pressure (PAP) therapy, which reinforces the broker's view that the fall-out from this setback should be contained. UBS does not make any fundamental changes to the outlook, retaining a Buy rating, but recognises the failure will carry some negative sentiment for the stock.

Taking a view that there will be no future ASV sales for this patient population and potential flow-on effects to other indications, as well as lower corresponding masks sales, Credit Suisse reduces forecasts by 7.0% for FY16 onwards and downgrades to Neutral from Outperform.

JP Morgan takes a different stance. While acknowledging the adverse sentiment triggered by the results, the broker believes the company's other products are robust and there is associated margin upside. JP Morgan retains an Overweight rating. Quantifying expectations around the trial is difficult as the option value on this particular outcome was widely expected to re-rate the stock, the broker contends.

As UBS also notes, JP Morgan highlights data in March from 64 patients admitted for CHF with sleep disordered breathing found a significant reduction in hospital admissions after they were treated with PAP therapy. While accepting the trials are not directly comparable, it seems to the broker this data appeared to generate enthusiasm about the primary end point of the SERVE-HF trial and underpinned some growth expectations around flow generator sales in Europe as a result.

Over and above this opportunity, ResMed intends to pursue other co-morbidities such as chronic obstructive pulmonary diseases and hypertension. Hence, for JP Morgan there is no read-through on the treatment of central sleep apnea nor is this outcome a reflection on PAP therapies. Based on the company's estimates of ASV products sold in the last 12 months to patients identified by the safety issue associated with an adverse mortality rate, JP Morgan removes sales factored into Europe on the basis of favourable trial data. Hence, earnings forecasts for FY16 and FY17 are downgraded by 1.9% and 3.3% respectively. This brings the broker's share price down to $8.70 from $9.70.

FNArena's database now has one Sell rating as a result of the update – Citi. Otherwise, there are three Buy and four Hold. The consensus target is $8.77, suggesting 29.9% upside to the last share price. This compares with $9.88 ahead of the news. Targets range from $7.67 to $9.73.
 

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