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ResMed Judged Harshly As Costs Mount

Australia | Jan 30 2019

The core sleep therapy business of ResMed remains solid but brokers and the market have judged the stock harshly as details emerge regarding the cost of acquisitions.

-Data investment provides potential to improve quality of care
-US Medicare reimbursement now more favourable, less gross margin pressure
-Is the sell-off in the stock overdone?


By Eva Brocklehurst

While the core sleep therapy business of ResMed ((RMD)) continues to perform well, expenditure on acquisitions dragged on earnings over the December quarter, resulting in brokers downgrading forecasts for FY19.

The top-line performance of the core sleep therapy business in the US was strong but recent investments in the software-as-a-service (SaaS) platform have led to higher costs. December quarter sales were US$651m, up 8%. Revenue growth was 9% in the US and down -2% in the rest-of-world (RoW). Sales in RoW were weaker than expected because of completion of cloud-connected device upgrades in France and Japan.

There was also a sizeable drag from Propeller Health and the Verily joint venture investments. The equity investment in Verily of -US$3.4m was a surprise to UBS, with the loss expected to increase to -US$7m per quarter in March and June.

Sales growth was weaker than Ord Minnett expected, offset by a better-than-expected gross margin. The broker remains comfortable with the company's leading position in sleep therapy, although acknowledges recent results were boosted by the one-off benefit from renewals in France and Japan.

Yet, of greater concern, is a slowdown in Brightree revenue growth as this impacts on the rationale behind the US$1.5bn investment in the SaaS business. Such challenges are likely to lead to a further de-rating of the stock and Ord Minnett downgrades to Lighten from Hold.

Focus Turns To Investments

Citi believes the impact of the various investments should have been obvious but acknowledges a focus on the underlying CPAP (continuous positive airway pressure) business underscored expectations that a high-multiple stock would justify the rally in the share price via operating leverage, resulting in strong earnings growth.

Instead, the market was forced to focus on the acquisitions and the joint venture, which will, it is now revealed, contribute an operating loss in the next 12 months. Nevertheless, excluding this impact and the downgrade to FY19-21 estimates, Citi believes ResMed remains an excellent business, albeit fairly valued.

Medium-longer term opportunities from SaaS acquisitions are well and good but Macquarie also points out near-term risks in the core sleep business, such as lower device growth in RoW and competition in terms of Fisher & Paykel's ((FPH)) new masks which are to be launched over 2019.

Credit Suisse remains upbeat about the investment in data for longer-term growth, while decreasing estimates by -8% over the forecast period, given the potential for improving the quality of care to patients in the home setting, as well as increasing penetration within the sleep and COPD (chronic obstructive pulmonary disease) markets.

The long term is still supported by growth in the installed base, stable US reimbursement and Brightree is driving higher resupply. Hence, Morgan Stanley believes the company's expertise in patient connectivity within the OSA (obstructive sleep apnoea) system has borne fruit.

Propeller Health may also open up the COPD market and lead to downstream referrals of inhaler patients and the Verily JV can lead to higher diagnosis rates for OSA sufferers and support long-term CPAP device growth.

The broker envisages less gross margin pressure than in the past five years, as US Medicare reimbursement is more favourable. There is also upside with traction from the Mobi portable oxygen concentrator as well as a recovery in RoW devices in FY20 once the high-growth period has been lapped.

ResMed is a strong franchise, CLSA accepts, but low growth and a relatively high PE (price/earnings) signals a downgrade to Underperform from Outperform. The broker, not one of the eight monitored daily on the FNArena database, reduces the target to $15.10.

The company needs to show a return on its investment in SaaS, UBS asserts, having spent around US$1bn on connected-care transactions recently. The broker believes a path to generating operating earnings (EBIT) above the cost of capital needs to be outlined in order to support the stock performance in the future.

Deutsche Bank is also cautious about the acquisitions and Verily investment until there is more transparency and a return profile can be articulated.

Meanwhile, Morgans points to the growth in patients in the RoW, outside of France and Japan, noting market share gains, stable pricing and expanding margins. The broker is not overly concerned with the additional costs from acquisitions, and considers the sell-off in the stock shortsighted and overdone. Morgans believes the slowdown in growth is not driven by fundamentals, as patient growth is solid and the company is taking share.

There are three Buy ratings, three Hold and two Sell on the database. The consensus target is $15.08, suggesting 15.5% upside to the last share price. Targets range from $13.40 (Ord Minnett) to $17.00 (Morgan Stanley).

See also, ResMed Propels Forward on December 6, 2018.

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