-Pathology growth robust
-Health insurers most attractive
-Private health sector growth assured
 

By Eva Brocklehurst

Australia's government may have changed ship in September but in the health care sector private provider relationships with the public sector appear on firm ground, underscoring brokers' revenue projections for the year ahead. Moreover, little risk is seen to health insurance levels or the consumption of health-related services, given the population continues to age.

August Medicare data has revealed 12-month growth in total pathology benefits was 6.2%. Given the volatility in the monthly Medicare data, tracking market share movements is problematic but Citi suspects Primary Health Care ((PRY)) is gaining market share at the expense of Sonic Healthcare ((SHL)) and Healthscope. GP benefits growth continues to remain strong and this is supportive of Primary, given the relatively high level of operating leverage in its medical centre business.

Rolling 12-month growth in diagnostic imaging benefits was 7.0%, in line with the FY13 growth of 6.9%. Pathology fee cuts are likely in the second half of FY14 to bring outlays back in line with the revised targets agreed under the Pathology Funding Agreement. Healthscope noted during its FY13 results that discussions with the government for pathology fee adjustments have already commenced. Citi factors in a 1% funding cut in Primary and Sonic forecasts, starting in January 1 2014, half of which is offset by cost reduction initiatives.

The August growth rates across these services was robust, in Credit Suisse's view, and this augurs well for both Primary and Sonic in the short term. The key item for the broker is the funding agreement, as spending was 4.2% ahead of the agreed cap in FY13. The quantum of any fee cut remains difficult to predict because of the recent change in the federal government. For Sonic, in particular, there could be a bigger headache coming from the US market with regard to both volume and price. In Australia, GP attendance growth is robust but Credit Suisse questions whether a changing workforce demographic - a large proportion of GPs working fewer hours per week - could produce difficulties in sustaining the current operational metrics.

Where Credit Suisse urges caution is in interpreting Medicare data. The data is extremely volatile and broker believes it is important to rely on trends rather than monthly figures. Medicare is not the only provider of revenue for pathology providers. Other sources include patient co-payment, third party and workers compensation claims, veterans payments and privately billed tests for which there is no scheduled fee. In terms of funding outlays, not all Medicare payments go to private providers. A hospital lab providing the tests/service can also receive the funds.

On most income measures, the health insurance segment is more attractive than hospitals but it's hard to foresee any major problems overall, in Macquarie's opinion. The measures Macquarie uses to compare the two include return on investment capital (24% versus 12%), 10-year earnings growth (16% versus 10%) and the potential for a capital windfall (significant versus zero). Macquarie conducted an analysis of the sector and found variability across hospitals was also significant, with Ramsay Health Care ((RHC)) well ahead of the industry average on most metrics.

It has been speculated that insurers are taking issue with excessive price demands from hospitals but Macquarie doesn't expect any pressure in this area will be lasting. Hospitals generate pre-tax returns on capital of only 11.6% and costs are already comparatively low and slow-growing compared to the public hospital system, or indeed OECD peers. The relationship with the government means regulatory risk for hospitals is low and the expanding private system helps promote savings, given the government pays around 27% of the cost of private volumes as opposed to 100% in the public system. Hence, Macquarie continues to expect the private system will receive a disproportionate share of future growth in health care volume.

Macquarie thinks it's unlikely that the drivers of Australian health care growth will fade away. The population continues to age and become more health conscious. Affording that health care could be a concern. Health insurance policy inflation has averaged 6.5% since 2002 and, in the current weak economic climate, affordability issues are often raised. The 2012 removal of the rebates for holders of private insurance whose income was above revised limits and the indexation of the rebate for those who still receive it made affordability more of an issue, but it's still not major in Macquarie's analysis. Whilst there is evidence that means testing drove some policy downgrading, the quantum of the impact was relatively small. Hence, the broker is not worried about affordability and policy downgrades. Policy inflation above the CPI cannot continue indefinitely but on the other hand there is little risk of widespread downgrades. This is because of low policy churn and low price sensitivity.

