Australia | Jan 31 2024
This story features RESMED INC. For more info SHARE ANALYSIS: RMD
By Rudi Filapek-Vandyck
What a difference five months can make!
In August last year, global CPAP market leader ResMed ((RMD)) released a rather uninspiring financial update, showing yet again a gross margin under continued downward pressure. Healthcare post covid was in a struggle, globally, to rid itself of the post-pandemic negatives and ResMed's market update revealed the timing of the turnaround lay even further into the future.
Soon after the initial share market punishment, hedge funds started targeting the shares in a global quest to seek out the losers from ultra-successful GLP-1 diabetes/weight loss drugs developed by Novo Nordisk and Eli Lilly. As the world woke up to the fact these modern day 'wonder drugs' promised to eradicate obesity -exact timing unknown- the ResMed share price kept falling, and falling, and falling.
What had previously looked like a volatile journey in between $30-$40 post 2021 had now become a rapid descent into the low $20s. At least one analyst suggested the board should look into pulling up stumps and distribute all the liquidity it could muster to suffering shareholders (more on that below).
ResMed, one of the best performing stocks on Wall Street and locally throughout the prior decade, had met its Waterloo. At least such was the narrative dominating opinions and debates on social media. Add technical analysis-inspired forecasts and it now was pretty much guaranteed; the race to zero had begun.
What a shame! It had looked like such a great success story for such a long time. Every journey must come to an end, eventually.
Fast forward to this week, the release of December quarter financials suggests the death of ResMed's growth story had been grossly exaggerated. ResMed's quarterly financials (the shares are listed in the USA) showed a continuation of robust growth but, most importantly, this time growing sales and services came with a notable jump in the gross margin.
The negative trend that had persisted for six quarters in succession has now been broken. Analysts have been busy remodeling a higher gross margin and what it means for the quarters/years ahead. Company management is confident the gross margin will not only not return to last year's level, but it will further improve over the years ahead.
And the share price? The price is back to where the shares were trading when hedge funds initiated their attack. Yesterday's close just under $29 galvanises a great return for those who acted against the prevailing mood that depressed the shares into the low-$20s. It's not inconceivable at least some of those relatively fresh shareholders are now thinking about securing their windfall.
The return of margin confidence has led to upgraded EPS growth forecasts (in USD) of respectively 18.4% and 21.5% for this financial year and next. FNArena's consensus price target lifted to $33 from $32.22, suggesting, all else remaining equal, there's still plenty in the tank for those who stay put.
The one key factor that had gone missing, albeit temporarily, post August last year is the global sleep and respiratory care markets are huge, and penetration by the likes of ResMed remains benign. It is estimated no less than 424m people suffer from severe sleep apnoea, another 340m people battle with asthma and another 380m with chronic obstructive pulmonary disease, or COPD, a group of long-term lung conditions.
Diagnosis levels remain low with the most-developed sleep market, the US, only having a 20% diagnosis rate. This is why a company like ResMed should continue to enjoy an elongated runway of continued growth. In response to the freshly emerged GLP-1 threat, management has countered those anti-obesity drugs actually support an increase in awareness and diagnoses, which should only prove to the benefit of CPAP providers.
Reading through analysts' updates post this weeks market update, some are toying with the idea ResMed management might be onto something here. Maybe GLP-1s and CPAP are the combination made in heaven for new patients, at least in the initial phase of treatment?
The future will tell. Meanwhile, the vast size of the opportunity that resides with obseity and all its treatments and related devices remains a significant attraction for the pharma industry so don't expect any pause in the efforts from Novo Nordisk, Eli Lilly, and their peers, to command their share. But at least the market at large has come to the understanding this is a far more complex situation, not an instant winners-take-all set up.
And yet, this is not the full extent of this saga just yet…
ResMed's major competitor, Philips of the Netherlands, is in deep struggle street. Gone are the days when Philips and Sony battled for global domination in consumer electronics. Nowadays my former colleagues in the Dutch media are publishing in depth analyses with titles such as: Where did it all go wrong?
Philips' troubles extend into its healthcare operations, including CPAP and other medical devices. Philips has not been able to sell its Respironics competing devices in the lucrative US market since 2021. Oddly enough this too has weighed on the ResMed share price as investors worried Philips upon return would possibly start price discounting in order to regain lost market share.
That prospect has yet again been dealt a blow this week with Philips and regulatory authority FDA agreeing Philips will not sell any new CPAP or BiPAP devices in the US for longer. Respironics will only service and support existing patients. Most analysts had been incorporating the Philips market re-entrance in their modeling from early 2024 onwards.
Philips' announcement coincided with the decision to slim down its suite of products and services. CPAP machines have not been abandoned, and the company continues to sell them outside of the USA, but at least one team of analysts can see a scenario of Philips simply throwing in the towel and concentrating its efforts (and future investments) elsewhere.
Under the FDA agreement, any re-entrance into the US market will be spread out over multiple years.
Before problems started that led to the recall of millions of breathing devices and ventilators three years ago, Philips/Respironics had a market share in excess of 30% in the US. Analysts now assume the market share recovery will stop at 20%. ResMed should grab, and hold on to, the majority of the share permanently lost by the troubled Dutch-based competitor.
Incidentally, there's plenty of anecdotal evidence around the reputational damage done to Respironics' competing CPAP devices is large, and potentially permanent. New patients are overwhelmingly opting for ResMed, which, given the circumstances, should surprise no-one.
Analysts thus far have been hesitant to make bold statements about what this fresh development means for ResMed's outlook. Common logic dictates it can only be a positive, at least for the quarters ahead. Any additional positive, be it through an acceleration in sales or otherwise, has not yet been incorporated in current modeling.
The obvious observation to make from the sideline is that ResMed's fortune seems to have made a 180 degree turnaround incredibly quickly. As your stock standard Hollywood script writer would say: real life is much more surprising than human imagination.
And as far as that analyst advice from last year is concerned: clearly, there's more to share market research than doing the numbers and making numerical assumptions. In-depth knowledge about a company and its industry are simply a necessity.
Investors take note.
(Plus, I am sure, there are a number of lessons to be gained from this experience).
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