-Potential market increases
-Dose sales still up strongly
-Outcome of further studies needed
-Queries still re overall benefit

By Eva Brocklehurst

Sirtex Medical ((SRX)) has delivered some positive news with further data from its SIRFLOX study into the survival rates for SIR-Spheres treatment of liver cancer. The company has confirmed that its secondary end point has been achieved in terms of progression-free survival for liver cancer.

The latest data revealed progression-free survival improved 62.7% while SIR-Spheres offered a 31% lower risk of liver tumours progressing. While the company had previously announced it had met its secondary end point the extent of the improvement and degree of statistical significance was not known until now. The company also reported that dose sales were up 22% in the first 10 months of FY15 and that the negative commentary on the study in March had not affected sales growth. March and April were record months.

The share price in the lead-up to the latest data reflected the disappointment with the failure in the primary end point, in Moelis' view. In March, the company announced a lack of statistical significance for metastatic colorectal cancer (mCRC) treatment. The broker now feels vindicated, having suspected that when the confusion around the wording of the initial announcement dissipated the market would respond positively. Given the positive statistical significance of the secondary end point has now been confirmed this should elevate the prospective use of SIR-Spheres as an early stage therapy, in the broker's view.

The use as an early stage therapy is critical to expanding the market opportunity. Extra studies were needed as, while the product is approved for use in both primary liver cancer and mCRC, there is not enough evidence of its effectiveness, which means it is not yet a standard therapy. Oncologists tend to prescribe it as a last option when other forms of therapy have been exhausted. Further studies are due in coming years.

From here, peer review is required to interpret the clinical implications and this will take place on May 30. Moelis expects a strong FY15 performance, with dose volume growth, increased US pricing and a depreciation of the Australian dollar providing the near-term catalysts and validating the strength of the business. The broker has a Buy rating and target of $35.57.

Morgans, yet to update on the latest information, had considered the lack of support for the primary end point a major setback. The broker expected that result would make physicians hesitant to use the product in a front line setting and insurers would be less likely to reimburse treatment in these patients. That said, Morgans did not expect disappointment with the primary end point would affect the use of the product in its current "salvage" setting. Despite the sell off at the time, the broker did not consider the stock a buying opportunity and retained a Reduce rating and $15.06 target.

Bell Potter also believes many will question the benefit of subjecting patients to this treatment in the absence of proven survival benefit while the lack of an overall benefit may be a significant issue for oncologists. Hence this broker believes there is no scope to expand the indication for Sir-Spheres based on this result. The broker does not expect the company will gain an extension of its label claim based on the liver survival measure alone, hence subsequent studies remain crucial for proving an overall survival benefit. Sub-group analysis will be of interest to the broker when the full results are released later this month. Bell Potter retains an unchanged Sell rating and $19.36 target.

UBS disagrees, suspecting that the regulators could allow a label for third or second-line treatment for liver cancer, and this could increase the potential market opportunity by as much as four to sixteen times. The latest result alone may not garner first-line status but the broker still believes there will be a positive impact on industry sentiment. This latest data is a positive precursor to the SARAH study, which is comparing Sir-Spheres with Nexavar, a standard treatment for primary liver cancer. The broker retains a Buy rating and raises the target to $35.00 from $30.35.

The statistical significance in the latest data impressed Macquarie, generating an upgrade to Outperform from Neutral. Target is increased to $30 from $26. Even if overall survival, the primary end point, cannot be demonstrated, the benefit in terms of liver metastases is critical, in the broker's opinion. The liver is generally the first and often only site where metastases - the spreading of cancer from the original site - occur in mCRC. Macquarie believes SIR-Spheres could play a large role in the earlier treatment of mCRC for those patients with cancer of the liver.

Goldman Sachs considers the result a meaningful outcome which should have positive implications for the therapy. The broker does not, however, include a contribution for first line treatment following he failure of the primary end point but notes the option clearly still exists. Goldman awaits the further details from the presentation to industry peers on May 30 to gain greater insight into the commercial significance. A Buy rating and $28.00 target are maintained.

FNArena's database has two Buy ratings (Macquarie, UBS) and one Sell (Morgans). The consensus target is $26.69, signalling 1.3% downside to the last share price, and compares with $23.80 ahead of the update.