On another aspect of the sector, CSL ((CSL)) has revealed some developments in product approval. The blood products provider has progressed with Hizentra, a 20% immunoglobulin therapy that is subcutaneously delivered, having been granted approval for the treatment of primary and secondary immunodeficiency by Japanese regulators. CIMB views the market opportunity as incremental and less than US$100m while uptake is likely to be protracted, given the modest estimated patient population and parochial nature of the Japanese market. Together with slowing earnings growth and a developing haemophilia portfolio, which has greater earnings volatility,  the broker believes the upside is limited for the stock at current trading levels.
 

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-Solid boost to earnings expected
-Stronger synergies and positioning
-Further German consolidation seen
 

By Eva Brocklehurst

Pathology provider Sonic Healthcare ((SHL)) has expanded its presence in Germany with the acquisition of five regional laboratories. Brokers were not surprised, as management had flagged an intention to pursue more acquisitions at the FY13 results briefing in order to exploit such opportunities.

Deutsche Bank expects this expansion should boost earnings and returns, with Sonic also benefitting from improving operations in the rest of Europe and Australia as well as from cost cutting in the US. A weaker Australian dollar adds a fillip too. The purchase price is EUR76m, equating to around $110m. The operations are in the west/south-west of Germany, where Sonic is lightly represented, and are being purchased from France-based Labco's private equity owners. The business has faced operating challenges in recent years but it generates revenue of EUR53m. Deutsche Bank does not expect Sonic will have a problem with competition regulators because there's only a small geographic overlap with the company's existing business. Sonic has a strong history of integrating laboratory businesses and this should be relatively straight forward, in Deutsche Bank's view.

The FNArena database also presents a solid picture. There are three Buy and five Hold ratings. The consensus price target is $16.50, signalling 1.8% upside to the last share price. The range is $15.23 to $18.00. The consensus target has moved from $16.18 ahead of the announcement. There is a 4.3% dividend yield on FY14 earnings forecasts and 4.7% on FY15.

Deutsche Bank estimates the acquisition will lift Sonic's German revenues by around 12% and boost earnings by 3% in FY15. The broker sees little risk to these forecasts given Sonic's good track record in Germany and its extensive experience with integrating acquisitions. JP Morgan thinks the company's track record on delivering returns from acquisitions has not been speedy, particularly when it comes to the US. Nevertheless, in terms of margin improvement, in Germany the record has been impressive. JP Morgan has stated a preference for the acquisitive behaviour to stop, because of the dilution to the returns on invested capital, but in this particular case there is merit in the extra scale, which could provide a buffer to any future funding pressures in Germany.

This pathology funding environment presents the most risk to brokers' evaluation of Sonic. There is considerable uncertainty in Germany and it's not clear if further adjustments will occur beyond the first half of FY14. The market is ripe for further consolidation. Ongoing funding pressures are likely to put smaller operators under significant financial pressure. In Citi's view this should benefit Sonic. Nevertheless, the risk to reimbursement and lack of clarity on funding means accurately pricing such acquisitions can be more difficult. Germany has advantages in its infrastructure and the potential synergies are high so this should be a source of earnings upside and potential share price improvement for Sonic, according to Citi.

A strategically sound purchase, was how Credit Suisse described it. There are obvious synergies and, while the market share issue may be of concern in one of the regions, it should not be enough to hamper the deal. Financial details were not disclosed but the broker estimates that, assuming Labco generates a 15% earnings margin, pre-synergies, the implied multiple is around 9.5 times. Credit Suisse would expect Sonic to double the current margin because of physical asset rationalisation and the procurement benefits that come with a bigger grouping. Credit Suisse deems the earnings accretion, at around 5% in FY14 and 3-3.5% beyond, as modest, but helpful.

CIMB also liked the deal and think this is a well-positioned acquisition with multiple earnings drivers. Moreover, it does not stretch trading levels. The acquisition would take Sonic to around 13% of the EUR3.5bn market in Germany and, hence, it is unlikely to raise the ire of regulators. UBS describes the acquisition as compelling. Labco appears to have had some losses to market share in recent years but Sonic has assured the broker that this has stabilised. UBS' channel checks have suggested there is likely to be a further 8-10% reduction in the rates paid under the German EBM into 2014 but this largely represents a flat year-on-year fee and the underlying volume growth should contribute to Sonic's operations.
 

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-Diverging outlook for health stocks
-Organic revenue growth vs acquisitions
-Cochlear under pressure
 

By Eva Brocklehurst

Outperformance is showing its age, that's the message CIMB is receiving from the healthcare sector. The stocks that make up this sector have been widely seen as defensive yield plays but cracks are starting to appear in this picture.

