The Focus For ResMed Returns To Sleep

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Has demand for ventilators stemming from the pandemic run its course? The main issue for ResMed in the near term is whether a reduction in ventilator sales will be countered by a recovery in its sleep business.

-Stock outperformance suggests much upside is factored in
-Re-supply sales in the US remain robust and policy favourable
-Long-term drivers of demand for OSA masks intact
 

By Eva Brocklehurst

As the coronavirus pandemic took hold, the flurry of demand elevated sales of ventilators for ResMed ((RMD)) but this was countered by a sharp drop in sales from its core sleep (OSA) business.

Demand from the pandemic has now run its course, several brokers assert, so the focus is on servicing the traditional OSA market. However, depressed economic conditions are likely to mean sales will grow at a slow rate. The company also expects ventilator benefits will be significantly lower in FY21. The issue is the extent to which ventilators and OSA sales balance out over the months ahead.

Pandemic-related ventilator sales contributed US$125m to the fourth quarter but this was partially offset by double-digit declines in sleep apnoea diagnosis. Cost growth was slower in the fourth quarter and this offset the weaker revenue although ResMed was able to deliver 9% top-line growth and 40% growth in earnings per share.

Morgan Stanley expects the company will emerge from the pandemic in a stronger position but this has been encapsulated by the more than 40% outperformance in the stock in the year to date. Hence, the broker downgrades to Equal-weight.

Nevertheless, the company will remain a beneficiary from its connected care and cloud-based strategies. Strong demand for ventilators has meant a tripling of production capacity while mask and re-supply sales associated with OSA have been strong in the US.

Wilsons' modelling suggests the balance between excess ventilator demand and sleep volume deficits may continue favourably at the sales line over the next three quarters before becoming normalised in the fourth quarter of FY21.

Yet, compared to management's commentary in mid-June the main detraction, in Goldman Sachs' view, is confirmation that in-patient sleep laboratories are still operating at around -30% below pre-pandemic capacity.

The broker now forecasts a mismatch in the second and third quarters, when the recovery in OSA will not compensate enough for the loss of ventilator demand, and does not envisage sustainable tailwinds from the pandemic beyond the first quarter of FY21.

That said, the foundation for revenue is coming from re-supply programs and the broker emphasises OSA dynamics are robust. Around 80% of US mask growth is generated by existing patients and this has proven resilient.

Citi believes it is worth taking a closer look at the role ResMed and peers have played in supplying the world with ventilators during the pandemic. ResMed increased ventilator production by 350% in the second half but, of course, with the disruptions to people's lives the underlying OSA business was negatively affected.

Over time, Citi believes ResMed can continue to gain market share at the expense of competitors and the pricing environment is benign, while industry growth is expected to return in FY22.

Beyond Pandemic

Beyond this pandemic, competitive bidding in the US remains a downside risk but the broker envisages upside includes accelerated market growth from the return of previous OSA patients, a profit contribution from Propeller Health and increased penetration in the COPD (chronic obstructive pulmonary disease) market.

Long-term prospects could be enhanced, Morgan Stanley acknowledges, by the accelerated adoption of remote patient monitoring programs. Through channel checks with US-based CPAP (continuous positive airway pressure) suppliers, the broker assesses demand was strong at the beginning of the year but from April it started to slow.

Still, re-supply to existing patients should continue where they are able to be serviced remotely and receive items through the mail. This suggests that mask sales are more insulated from the slowdown in new patients compared with devices. Moreover, US policy remains favourable in terms of ensuring the financial and operational viability of long-term post-acute health care settings.

Credit Suisse does not forecast CPAP sales returning to pre-pandemic levels until the third quarter of FY21 as further lockdowns are likely in some markets over the next six months.

The broker concludes that despite the business being well-placed to benefit from any behavioural shift after the pandemic, and potentially greater demand for home health care, a protracted recovery in OSA diagnosis, reimbursement pressure and potential for oversupply of ventilators keeps it on a Neutral footing.

Ord Minnett, too notes, while a recovery is evident across major markets the emergence of a second wave of coronavirus in many countries could hamper a return to historical levels.

Re-supply infrastructure performed well during the pandemic and US mask sales held up. However, outside of the US, sales were well below forecasts. Ord Minnett attributes this to the smaller installed base and less-developed re-supply infrastructure.

Gross Margins

ResMed has not provided specific gross margin guidance but expects a decline in the short term. Credit Suisse anticipates a drop in gross margin of -70 basis points in FY21 because of weaker product mix and higher freight charges.

UBS agrees a more rapid decrease in pandemic-related ventilators sales amid ongoing pressure on CPAP sales growth will result in the slightly lower gross margin outcome.

Despite curtailed contribution from higher-margin ventilator sales and short-term pressures from limited in-lab sleep diagnostics, the drivers of longer-term growth are intact, although the broker considers the growth outlook is currently reflected in valuation.

Morgans is more upbeat and remains confident in profitable growth, believing the low single-digit revenue growth in July spooked the market and this is a temporary setback as the outlook is robust beyond the first half. The broker believes there is upside potential from vaccines and therapies related to the pandemic, while anticipating a gradual improvement in new patient diagnoses for sleep apnoea.

Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, has an Overweight rating and $28.55 target while Goldman Sachs, also not one of the seven, downgrades to Neutral with a target of $26.40. The database has one Buy (Morgans), four Hold and two Sell ratings. The consensus target is $24.96, suggesting 2.7% upside to the last share price.

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