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Robust Outlook Maintained For Fisher & Paykal Healthcare

Australia | Jun 02 2016

This story features FISHER & PAYKEL HEALTHCARE CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: FPH

-Positive impact of direct US distribution
-Opportunity in high flow oxygen therapy
-Gains market share in masks
-Loses share in flow generators


By Eva Brocklehurst

Fisher & Paykel Healthcare ((FPH)) extended its track record of beating earnings guidance for another year, delivering FY16 net profit ahead of most broker forecasts and proffering FY17 guidance that appears conservative.

Deutsche Bank envisages upside risks to guidance at current FX rates. At spot FX rates the company is expected to enjoy a NZ$9m currency tailwind to earnings. The broker is attracted to a decade-long growth story in and considers FY17 profit guidance of NZ$165-170m is conservative. Moreover, the company has a consistent record of upgrading guidance that is provided in May three months later.

FY16 is the fourth year in a row the company has delivered strong double digit growth in profit as it continues to gain traction in its Obstructive Sleep Apnea (OSA) masks and new Respiratory & Acute Care (RAC) applications. Deutsche Bank believes the result is even better than it appears at first glance, given disruption was expected from a move to directly distributing RAC products in the US.

Citi also notes industry sources had indicated the internalisation of US sales, previously distributed by CareFusion, would provide an opportunity for competitors, as hospitals seek one-stop shops for respiratory care. Yet, the broker observes no material impact, and suspects this is due to F&P Healthcare's large and dominant market share in humidification circuits.

Earnings were up 24% in FY16, slightly below Citi's expectations. The RAC division grew revenue by 16%, with consumables from new applications growing 30%. Revenue was helped by higher US pricing, achieved through internalisation. Gross margins expanded 280 basis points on a constant currency basis, which Credit Suisse attributes to a shift in mix to a higher margin product and the ongoing skew in production to the Mexico facility.

The broker calculates new applications revenue within the RAC segment increased 23% in the second half, after adjusting for the positive impact of the transition to a direct distribution model. The broker's discussions with management have highlighted the positive leverage potential that exists across RAC therapies.

All humidified therapy has the potential to be interlinked. In theory, therefore, the growth achieved in one category should act as a positive lever for growth in another. Credit Suisse also believes this could act as a natural barrier to increased competition.

Brokers observe there is considerable opportunity for high-flow nasal oxygen use. These new applications now account for 50% of RAC consumables revenue. Citi believes high flow oxygen therapy is in a sweet spot, as it provides for lower nursing and cost burden than standard oxygen therapy and, hence, continued strong growth is likely. Both UBS and Credit Suisse also note this is main driver of underlying RAC revenue growth.

Citi likes the annuity style of much of the RAC consumables revenue and believes, despite stiff trading multiples, the stock is attractive based on the high quality RAC division. The broker also observes wound humidification offers a further avenue for growth but requires significant investment, given a presence in surgical suites would be required.

Meanwhile, OSA masks continue to gain market share and Citi highlights the prospective launch of a nasal pillow mask in FY17 to round out the product portfolio. One area where the broker observes the company losing market share is in OSA flow generators and wonders whether F&P Healthcare can be a viable player in the OSA market if it only sells OSA marks, which the broker estimates contribute 80% of OSA division revenue.

This may not matter in the short term but there could be consequences for the longer term, Citi suspects, if bundling leads to disintermediation in the US DME channel, or if either ResMed ((RMD)) or Philips implement a technological lock on their flow generators.

The company expects profits to double in the next 5-6 years and Macquarie is comfortable with this forecast for the medium term. The broker explains the stock's strong multiple by the increasing proportion of revenue from consumables, increasing gross margin and strong market position.

While Macquarie acknowledges it is becoming more difficult to justify the valuation with a discounted cash flow model, the company does have a history of positive surprises. The main risk to the investment thesis, the broker contends, is the NZ currency.

While the company continues to show good execution on a strategy which has transformed the business, with the share price up 63% over the past year, UBS believes growth is more than captured in the price and this leaves little room for execution risk.

This is considered particularly the case against a backdrop of a maturing OSA product and NZ dollar volatility. Hence, the broker has a Sell rating, the lone one on the FNArena database. Otherwise, there are three Buy ratings and one Hold (Credit Suisse).

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