What is driving brokers to review the area is the prognosis for global growth. The mixed signals as to whether the strengthening of the growth outlook will continue and the decision by the US Federal Reserve to continue economic stimulus will underpin the sector for the time being, but CIMB contends that there is an increasing shift to stocks that offer better prospects for earnings momentum and capital appreciation. This should limit further gains, or at the least make them harder to win.

CIMB has moved the sector to Underweight but continues to advocate stock selection in lieu of sector allocation because of the diversity of business models. What's the broker's top picks? Top for CIMB is Primary Health Care ((PRY)), ResMed ((RMD)) and Sonic Healthcare ((SHL)).

ResMed has to deal with challenging industry dynamics but CIMB thinks margin stability will enable the company to offset the pressures it faces, hence the broker retains an Outperform rating. Goldman Sachs is on the same song sheet with regard to ResMed and adds the stock to its Buy list, expecting double digit earnings growth in FY14 given a positive shift to higher-value devices, new patient acquisitions and a focus on costs. The broker divides ResMed, along with CSL ((CSL)), Ramsay Health Care ((RHC)) and Cochlear ((COH)), as those with faster organic revenue growth, from Ansell ((ANN)), Primary and Sonic. Over the past five years, this faster organic revenue growth has partly driven the stronger growth in value and returns. What is notable also is that these faster growing companies received relatively little boost from acquisitions.

Goldman adds CSL to the Buy list for these reasons and expects earnings in each of the next three years will be supported by strong organic revenue growth, market demand and further share buy-backs. CIMB is more neutral on CSL, suspecting that, while the operating environment remains favourable and sentiment is positive for Australia's largest biopharmaceutical company, the moderating and evolving product pipeline is likely to pressure earnings over the medium term.

Goldman has downgraded Ramsay to Neutral given a lack of valuation support. Deutsche Bank is also muted on the stock, but has observed the UK Competition Commission's report on the UK private healthcare market, due next year, is unlikely to be material for Ramsay. Ramsay's competitors will probably be forced to sell hospitals, so maybe there's some developing opportunities, but it will be hard for Ramsay to take out a larger competitor. Deutsche Bank does not expect Ramsay to bid for any of the NHS hospital operating contracts currently in tender, given the restrictive terms of the proposed arrangements.

Cochlear has suffered from strong currency headwinds as well as product recalls and market share erosion. CIMB rates the company as Underperform and thinks competitive pressures, slower sales and growing reliance on emerging markets as well as adult patients bodes for increasing volatility. Deutsche Bank has decided that, because the company missed out on the latest Chinese tender, it's time to downgrade the rating to Sell. The tender miss is considered symptomatic of the increased competitive pressures Cochlear faces. While the N6 offers the potential for some differentiation, the broker doubts this will be evident in the near term given the staggered US regulatory process. Goldman also expects slower growth at Cochlear but thinks processor upgrade sales should trend up strongly in FY15, once the fully featured product enters the market.

Of the slower growing companies that Goldman outlines - Primary, Ansell and Sonic -- Primary's organic growth is seen as being too modest. This is partly from run-off of Symbion GPs, partly from pathology fee cuts and partly from a change in revenue recognition in the radiology division. The broker notes strong revenue growth has come largely from the Symbion acquisition that was made in 2008. CIMB takes a different tack and thinks Primary's operation will continue to improve, as Australia’s largest private medical centre operator and a major pathology provider benefits from GP productivity gains. Primary remains one of CIMB's top picks.

CIMB thinks Ansell will continue to suffer volatile earnings and the company's softer FY14 outlook is considered an accurate barometer of a turbulent future, rather than simply being conservative. Goldman also observes that Ansell has relied heavily on acquisitions to augment what the broker describes as sluggish organic growth.

Sonic has made a significant number of acquisitions over the years, such that its overall revenue growth was more in line with the organic growth achieved by the faster growing companies, according to Goldman. The broker has decided to downgrade Sonic to Sell. Without acquisitions, Goldman can find few positive catalysts for Sonic in FY14. CIMB goes the other way, listing it as a top pick and comfortable that the pressure surrounding global fee adjustments can be overcome. Relative trading levels also point to further upside for the stock, in CIMB's view, with the shares trading at forward price/earnings of 1.08 times.
 