See also All Is Not Lost For Sirtex on March 18 2015.
 

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-Warning label on ASV needed
-Damage to market sentiment
-Earnings estimates reduced
 

By Eva Brocklehurst

The market has responded harshly to ResMed's ((RMD)) acknowledgment that its phase III SERVE-HF clinical trial missed its end point, with increased risk of mortality in a specific group of patients under study. The disappointing preliminary findings, announced six months ahead of expectations, are likely to have a material effect on sales of the Adaptive Servo-Ventilation (ASV) product and reveal a lost opportunity for growth.

The outcome was eagerly awaited, amid expectations the ASV therapy could treat patients with central sleep apnea and severe congestive heart failure (CHF). Instead, the company has to issue a safety warning, with a contra indication label, as the preliminary results signalled a statistically significant increase (2.5%) in morbidity for sufferers using the therapy. Of note, the trial did not include patients with an absence of heart failure and only related to a specific sub-set of CHF suffers, namely reduced fraction with cheyne-stockes respiration - a severe and intractable stage of the disease.

While less than 2.0% of ResMed's current sales are to patients contra-indicated in this aspect, Deutsche Bank expects the warning label will have a dampening effect on other sales of ASV. Given the high margin earned on the ASV devices reduced sales in turn reduces earnings expectations, particularly in outer years as the opportunity was expected to support medium-term growth.

Citi also notes the downward pressure on sales of this high price, high margin device. The broker was very supportive of ResMed's investment and efforts to establish a business in treating heart failure. In the short term, a recall/field notification will lead to some brand damage and a one-off charge is considered likely. Given trial success was critical to high expectations built into the stock, Citi acknowledges a significant reduction to its FY16-17 estimates and downgrades straight to Sell from Buy.

The result does not stretch to the company's core obstructive sleep apnea treatments and, as such, was not factored into many broker estimates. Still, share price weakness is likely to prevail, although most brokers remain confident in the company's outlook as new products ramp up. Morgan Stanley considers the CHF option now removed from the growth story and the stock should move down towards its new price target accordingly, reduced to US$55.39 from US$62.33. That said, the share were trading above the broker's base case valuation on the option value of SERVE-HF success.

Morgan Stanley accepts industry investigations had provided a positive bias on the outcome of this trial and, hence, the result was a nasty surprise. On the broker's numbers, ASV comprises around 7.0% of global sales and around 25% of these were to the patient population identified by the safety warning. Hence, the broker estimates a 3.0% negative impact on FY16 and FY17 earnings and considers its Equal-weight rating justified.

UBS suspects, given the results relate to a very specific area of study, that trials in the CHF condition may yet continue. ResMed was adamant that a wider impact from this adverse finding was unlikely as ASV is used for complex sleep apnea as well, and medically this does not compare with the SERVE-HF trial. Moreover, a strong association has been found for reduced hospital admissions post treatment with positive airway pressure (PAP) therapy, which reinforces the broker's view that the fall-out from this setback should be contained. UBS does not make any fundamental changes to the outlook, retaining a Buy rating, but recognises the failure will carry some negative sentiment for the stock.

Taking a view that there will be no future ASV sales for this patient population and potential flow-on effects to other indications, as well as lower corresponding masks sales, Credit Suisse reduces forecasts by 7.0% for FY16 onwards and downgrades to Neutral from Outperform.

JP Morgan takes a different stance. While acknowledging the adverse sentiment triggered by the results, the broker believes the company's other products are robust and there is associated margin upside. JP Morgan retains an Overweight rating. Quantifying expectations around the trial is difficult as the option value on this particular outcome was widely expected to re-rate the stock, the broker contends.

As UBS also notes, JP Morgan highlights data in March from 64 patients admitted for CHF with sleep disordered breathing found a significant reduction in hospital admissions after they were treated with PAP therapy. While accepting the trials are not directly comparable, it seems to the broker this data appeared to generate enthusiasm about the primary end point of the SERVE-HF trial and underpinned some growth expectations around flow generator sales in Europe as a result.

