Patent Dispute Hinders Fisher & Paykel Healthcare

This story features FISHER & PAYKEL HEALTHCARE CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: FPH

Fisher & Paykel Healthcare has signalled robust growth in its hospital applications but remains hindered by a patent dispute with ResMed.

-Litigation moves to ITC, suggesting higher risk in the outcome
-Nasal high-flow oxygen therapy driving growth in hospital applications
-Trump ascendancy flags potential issue for Mexican manufacturing
 

By Eva Brocklehurst

Fisher & Paykel Healthcare ((FPH)) delivered a strong first half result, upgrading guidance and signalling robust growth in its hospital applications. Yet the company is hindered by a patent dispute with ResMed ((RMD)), which could put a dampener on the stock until it is resolved.

First half net profit was up 26%, and 3% ahead of guidance. Hospital growth was 23%, although this included a pricing and inventory benefit. FY17 guidance has been upgraded to NZ$165-170m in net profit at a USD exchange rate of NZ70c.

Deutsche Bank downgrades to Hold from Buy following a detailed review of the risks around the action in the International Trade Commission regarding the company's litigation with ResMed. The ITC action appears to have both higher risks of a worst-case outcome and an outcome that is likely to come much sooner than previously expected. The broker's review of the process and case history suggests that, via this avenue, the risks are significantly greater than through the US courts.

While the stock remains an attractive long-term growth story, the significant uncertainty means the broker does not believe the risk/reward balance is attractive. Deutsche Bank applies a 20% discount to its discounted cash flow valuation pending resolution of the process in the ITC.

The company has suggested costs associated with the patent infringement dispute would put upward pressure on expenses, but this would be offset by efficiency gains. The company now expects general and administrative expenses to grow in line with sales, as opposed to its previous expectation that growth in these expenses would be restricted to 1% below sales.

Macquarie adopts the new guidance and, for the sake of conservatism, does not incorporate a subsequent step-down in expenses after the conclusion of the dispute. The broker notes the stock has been caught up in the sell off of high-multiple stocks and is now trading on 25 times next year's forecast earnings. This significant premium is warranted in the broker's view, given double-digit growth rates and strong market position in hospital humidification, and an Outperform rating is retained.

The headline numbers impressed UBS, being slightly ahead of its estimates, although this was largely because of the greater than expected benefit from the internalisation of US distribution. The 24% constant currency revenue growth in home care was below UBS estimates, reflecting a maturing of the market share gain in obstructive sleep apnea (OSA) masks.

Despite downgrading earnings estimates by 3% for FY18 and FY19, the broker observes net profit growth remains strong at 16% and 20% for FY17 and FY18 respectively, driven by constant currency revenue strength and earnings margin expansion. UBS retains a Neutral rating because of the heightened risk associated with increasing competition in OSA and the patent infringement cases.

In the medium term, the broker envisages solid market growth prospects for OSA and increased manufacturing offshore, underpinned by growth in earnings per share. The broker also notes comments from US President-elect Donald Trump raise the prospect of tariffs on Mexican imports if the North American Free Trade Agreement cannot be successfully re-negotiated.

If this scenario were to occur without exclusion for medical devices, UBS believes it would then take out the cost benefits for the company from its Mexican manufacturing facility. The imposition of import tariffs could incite changes to the company's supply chain, with manufacturing of US-related product shifted back to New Zealand and manufacturing of products for the rest of the world remaining in Mexico.

Use of nasal high-flow oxygen therapy has been the driving force behind the growth in new applications in hospitals and now accounts for around 30% of the company's total revenue. Citi believes this therapy has significant room to grow for a number of reasons. It is currently used in intensive care settings but expansion to other emergency, surgical, medical and respiratory wards will significantly widen the addressable market.

Fisher & Paykel has been a high-flow pioneer and enjoys significant first-mover advantage. High-flow is better tolerated by patients, largely because the mouth is not covered and the patient can talk, see clearly and eat easily.

Citi also believes the unwinding of the yield trade poses a risk for high-multiple stocks. This is somewhat offset by a corresponding currency benefit for Fisher & Paykel Healthcare. Despite its rich price/earnings multiple the broker believes the stock is attractive, given the growth outlook for earnings per share.

Nevertheless, the broker expects the share price will be more volatile as it responds to news flow. The broker has no basis for preferring one company's position over another in the patent dispute and continues to expect a negotiated outcome.

While the results highlight the strengths of the company's business model, Credit Suisse believes these are well understood and should be balanced against the tailwinds that are now fading on some fronts. The stock is now trading at a level which the broker believes is fair value and more commensurate with the risks. Credit Suisse retains a Neutral rating. There are two Buy and three Hold ratings on FNArena's database.
 

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