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-Increased R&D spending justified
-As long as there's sales and margin growth
-Guidance looks achievable

By Eva Brocklehurst

Blood product company CSL ((CSL)) proved resilient in FY13. The numbers had both hits and misses but what pleased most was the ability to gain market share and expand margins. Brokers are happy with the increased research and development spending (R&D) as long as margin expansion and sales growth of current products remain robust.

Revenue was up 10%, net profit up 21% and earnings per share up 26%, driven by strong product growth in most categories - immunoglobulins up 9%, albumin up 28%, specialty products up 17% and haemophilia products up 2%. Helixate sales were the slowest growing of the major product group because of strong price competition in European tenders and patients being taken from existing therapy to participate in new trials for haemophilia drugs. CSL expects FY14 earnings growth around 14%, with profit a little slower at 10%.

The results held few surprises and this makes the stock attractive to Macquarie. Words like steady, consistent, reliable are proffered when describing CSL. The results missed Macquarie's estimates largely on the back of a stronger currency headwind and higher R&D spending but were made up for by the margin outlook, which is very favourable. UBS finds trading conditions continue to be favourable as global demand growth is robust and this implies market growth. Competitor Baxter's supply problems are expected to persist into 2014 and this will, on UBS' assumption, contribute to more market gains by CSL. UBS thinks CSL is collecting about 15% year-on-year volume growth in the CSL Behring division. UBS also rates structural margin gains as sustainable and has decided to upgrade to a Buy rating from Neutral.

CSL previously announced plans to add 11 new countries for its Privigen and Hizentra registrations and is also focused on product development around dose and labelling. There are two projects which may deliver yield gains of 0.2g-0.4g per litre and thus gains of 5-10% are plausible inside three years for UBS, with material upside possible. Albumin demand remains robust. For Citi, the positive aspects lie with immunoglobulin and albumin growth, tempered only by Baxter's supply constraints easing throughout FY14 and FY15. Specialty products could surprise on the upside if Kcentra and Fibrinogen are particularly successful. The negatives are that the haemophilia product is likely to remain somewhat of a drag, given increased competition, while the influenza business is challenged. R&D is set to increase materially to support late stage trials.

The latest result was affected by some one-off factors such as $30m from renegotiated pension plans and resolution of legacy contracts which won't be repeated in FY14. There was also additional sales of albumin to China because of inventory re-stocking with a new distributor. Albumin sales growth in Asia is expected to be more around the 15% mark in future. Plasma collection efficiency initiatives were also a positive in FY13 but this also may not be repeated in FY14.

Citi also is sceptical that the market share gains CSL made at the expense of Baxter in immunoglobulin will continue, at least at the same rate. Baxter indicated at its second quarter result that the US FDA had accepted the regulatory submission for the planned modification of the old LA fractionation facility, with shipments expected to begin in July. Baxter expects to increase production capacity through 2013 such that it will exit 2013 with immunoglobulin volume growth in the US at 6-8% per annum rate. On this basis, Citi thinks the market share gains CSL is currently enjoying in immunoglobulin will slow. Citi still thinks the growth outlook is solid but it will ease. All up, the broker was not swayed from a Sell rating, believing that on a risk reward basis in the sector, ResMed ((RMD)) offers almost twice the earnings growth on a lower price/earnings ratio.

UBS notes CSL has previously commented on the potential for acquisitions, but now appears to be more focused on investing in organic growth and R&D. CSL is not interested in purchasing earnings unless it comes with synergies, apparently. Credit Suisse thinks Behring will be the power behind the throne. It should continue to outpace market immunoglobulin growth because of the lack of competition and based on competitive pricing for Privigen in Europe.

BioCSL is not expected to deliver a near-term turnaround in earnings contribution. While a sale of the division may seem an obvious solution, contractual arrangements with governments regarding supply of flu antigen, such as in a pandemic, could prohibit this occurring in the short to medium term. Nevertheless, the broker thinks the company's guidance is achievable. Further ahead the potential value of the R&D pipeline is a clear winner for Credit Suisse.

Plasma fractionation accounts for around 85% of CSL's earnings and the remainder is from the manufacture and sale of influenza vaccines, distribution of pharma products in Australia as well as royalties on HPV vaccine sales globally.

