ResMed Faces Challenges In FY16

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

-Further signs of accelerating sales needed
-Margin pressure from re-mix of product
-FX may underpin rebound towards FY17
 

By Eva Brocklehurst

Sleep and breathing specialist ResMed ((RMD))  delivered strong revenue growth in the September quarter. Sales in flow generators grew 20%, while masks were up 9% in the quarter after a flat performance through FY15. Subsequent quarters are expected to remain challenging given a key competitor, Philips, is launching new products and competitive bidding rolls out in the US from January 1.

Morgan Stanley notes the company began its discount mask strategy in June last year and this was a low hurdle that was successfully cycled this quarter. The pricing strategy enabled a gain in market share, ahead of the launch of a competitor's product. Signs that sales are accelerating after growth in the installed base are now needed for the broker to be comfortable that the company's discounting is translating into a commercial outcome.

If ResMed can sustain high single digit US mask growth for two quarters against a market that is growing 6-8%, the strategy may have worked, and UBS intends to review assumptions at that time. Given precedent, flow generator growth should retreat below 10% now, with the company cycling significant growth amid the upcoming offering of the Philips' DreamStation.

This time it may be different, the broker suspects. ResMed's AS10 is now part of the distribution process for US Durable Medical Equipment (DME) suppliers and this makes switching to competitor products more difficult. UBS suspects Philips will continue to lose flow generator share and if so, it will be a turning point for long duration sales and valuation for ResMed.

The high growth hurdles driven by the launch of the company's AS10 over FY16 will be more difficult to overcome now so Morgan Stanley suspects the September quarter US devices growth of 39% will probably be the last strong number for some time. The broker suspects there will be a drag on sales outside of the US from FX over the first half. The competitive product launch and competitive bidding in the US could make growth hard to come by. The  risk in the competitive bidding process is of an unknown magnitude at this stage.

Gross margins occupied broker attention in the quarter, as these dropped 440 basis points to 58%. The removal of Adaptive Servo-Ventilation (ASV) sales to patients with congestive heart failure presents a headwind to margins, as Morgan Stanley notes these devices are higher margin compared with the CPAP (continuous positive airway pressure) and bi-level products. This is because of a relatively small difference in costs but a large difference in headline price. The company has maintained guidance for gross margins of 57-60% for FY16, with a smaller contribution from ASV sales likely going forward.

Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, is confident gross margins will rebound but, offsetting this, acknowledges the lost ASV sales in Europe. Now that pricing cuts in masks have been cycled this should provide further momentum although flow generator sales are expected to moderate with the rival product launches. The broker retains a Buy rating and $9.30 target.

The issue of gross margin leverage should extend into subsequent quarters as mask growth outstrips growth in flow generators, JP Morgan asserts. At the same time, FX should assist in savings in logistics, procurement and manufacturing. R&D will obtain a benefit from a weaker Australian dollar and effective tax rates will improve as ResMed moves more capability to Asia. Hence, JP Morgan expects a move back to double digit growth and margins to track back quickly to the top end of guidance (60%).

Credit Suisse is not so sure. The broker expects strong revenue growth will be met with limited margin recovery because of the relatively high growth in flow generators versus masks, and in the Americas versus the rest of the world. Still, with cash flow growing at around 40% and a healthy balance sheet, the broker believes the company can maintain the pace of its buy-backs and increase dividends in the near term.

Deutsche Bank is another broker that is wary of the outlook for the rest of the year. Price pressure will increase with the rollout of competitive bidding in the US and the mix of sales is likely to adversely affect margins. While earnings growth is expected to be modest in FY16 the broker expects a return to double digit growth in FY17, supported by a weaker Australian dollar.

Morgans remains confident that the September quarter marks a nadir for earnings and momentum should increase throughout the rest of the year. Sales outside the US maybe affected by the disappointing SERVE-HF trial (ASV product), but the impact is limited and should not detract from growth. Strong US flow generator uptake and continued strength in masks means the company should beat market growth rates and the broker expects the company to maintain its market leadership across the segment.

FNArena's database has four Buy ratings, three Hold and one Sell (Macquarie, yet to update on the quarter). The consensus target is $8.48, signalling 8.3% upside to the last share price.
 

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