Over and above this opportunity, ResMed intends to pursue other co-morbidities such as chronic obstructive pulmonary diseases and hypertension. Hence, for JP Morgan there is no read-through on the treatment of central sleep apnea nor is this outcome a reflection on PAP therapies. Based on the company's estimates of ASV products sold in the last 12 months to patients identified by the safety issue associated with an adverse mortality rate, JP Morgan removes sales factored into Europe on the basis of favourable trial data. Hence, earnings forecasts for FY16 and FY17 are downgraded by 1.9% and 3.3% respectively. This brings the broker's share price down to $8.70 from $9.70.

FNArena's database now has one Sell rating as a result of the update - Citi. Otherwise, there are three Buy and four Hold. The consensus target is $8.77, suggesting 29.9% upside to the last share price. This compares with $9.88 ahead of the news. Targets range from $7.67 to $9.73.
 

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-Concerns over mask sales
-Countered by strong FG sales
-Still taking market share
-Global environment stable
 

By Eva Brocklehurst

ResMed ((RMD)) disappointed the market with its March quarter results when it came to masks. Countering this weakness was strong growth in flow generator sales. The company also downgraded June quarter margin guidance to 59-60% from 60-62%.

The miss to forecasts was largely as a result of weakness in gross margins and currency movements, which JP Morgan expects to reverse in 3-6 months. The broker found the downgrade to margin guidance a little unnerving but believes it can be easily explained by FX movements and an adverse shift in the mix of sales. The latter is more than likely temporary because of the unprecedented demand for the lower-margin flow generators in the quarter. The main offset to the weakness was what JP Morgan describes as an extraordinary validation of the company's latest flow generator platform, a 42% growth rate in the US. Globally, flow generator sales rose 26%.

Momentum is building as recent launches of Aircurve and Astral products ramp up and, in JP Morgan's view, especially if the Serve HF data is as compelling as it sounds for ventilator use amongst cardio/respiratory patients. The broker believes the value proposition of the Airsense-10 (AS10) is resonating with the durable medical equipment channel and this should generate similar US growth in the June quarter.

Management explained the lacklustre mask growth as the impact of a re-basing of prices, which has taken longer than expected. JP Morgan suspects this stems from further discounting by peers. While ventilators have the potential to more than offset the weakness in masks, a rebound is still required in that market for further upside to the group's earnings outlook. JP Morgan retains an Overweight rating and raises the target to $9.70 from $7.71.

Macquarie considers the market typically places high value on the flow generator sales because these are the best measure of the rate of new diagnoses and a leading indicator for mask sales, as newly diagnosed patients begin using and replacing masks. However, the broker suspects the usual dynamics may not be in play this quarter. There is no doubt ResMed has gained share in flow generators but the broker argues this is likely emanating from a large increase in upgrades to the AS10. Upgrades would be the reason why there is a lack of flow-on benefit for mask sales.

Macquarie suspects these upgrade sales will fade next year and turn into a headwind for earnings growth. The broker has lingering concerns about sluggish growth in masks and whether this can be turned around. Hence, a ratings downgrade to Neutral from Outperform with a target of $9.00.

The market should be cautious about over-interpreting the March quarter results, in the opinion of UBS. Distortions in the quarter are typically reversed in the June quarter. Likewise, US flow generator comparables are encouraging and should support a more positive interpretation of the outlook. The broker normalises estimates for "channel stuffing" and partial price reductions which occurred in the prior March quarter and calculates that underlying mask growth may have been 7-8%, instead of the 4.0% contraction in the headline numbers.

Furthermore, given the size of flow generator growth in the quarter, UBS maintains AS10 has captured momentum not seen since FY06 and, with a staged roll out and positive signals, this could persist at higher levels and beyond the 12-month cycle that the market is currently estimating. That said, while believing the headline numbers for masks understate underlying growth, the broker acknowledges there is no near-term strategy that promises higher growth. Ideally, ResMed should be able to improve the ratio of flow generators fitted with its own masks.

Morgans is also confident of the longer-term earnings profile, given the early stage in the product cycle. The softer gross margin disappointed the broker but this is expected to stabilise on the back of a weaker Australian dollar, optimisation of product mix and cost cutting programs. Global pricing and regulatory environments are stable and the company continues to take market share in the sleep disorder segment. The share price sell-off is overdone and a buying opportunity in Morgans' view, while trading levels are undemanding.