On the FNArena database there are five Buy ratings, one Hold and two Sell. A consensus target of $66.55 suggests 3.6% upside to the last traded share price.
 

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-Least funding risk, best premium
-Handling of US cost cutting critical
-FX movements matter
 

By Eva Brocklehurst

How healthy is the health care sector?

Funding is the main risk for for nearly all stocks in the health care sector but robust demand, underpinned by an aging population, should ensure most report solid earnings growth in FY13. Deutsche Bank has observed companies with the least apparent funding risk continue to attract the richest premium, given the low risk to earnings, especially with the weakening Australian dollar. However companies currently grappling with reimbursement pressure emanating from the US offer the potential for greater outperformance, if the funding cuts can be managed.

Of those stocks that are reporting with a June year-end, Citi is seeing tough industry conditions in the offshore businesses to be the largest drag. Maybe more so than consensus estimates are factoring in. Currency considerations are also a major variable as most have offshore exposure. Here, any rally in the Australian dollar against the US dollar or euro is seen having a negative impact. Credit Suisse expects no surprises and less volatility in the June half than has been previously seen.

Cochlear ((COH)) is facing the risk of a multiple de-rating as its growth slows, in Deutsche Bank's view. The question is whether the company can turn around a sceptical broking community with unit sales growth and market share gains. Citi suspects consensus views are underestimating the negative impact of the continued roll of hedging gains, or overestimating the offset from cost improvement. Growth is developing regions also seems to be slowing, with a competitor now emerged in China. Cochlear's FY13 result posted yesterday was in line with consensus but only after June's profit warning. The company is reliant on the new Nucleas 6 device gaining traction and leading to upgrade sales, but US hold-ups may delay the release and cut into the window has for COH to move before peers.

No ratings changes flowed from database brokers post result, leaving five Sell and three Hold (or equivalent) ratings. Cochlear is expensive, most brokers believe, and could be ex-growth.

Citi retains a conservative view on CSL ((CSL)), due to report August 14, and is 2% below the market consensus for profits in FY14. The broker thinks market share gains from Baxter are likely to diminish, given Baxter's supply situation is improving. The stock boasts a 15% premium to Deutsche Bank's US dollar Discounted Cash Flow valuation and the broker thinks this is justified for the upside that's on offer from the company's target markets, robust earnings profile and potential for further capital management. Downside risks stem from pricing pressure in European markets and adverse FX movements. Credit Suisse also thinks the stock is undervalued and the current and potential markets under-appreciated. Moreover, the track record of being the best plasma fractionation company should be confirmed in the upcoming results.

Citi thinks consensus estimates for Ramsay Health Care ((RHC)), due to report August 29,  are overly optimistic for FY14. Citi is 8% below consensus. Consensus expectations for FY14 appear to entirely discount any negative impact from means testing of the PHI rebate in Australia, any continued drag from the offshore businesses, and/or any slowdown in the incremental earnings contribution from brownfield investments in Australia. If company guidance is more conservative at the results briefing, this may result in some modest negative consensus earnings revisions, in Citi's view.

Deutsche Bank names Ramsay as a stock where the least apparent funding risk deserves the richest premium. The broker has applied a 10% premium to DCF valuation to arrive at a price target and thinks upside risks are for higher-than-expected returns form brownfield expansion, private health insurance premium increases and potential acquisitions. Credit Suisse believes, despite headwinds from private health means testing legislation and the risk of consolidation in the industry, Ramsay should benefit from underlying demand for high quality private health care and this should drive volume growth.

Sonic Healthcare ((SHL)), due to report August 20, offers potential for outperformance, in Deutsche Bank's view, if those US funding cuts can be managed. Acquisitions in the second half may also have assisted the company to reach its target of 5% earnings growth. Citi also thinks the main source of surprise will likely be the performance of the US business and whether cost cutting initiatives have been, or are likely to be, sufficient to offset this. The performance of Germany may also be important, given funding reductions in that market.

Credit Suisse will scrutinise Primary Health Care ((PRY)), due to report August 14, for the operating metrics at the core medical centre division. GP attendance, revenue and head office costs should all influence Primary's earnings margin.

