Risks To The Downside For F&P Healthcare

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

Fisher & Paykel Healthcare may be capable of producing mid-teens growth for the next few years but the substantial run-up in its shares signals the risks are on the downside.

-Stock now substantially overvalued versus medical device peers
-Risks associated with a potential change in NZ government
-Growth in OSA market likely to slow
 

By Eva Brocklehurst

Fisher & Paykel Healthcare ((FPH)) may be a blue-chip NZ company capable of producing mid-teens organic growth for the next 3-5 years but the significant run-up in its share price suggests it is over-bought.

UBS believes so and downgrades the stock to Sell from Neutral. The share price is up 30% since the FY17 result in May and now trading at an all-time high one-year forward price/earnings ratio of 37, and at a 14% premium to the broker's de-risked valuation of NZ$11.35 a share.

Current earnings growth forecasts suggests the stock is now substantially overvalued relative to global medical device peers. UBS believes the three-year EPS growth profile would need to lift to around 25% pa from 16% pa to justify the current share price.

Macquarie has an Outperform rating, acknowledging the stock is trading at demanding multiples but remaining comforted by the company's expansion into adjacent businesses, which should allow mid-teens growth rates for some years to come.

There is also the possibility, UBS concedes, that a large portion of the recent strength in the share price reflects a temporary liquidity squeeze created by index-related buying and loyal Australasian shareholders with limited alternatives.

Nevertheless, scenario analysis suggests the risk is skewed to the downside, especially if the patent disputes with ResMed ((RMD)) in Obstructive Sleep Apnoea (OSA) or North American free trade agreement (NAFTA) negotiations do not go to plan, and growth slows.

Credit Suisse too finds the litigation an unwelcome distraction, although remains impressed by the fact the company achieved an 18% rise in net profit in FY17, despite litigation costs.

NZ Poll

UBS even suggests that the stock may be a good place to park amid risks associated with a potential change in the NZ government. Deutsche Bank agrees the recent polls point to an increased probability of a Labour-led government in New Zealand and suggests this could be a net positive for the stock.

Aside from the potential impact on the NZ dollar (weaker so far and a positive for FPH), the main change would be the way in which the government incentivises R&D. Labour's policy would add around 3.3% to the company's after-tax earnings. Fisher & Paykel Healthcare has received funding under the current government policy, capped at NZ$5m per year. Had Labour's policy applied to FY17, Deutsche Bank calculates the company would have received a NZ$10.5m tax credit.

Slowdown

UBS suggests a slowdown in global revenue growth for the OSA market to around 7% and 6% in 2017 and 2018 respectively, from 8% in 2016, is on the cards. The main question the broker ask is whether the company can maintain its double-digit constant-currency OSA revenue growth as new mask come towards the end of their traditional product life-cycle.

The broker believes structural industry factors will be the major drivers of market growth over the next few years. Incorporating analysis of what is driving the market, UBS suggests a stable market share for F&P Healthcare in FY18 followed by a gain of 0.5% in FY19 and FY20.

At its AGM, the company reiterated FY18 net profit guidance of NZ$180-190m, suggesting a slow start with first half net profit up just 2% on revenue of 8%. Moreover, UBS assesses this reflects lower growth in the traditional invasive ventilation hospital sales and higher legal costs. The broker does not envisage home care revenue growth will rise above 10% in FY18 and FY19.

That said, the broker acknowledges growing penetration of high-flow nasal cannula (HFNC) and long hospital product cycles, as well as reasonable OSA market growth, will underpinned mid-teens growth in earnings per share over the medium term.

The broker's analysis of clinical trials is supportive for HFNC over low-flow oxygen therapy for ICU and post-extubation patients but inconclusive for post cardiac surgery. Channel checks also suggest the company's new mask is driving a higher market share. There are two Buy ratings, two Hold and one Sell (UBS) for the stock on FNArena's database.
 

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