ResMed’s Margin Upside Excites

Australia | Aug 07 2024

Sleep treatment leader ResMed has faced a number of headwinds but has surprised analysts with a strong improvement in gross margins.

-ResMed's weaker mask sales offset by stronger device sales
-Gross margin improvement surprises to the upside
-Weight-loss drugs not seen as a major threat
-More capital management ahead

By Greg Peel

At the Margin

If it wasn't enough that investors had been scared away from ResMed ((RMD)) with the explosion of GLP-1 drugs (which treat diabetes but have the added benefit of reducing weight, therefore, in theory, reducing incidences of sleep apnoea), the effective closure of the Red Sea due to Houthi attacks on shipping significantly increased ResMed's freight costs to Europe.

Analysts have a different spin on the GLP-1 effect, which we'll get to shortly, but the highlight of Friday's result was a better than expected increase in gross margins, upon which freight costs are a drag.

A "miss" in device sales (vis a vis analysts' forecasts) was offset by a beat on mask and accessory sales, leading to an earnings result that either matched or exceeded analyst forecasts.

Gross margins lifted in the June quarter to 59.1%, well ahead of consensus, despite the freight headwinds. This was attributed to a range of offsetting margin tailwinds, including (i) manufacturing improvements; (ii) procurement initiatives; (iii) increasing scale benefits, such as overhead recoveries; (iv) manufacturing efficiencies as ResMed transitions to the AirSense11; (v) mix shift, in particular masks versus devices; and (vi) new product launches such as AirFit F40, with other mask launches to come.

In Jarden's view, there is further upside in gross margins as freight normalises, with the potential to move beyond pre-covid margins.

Furthermore, headwinds from elevated component costs incurred in prior periods continue to unwind, underwriting a stable to growing gross margin position for FY25-26.

While the Red Sea issue is not resolved, and freight cost headwinds will continue for now, gross margins are expected to lift in FY24 as mix, price and manufacturing efficiencies continue.

ResMed is guiding to a 59-60% gross margin in FY25, ahead of consensus, providing analysts with confidence.

Moreover, the miss on mask sales was not a great surprise given ResMed was cycling a 30% mask sale increase year on year.

Taking GLP-1s Head On

GLP-1s such as Ozempic have taken the world by storm as the ultimate weight-loss drug, even if that was not the original intention. But they are expensive, and if you stop taking them you put the weight straight back on. That is an impediment to begin with.

Obesity commonly leads to sleep apnoea, hence GLP-1s are seen as undermining ResMed's customer base.

However, the flipside is that increased attention to weight-loss has actually boosted recognition of sleep apnoea as a related problem and the availability of masks and devices to treat it.

While anti-obesity drugs could displace continuous positive airway pressure (CPAP) devices in some patient categories, suggests JPMorgan, the evidence to date continues to point to complimentary usage and higher CPAP adherence.

To that end, Morgans notes ResMed is aspiring to become a leading digital health "sleep concierge" by leveraging its strong data analytics around megatrends in consumer wearables and Big Pharma's focus on weight loss drugs, helping patients better access information on screening, diagnosis and treatment.