Further comments on new product performance in FY13 will have a bearing on Credit Suisse's valuation of Ansell ((ANN)), due to report August 20. The competitive advantage is in the company's R&D and intellectual property but if new products are not gaining traction this may be a sign that this advantage is waning. Citi surmises that strong sales momentum from new product launches will likely be required to achieve FY14 expectations, as end-market conditions remain subdued.

ResMed ((RMD)) having already reported, remains Citi's only Buy rated stock in the group. The broker's preference is for Primary Health Care over Sonic Healthcare given less downside earnings risk. Sell ratings are applied to Ansell, CSL and Cochlear because of excessive valuations. Deutsche Bank rates Sonic Healthcare as a Buy, because of the potential for outperformance if the funding cuts can be managed. The rest of the stocks referred to above rate a Hold in Deutsche Bank's view. Credit Suisse rates CSL as Outperform and Cochlear as Underperform. The remainder of those reviewed take a Neutral rating.

ResMed's fourth quarter revenue was up 11% on the prior corresponding quarter and US machine sales were again strong, while masks were weak. Revenue growth was enhanced by margin growth, and solid cash conversion has led the company to increase its dividend by 47%. Brokers such as UBS, Citi and JP Morgan have retained Buy ratings for the stock. Deutsche Bank has upgraded ResMed to Buy.
 

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-US revenue growth seen strong
-Many options to offset price pressure
-Further upside to share price seen
-Generous margin buffer
 

By Eva Brocklehurst

Sleep disorder equipment specialist, ResMed ((RMD)),  provided a number of inducements to look favourably on the outlook after a strong fourth quarter finished off FY13. This was the first full quarter since the announcement in January of round two of the US Medicare competitive bidding pricing. Pricing was seen by brokers as the most contentious issue in the latest results, and for FY14.

Management does not think the US competitive bidding issue will be a problem. US industry revenue growth is 6-8% and there's not much change expected either to price or volume. Moreover, ResMed has grown market share. CIMB's confidence has increased as a result, despite the challenging industry dynamics. Margin stability was seen in the result and this should enable management to offset pressures via such things as manufacturing efficiencies, shifting the mix of products and more volume-based deals. There are also benefits from the fall in the Australian dollar. Although the shares are up more than 10% from lows last month the broker sees further upside potential as trading levels are not too demanding. CIMB upgraded the rating to Outperform from Neutral.

It was a solid set of numbers, in most broker opinions. Fourth quarter earnings per share was up 18% year on year and 7.2% quarter on quarter. Revenue was up 11% year on year. US sales were up 11% and the rest of the world up 12%. Earnings margin at the EBITDA level improved by 40 basis points to 31.5%, while a tax rate of 20.7% (excluding the University of Sydney payment) was better than CIMB expected (21.2%).

Deutsche Bank's confidence was also boosted. The broker noted the accelerating trend to home sleep testing (boosting market growth and mix), the impending benefits from new mask launches, the growing importance of the ventilation range and the tailwind from the falling Australian dollar. The first quarter of FY14 will contain the acid test but the results do allow for revision to earlier cautious assumptions with regard to competitive bidding round two. Deutsche Bank lifted earnings forecasts by 6% for FY14. Given the growing upside risk to earnings the broker moved the recommendation to Buy from Hold.

For Credit Suisse, operating cash flow generation stood out, with a reduction in the days inventory a key contributor. While the broker suspects the full impact of round two of competitive bidding is yet to be seen, as some small durable medical equipment (DME) enterprises could struggle to remain profitable, disrupting patient flow and volumes while patient lists are absorbed within a consolidating industry. There are levers within ResMed's control which should help alleviate any impact from this aspect.

Having recently surmised that the US price erosion was on the high single digits, UBS locked the 3-year growth outlook at 13%, made possible by cost savings equivalent to around 500 basis points of earnings margin over two years  and offset by price pressure. The results have proved this thesis, with leverage in the fourth quarter seen despite elevated price tensions. ResMed reported price erosion of 4-6% across the entire business, not just in the US segment, which compares with 2-5% historically.

ResMed made specific mention of the VPAP Adapt product performance in the result. UBS observed that channel checks rarely show this up because of the low volume but at over 10 times the price of more basic equipment it does not take much volume movement to make an impact. UBS also noted that, although reimbursement for bilevel devices was reduced through competitive bidding. Home health care dealers are making a more comfortable margin on these products.