Industry feedback suggests to Deutsche Bank that the Air devices are a superior offering. Nevertheless, the inability to leverage a dominant position into mask sales is of concern to this broker, especially given the impact on margins. Deutsche Bank is optimistic ResMed will be able to rebuild its position with masks but now expects the weighting of sales to devices will be larger. This results in a sharp cut to the broker's gross margin forecasts, which is only partly offset by improving cost leverage. Morgan Stanley does not envisage a recovery in mask sales until the first quarter of FY16. The stock looks fully valued. Hence, the broker maintains an Equal-weight rating on an industry-relative basis.

Credit Suisse, on the other hand, believes the result was actually better than the headlines suggest. While reducing earnings estimates by 2-9% across forecasts, because of re-basing in mask sales, gross margin and share repurchases, the broker maintains an Outperform rating but reduce its target to $9.80 from $10.70. Mask growth should recover, along with gross margins, over FY16 as the product mix reverts to more normal levels and cost cutting is achieved, in Credit Suisse's view.

While stabilisation of market share in masks is necessary to support the current valuation the broker believes the company's' strategy in growing a larger installed base of customers should deliver recurring revenue benefits.

On FNArena's database there are five Buy ratings and three Hold. The consensus target is $10.05, which suggests 18.5% upside to the last share price. 
 

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-Priceline outperforms
-Uncertainty over PBS changes
-Should manage funding cuts
 

By Eva Brocklehurst

Australian Pharmaceutical Industries ((API)) has made strides in its operating earnings despite a weak environment. The pharmacy wholesaler/retailer's cash flow and debt position have improved, which drove first half results. Operating profit was up 31% against the prior first half. This is coupled with a working capital profile that rivals competitor Sigma Pharmaceutical (((SIP)), in Morgan Stanley's view.

Still, the company's ability to resist mounting pressures in its industry are a key uncertainty and Morgan Stanley retains an Underweight rating. The worst may be over in terms of industry headwinds but the broker believes it will take time for that to become evident. Independent customers are still under pressure while there is the threat of further increases to prescription co-payments. The broker also suspects the company has lost distribution market share to Sigma.

Morgan Stanley anticipates cost savings in pharmacy distribution as a percentage of total revenue will contribute to improvements in operating margins, but these will still be at a level below competitors. That said, the broker acknowledges the company's shift in focus towards winning retail market share and diversifying away from the government's pharmaceutical benefits scheme (PBS) funding. Negotiations for the sixth community pharmacy agreement continue ahead of the expiry of the current agreement in June. 

Credit Suisse increases earnings forecasts by 6-10%, driven by higher revenue assumptions and lower interest expense. The company tightly controlled costs in the first half, particularly in warehousing and distribution despite the headwinds emanating from the PBS. All up, the broker considers the outlook is favourable but awaits the outcome of pharmacy agreement in terms of the implications for the company's wholesale division.

The retail side, Priceline, drove the overall growth with like-for-like sales up 3.9% in the March quarter. Macquarie considers the 17% increase in group earnings can largely be attributed to Priceline and this was impressive, given the broader industry is relatively subdued. The broker acknowledges the challenges in the distribution business and the possibility of adverse outcomes from the upcoming pharmacy agreement, or the Commonwealth government's budget in May.

The stock is now trading at a significant premium to Sigma, Macquarie observes, driven by the stronger earnings growth as Priceline continues to outperform. The broker is cautious about the longer term outlook for Priceline, given increased competition from new entrants such as Sephora and the supermarkets, but near-term earnings appear unaffected and the risk of a near-term de-rating is considered low.

A stable cost base highlights the potential leverage in the Priceline franchise model, in Deutsche Bank's view. The risk of a poor funding outcome from the PBS is a threat but should have little impact on the retail operations. The broker maintains any funding reductions should be manageable as the company and its competitors have a reasonable buffer in the form of discounts offered to pharmacies. This should ensure profitability of the wholesale operations even if funding is further constrained.

Deutsche Bank increases forecast revenues from the retail operations to allow for a faster store roll-out and better operating margins. Given the relatively flat cost structure in the franchise model much of the benefit falls to the bottom line, the broker observes.The company expects to have 420 Priceline stores by the end of FY15. 

There are three Hold ratings and one Sell on FNArena's database. The consensus target is $1.39, signalling 14.9% downside to the last share price, and compares with 94c ahead of the first half results. Targets range from $1.10 to $1.75.
 

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