Robust Outlook For F&P Healthcare

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

Fisher & Paykel Healthcare posted a strong FY17 result, albeit overshadowed by litigation, and brokers remain confident of continued success with new products and market expansion.

-Offers long-term organic growth prospects, particularly in hospitals
-May be challenging to expand margins further
-Ongoing litigation remains a distraction for management
 

By Eva Brocklehurst

For brokers, Fisher & Paykel Healthcare ((FPH)) confirmed its superior strategy and execution at the FY17 result. Net profit was up 18% and revenue up 10%, overshadowed by litigation expenses, on which the company spent approximately NZ$21m in FY17. These expenses are expected to continue at a similar run rate in FY18.

The business is being driven by exceptional growth from the hospital division and brokers expect this will continue in the medium to longer term, notwithstanding the headwinds from litigation. Despite a high trading multiple, the stock remains relatively attractive because of the superior growth in earnings per share, which Citi forecasts at 14% in FY18 and 22% in FY19.

Macquarie also concedes the stock is trading at a demanding multiple but notes this includes the litigation costs, while the fact that the business is expanding into adjacent markets should allow it to generate growth in the mid teens for some time to come. The broker notes operating expenses were pushed up by litigation and considerably higher than had been forecast.

Litigation costs aside, Deutsche Bank believes the company is trading well and the outlook is positive. Nevertheless, with operating earnings (EBIT) margins already at 27% the company is finding it more challenging to expand margins, and this has been a key driver of growth over the past five years.

Capital expenditure guidance increases to over NZ$80m in FY18 as the company's second factory in Tijuana is built. The company also plans a third location for manufacturing after New Zealand and Mexico and Deutsche Bank suggests this will either be Southeast Asia or the US, with the latter being the most obvious.

Deutsche Bank retains a Hold rating due to the limited upside to its target but acknowledges the stock offers superior long-term organic growth prospects, particularly in the hospital business. That said, the broker does not believe further multiple premium expansion is warranted because of the litigation overhang.

Credit Suisse was impressed by the fact that revenue growth appeared to have been uncompromised by the litigation costs. Flow generator sales remain extremely weak the broker observes, but the situation is expected to be remedied with the launch of a new platform as the SleepStyle features better connectivity.

The broker factors in better margins through time, offset in the short term by litigation costs. The broker's believes the company's strategy is hard to fault but, while the growth outlook is well understood, tailwinds should ease and litigation is an unwelcome distraction. The stock presents a well-balanced risk/reward profile in an expensive market and Credit Suisse retains a Neutral rating.

Product Outlook

The expansion in the use of nasal high-flow oxygen therapy has been a driving force in the hospital segment and now accounts for 30% of the company's total revenue. The key product, Optiflow, provides medical practitioners with an efficient and comfortable access to supplemental oxygen for patients with a variety of respiratory disorders.

High-flow is used mainly in intensive care and expansion to other settings in hospitals is expected to significantly extend the addressable market. The company enjoys a significant first mover advantage as a high-flow pioneer.

Upcoming US approval and subsequent launch of the new full face NIV hospital mask should further support hospital growth, Citi believes, while legacy products such as humidifiers will maintain low single-digit growth in revenue.

One area which has been going backwards has been the sales of the company's Homecare flow generator, which fell -19% in FY17. On Credit Suisse's estimates, this corresponds to the lowest absolute revenue contribution from flow generators in 10 years.

The overall stronger performance from the Homecare division was driven by OSA (obstructive sleep apnoea) masks. Growth in OSA masks were resilient in the second half, despite new product releases from competitors, and the main surprise for Deutsche Bank.

Management has provided guidance for low double-digit growth in mask sales in FY18 and this suggests to the broker success with the new Brevida nasal pillow mask. Deutsche Bank observes the company has lost significant market share in devices over the past three years, which reflects poor traction of its ICON device.

SleepStyle is a replacement for ICON which appears to be much easier to use and maintain. The company, however, is downplaying sales growth expectations at this juncture.

Macquarie does not expect Homecare will match the growth trajectory of hospitals and incorporates a decline in Homecare revenue growth rates as market share gains in masks become more difficult.

Litigation

In 2016 both FPH and ResMed ((RMD)) filed patient infringement proceedings against each other. Originally, Citi expected the actions would have a negligible impact, but the step up in expenses is higher than anticipated for FPH. Either way, the matters are a distraction for management.

In the US International Trade Commission, ResMed announced earlier this month it had filed a motion to dismiss its current complaint, planning to re-file a new complaint. Citi observes this is positive for FPH, as the withdrawal and re-filing will no doubt delay the impact on its results.

The broker has no basis for preferring one company's position over the other and continues to expect a negotiated outcome. Nevertheless, by design, the US ITC provides an asymmetrical benefit to ResMed as only US manufacturers can be plaintiffs in these cases.

Should the ITC rule in favour of ResMed it would have a significant impact on FPH results, as US OSA masks represent 14% of total revenue. Litigation costs in the short to medium term cause a downward revision to earnings for Macquarie but they are not expected to feature to the same degree in the longer term.

There are two Buy recommendations and three Hold for Fisher & Paykel Healthcare on FNArena's database.
 

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