Sleep apnea product sales are the most visible portion of the business and UBS' investment thesis also centres on increased high margin mask sales. With mask sales falling to the lowest point in five years in the US the assumptions need to be revisited. Despite the concerns, the broker found that mask launches were well timed to help offset elevated price tension and ResMed may have sacrificed some growth in masks over the last six months to support FY14 growth. The broker suspects the market has focused too much on market pricing and not enough on the impact on earnings. On this point UBS is resolute. ResMed can manage costs and maintain earnings growth above the price erosion that will be experienced over FY14 and may extend into FY15.

JP Morgan also expects ResMed should surprise on the upside with pricing in the next half, considering the generous margin buffer. Going forward management has retained expectations of a 61-63% gross margin, which is comforting to the broker in light of the introduction of competitive bidding. ResMed may be forced to accept price declines from the larger DMEs but has a number of meaningful drivers that will help keep gross margin intact. The real test for JP Morgan will be whether the company continues to grow margins whilst working through the paradigm shift in US pricing.

The stock has six Buy ratings on the FNArena database and two Hold. There are no Sell ratings. The consensus target price of $5.92 suggests 10.4% upside to the last share price.
 

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- French Government paying for latest tests
- Sales growth ramping up
- Profit making by 2015
- Broker sentiment positive


By Andrew Nelson

GI Dynamics ((GID)) is a small cap Biotech company that designs, develops and sells medical devices for non-surgical applications. The company operates in a number of countries including Australia, Chile, Germany, the United Kingdom, the Netherlands and Austria. The home office is in Massachusetts, but the US$165m company maintains a listing on the ASX.

The Company’s flagship product is the EndoBarrier, a gastrointestinal liner, or implant that is designed to assist patients with uncontrolled type 2 diabetes and obesity. The treatment not only aids in the reduction of blood sugar levels, but it also assists with substantial weight loss programs.

Analysts at Bell Potter note the latest news from the company is quite promising. The company reported earlier this week that the French Government has approved and will even fund a clinical trial for EndoBarrier in France. The trial, which has a working name of ENDOMETAB, is expected to be conducted over two years, with the French Government kicking in 1.16m euros, or about $1.63m.

The intent is to look at cost-effectiveness, with the French Government wanting to gauge both the cost and excepted end results from EndoBarrier over 12-months compared to a traditional 12-month program of diet, exercise and lifestyle change. The desired end result is to develop a firm economic grasp of the value provided by EndoBarrier therapy versus current standards.

The broker is quite optimistic about the outcome, not only given results of previous tests, but also because this is the second set of tests and trial for EndoBarrier that has been paid for by the French Government. Last year France commissioned a pilot trial.

Morgan Stanley also notes this second trial is part of the French Government’s STIC program, the purpose of which is to establish reimbursements and provide funding for novel, CE-marked medical technologies that have successfully completed prior clinical studies. The program only funds a few trials each year. In short, it’s a fast track study to set prices and reimbursement levels for a product that is very likely to be purchased.

Thus the broker assumes the French are most likely already buyers, they are just looking to figure out how much they are willing to pay for various EndoBarrier applications.

The latest news supports the broker’s assertion this will be a strong growth year for GID. Outside of France, the broker sees evidence that revenue is already ramping up. There are currently 37 EndoBarrier resellers and the plan is to increase this number to 50 by December. On these projects, Morgan Stanley believes the company may be in a break even position by the fourth quarter of 2015.

Long before that, really as soon as sales start showing sign of ramping up and re-imbursements start flowing in, the broker sees a market re-rating taking place. Even more momentum is expected once the company’s plans for a US launch draw nearer.

Morgan Stanley’s bear case valuation sits at $1.72 a share, while the bull case points to $2.73. The broker’s long term price target is $1.70, with shares closing at 60c yesterday.

There is one other Australian broker covering the stock, CIMB, and the analyst is just as upbeat about the ENDOMETAB project. The broker said in a report today that the news not only goes a long way to addressing cash utilisation concerns given the French are footing the bill, but it also represents an important milestone.

It’s not every day a junior biotech company is a step away from securing its first national reimbursement, especially from a key EU market. A “compelling investment opportunity” is how CIMB labels the stock, with an Outperform call and $1.90 price target in place.
 

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