Better Sales To Flow For ResMed In FY18

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This story features RESMED INC, and other companies.
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Sleep disorder specialist ResMed has revealed supply constraints and costs held back revenue, margins and operating income in the March quarter.

-Pressure on gross margins may continue beyond FY17
-Once back-order issues are resolved sales are expected to accelerate
-New products well received and outlook for sales momentum is robust

By Eva Brocklehurst

Sleep disorder specialist ResMed ((RMD)) revealed manufacturing problems caused supply constraints to continue in the March quarter, while increased freight costs affected revenue, margins and operating income.

US devices were unable to maintain strong growth momentum, although the company's market share held up. ResMed reported softer US growth versus broker expectations with a stronger March quarter in the rest of the world.

Gross margins were slightly softer than forecasts, at 58.3%. Nevertheless, brokers agree category weakness appears to be diminishing and new product acceptance is strong.

Margins

The softer gross margin shows a continuing impact from manufacturing issues, Citi contends, which may potentially persist into the first quarter of FY18 and constrain growth.

The broker downgrades to Neutral from Buy, as the shares are up over 20% for the last 12 months, and are now trading well above three-year average valuation multiples. The broker considers the stock fairly valued.

Morgan Stanley believes it is too early to expect recovery in gross margins and this will be delayed until the first quarter of FY18. Once back-order issues are resolved, the broker envisages resupply sales will accelerate and reverse the negative gross margin trend, driving positive revisions to earnings per share.

This expectation is supported by the large installed base, which is growing on the back of AirSense 10, the uptake of AirFit FY20/N20 and a benign US reimbursement environment as competitive bidding winds down.

Where Morgan Stanley differs from many other brokers is on the expectation of a delayed uplift to gross margins that will be offset by maintenance of good growth in high margin sales and the rest of the world. Netting off the effects means the broker revises down FY17 forecasts for earnings per share by -2.5%, makes little change to FY18 and a 4% increase to FY19 estimates.

In the broker's opinion, Brightree should insulate the company's market share and underpin a higher re-supply business. The broker expects gross margin to improve to 61% in FY19. The main risk is if this fails to emerge and there has been a structural change, given the length of time that margins have been depressed.

Credit Suisse estimates gross margin expansion organically of around 40 basis points should be forthcoming because of an improved product mix, while operating cash flow should improve following the recent build-up in inventory. This, in turn, should support a resumption of the buy-back program and the broker assumes this commences in the first quarter of FY18.

Risks And Catalysts

Potential catalysts, Credit Suisse believes, include the launch of the AirFit P20 mask and full resolution of the AirFit F20/N20 mask supply constraints. The risks in this broker's view include protracted litigation with Fisher & Paykel Healthcare ((FPH)) and discounting by competitors in order to stem their market share losses.

Morgans does not envisage cause for concern regarding the decline in devices growth in the US, believing it unreasonable to assume a strong trajectory should be maintained for over nine quarters.

The broker is encouraged by the fact the category is tracking the market and the company has not lost market share. Overall, Morgans remains comfortable that the earnings trajectory is increasing. UBS finds no meaningful clarity from the results regarding the launch of the new AirFit 20 mask, suspecting a clear trend may not be apparent until FY18.

Likewise, a weak number for flow generators during the quarter should be offset in FY18 by the launch of Air Mini, as the broker believes this new device will be a strong means for distributors to up-sell. The broker believes the AirFit 20 should drive material and compounding sales momentum.

While there is good evidence from the new ranges in masks that the company's product has been well received, Ord Minnett is inclined to remain on the sidelines at current levels in the stock, given the failure to deliver the expected boost to gross margins from higher margin products in the quarter.

This could largely reflect a sharp change in geographic mix or currency headwinds but has led the broker to become more cautious about the expected boost to earnings from a lift in masks sales.

A sharp slowing in US device sales was also disappointing for the broker and suggests that the second quarter included some sales being pulled forward, along with the usual price erosion associated with re-setting contracts in January. Given modest upside in the stock Ord Minnett maintains a Hold rating.

FNArena's database shows four Buy recommendations and three Hold. The consensus target is $9.62, suggesting 4.6% upside to the last share price. Targets range from $8.50 (Macquarie, yet to update on the quarterly) to $10.23 (Morgans).
 

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