ResMed Makes A Comeback

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

ResMed’s December quarter showed long-awaited margin improvement and relieved market fears of the impact of weight-loss drugs.

-ResMed’s Q2 result receives applause
-Gross margin expansion the highlight
-Efficiencies should lead to further improvement
-Weight loss drugs may actually help, not hinder

By Greg Peel

In August last year, global pharma companies Novo Nordisk and Eli Lilly each rallied over 15% after data from a cardiovascular study suggested that GPL-1 weight-loss drugs not only reduced weight, but also lowered the risk of cardiovascular disease in obese patients.

Given the connection between obesity and sleep apnoea, the market assumed the rise of GLP-1s would lead to a fall in demand for ResMed’s ((RMD)) devices. The stocks subsequently lost over -25% of its value in a month.

The stock has since been quietly making a comeback as market panic subsided, and on a positive response to the company’s December quarter earnings result released last Thursday, ResMed has all but recouped those losses.

At the Margin

Analysts have long been waiting to see improvement in ResMed’s gross margin, which took a hit as a fallout from covid. As it was, the gross margin rose 90 basis points in the December quarter from the previous quarter to 57%, exceeding analyst forecast by 60-80 points or so depending on their forecasts.

While ResMed’s device sales grew 11% in the quarter (constant currency), and mask sales 9%, it was margin expansion that had analysts cheering.

There were three clear drivers of the expansion.

Firstly, ResMed implemented low to mid single-digit price increases last October, which showed up in the December quarter but will progressively benefit in the next few quarters, analysts suggest, as customers roll off their current contracts.

Reduced freight costs were a big contributor to margin expansion as ResMed transitioned to sea freight from air freight during covid disruptions. While there could be further freight savings ahead, management is cautious given sea freight costs have recently increased due to the Red Sea conflict and “long way round” diversions.

If there is an impact, it will not impact the current quarter.

Finally, manufacturing efficiencies made a contribution. The availability of the newer AirSense 11 mask is increasing, which will allow ResMed to phase out the AirSense 10. Analysts note the shift to one manufacturing line should improve efficiency of the production process and provide an opportunity for manufacturing optimisation.

Furthermore, ResMed reduced its selling, general & administrative expenses in the quarter and its R&D expenses, largely as a result of reducing its global workforce by -5%, mostly in non-SG&A activities. The company is instead planning to invest more in product innovation and increased brand awareness.

Ord Minnett, for one, believes this is a sound strategy to help further penetrate the market.

Overblown Threat

When ResMed’s share price initially collapsed on the emergence of GLP-1s, analysts were quick to call the response overblown. One reason is the drugs are expensive, and not a once-only cure. Rather, weight will return if one stops taking them.

Fast-forward to now and there is more reason to believe the impact will be minimal. In fact, the drugs may even work in ResMed’s favour simply by increasing awareness of sleep apnoea among the obese.

UBS points to recent data showing patients with a GLP-1 script and an OSA (obstructive sleep apnoea) diagnosis are more likely to begin CPAP (continuous positive airway pressure) therapy than those with just the OSA diagnosis. This has attracted investor attention and the company plans to present more analyses later, although clinical trials are not planned.

However, Eli Lilly has been conducting its SURMOUNT-OSA trial to assess the weight-loss effectiveness of its drug. Results are expected in April. Importantly, the trial is broken into two groups of patients – those using CPAP now and those not.

ResMed emphasised at its conference call that a combination of GLP-1 and CPAP is expected to emerge as the best solution. Data have highlighted that patients on GLP-1s are more likely to initiate CPAP therapy, which would lead to higher rates of adherence and resupply, Macquarie notes.

The bottom line is a combination of GLP-1 and CPAP therapy is expected to bring better results than substitution of CPAP with GLP-1.

Management also noted that even when assuming the drugs will reduce sleep apnoea by -15%, there will still be over one billion people in the global addressable market by 2050.

Competition

Also hanging over ResMed’s outlook for some time now has been the anticipated return to market of Philip’s competing mask. Yet as time has gone on, that timeline seems to always move out further.

In the meantime, ResMed has improved market share. This is unlikely to be eroded by the return of Philips, most analysts believe, and at this stage the US FDA has requested supplementary testing on the recalled CPAP machines.

What’s more, ResMed has received regulatory and reimbursement approval for a new mask offering, with a market launch expected “soon”.

Citi nevertheless plays a cautious line, forecasting a rebasing of the CPAP device market over several years combined with Philips gradually regaining around 20% market share, stealing some 10% from ResMed.

Broker Views

ResMed’s result has seen brokers rush to upgrade their earnings forecasts, with increased revenues and margin expansion expected to continue.

There are six brokers monitored daily by FNArena covering the stock. Five already held Buy or equivalent ratings, although two are yet to update. UBS is the loner with a Neutral rating. The consensus price target has increased to $33.04 from $32.23.

(Note: UBS quotes a target in US dollars, and is thus not included in the consensus measure.)

Among brokers not monitored daily, Jarden has increased its target to $31.2 from $30.13 and retains Overweight.

Wilsons has increased its valuation by 4%, and set a target of $31.29 (last $30.00 in November). Wilsons retains Overweight.

Goldman Sachs has upgraded its forecasts and retains Buy, alongside a target of $33.50.

Elsewhere, RBC Capital has raised its price target by one dollar to US$182 while rating the US-listed shares as Sector Perform.

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