Will Shortages Limit Upside For ResMed?

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Some market share is likely to stick with ResMed as Philips struggles to replace its recalled device. Yet will supply chain constraints limit the benefit?

-Supply chain constraints expected to be apparent in second & third quarters
-ResMed contemplating freight surcharge to offset higher costs
-Some market share likely to stick even as Philips returns to the device market
 

By Eva Brocklehurst

Despite the advantage the Philips recall may present, there are supply constraints over the short term that could restrict growth for ResMed ((RMD)). Or is the company simply being conservative with guidance?

Guidance for FY22 is unchanged, at US$300-350m in incremental revenue from the recall, which reflects an expectation for component shortages before the situation eases in the fourth quarter. Jarden believes this must be a conservative estimate, as it implies declines in device sales over the next two quarters, if a surge in fourth-quarter sales will be forthcoming as constraints are lifted.

Moreover, supply chain constraints were not so obvious in the first quarter but management is signalling this will become apparent in the second and third quarters. Importantly, Jarden points out management has not noted any substantial increase in the pricing of chips.

ResMed estimates US$80-90m in incremental revenue related to the Philips recall was generated in the first quarter. Management asserts fewer patient set-ups occurred because of the recall and this reduced overall mask sales, in the US. Jarden suspects the recall may have meant some patients were without a device and unable to stay on therapy.

Management has also pointed out that patient volume should improve particularly in facility-based settings. Total devices revenue rose 31% in the quarter amid a recovery in new patients and increased demand from the Philips recall and the launch of AirSense 11.

Globally AirSense 11 and AirSense 10 being sold in parallel to meet increased demand as a result of the recall. Macquarie notes new patient diagnoses ranged from 75% to more than 100% of pre-pandemic levels depending on the geography. This was assisted by the roll-out of vaccines.

The company recorded US$4m in ventilator sales in the first quarter and expects minimal revenue from pandemic-related demand going forward. Inventory increased, which Jarden believes is a positive sign as ResMed attempts to meet demand for devices.

Freight disruption is an issue the broker expects will correct. ResMed is contemplating a surcharge to help offset the freight cost, and notes smaller competitors have already moved in this direction.

Morgans concludes, despite margin pressures and supply constraints limiting gains from the recall, the underlying fundamentals are improving and this underpins a strong outlook.

Supply Chain

Despite the opportunity presented by the recall of the Philips product, management has still warned that supply chain issues will constrain sales growth. Yet Morgan Stanley considers the pressures on the supply chain are not enough to impact the outlook substantially.

That said, the broker acknowledges, with no guidance, gross margins are likely to be soft. Gross margins of 57.2% were below most expectations as higher costs were incurred.

Macquarie notes freight/transport costs contributed 50% of the decline in gross margin in the quarter and an unfavourable shift in mix did the rest, as device sales trumped higher-margin masks.

As the supply chain returns to normal Jarden expects gross margin leverage will deliver growth in net profit of 26% in FY22, pointing out that, with the addition of the recent Singapore manufacturing capacity, ResMed now has an enough excess capacity in terms of internal manufacturing to meet the current demand created by the Philips recall.

Citi suspects the company would not provide guidance on margins because of volatility and higher component costs, with shortages likely to continue. Regardless, the broker believes there could be upside to guidance as it only includes devices. It is also possible ResMed could secure some components to ramp up production more rapidly than forecast.

Macquarie notes, on October 1, ResMed acquired Ectosense, a cloud connected home sleep apnoea testing technology from Belgium which has helped increase diagnosis rates.

Market Share

Citi assumes US$450m in extra sales as a result of the recall, comprised of US$350m in devices and US$100m in masks, yet believes market share gains from the recall are already priced into the stock.

The broker forecasts FY22 revenue growth of 19% and expects ResMed will be net cash by the end of the third quarter. Over the longer term, beyond FY24, Macquarie assumes ResMed retains 25% of the Philips device share and this underpins its valuation.

Moreover, Citi asserts it could take longer for Philips to complete the recall leaving the company as a sole device supplier for longer. Philips is unlikely to be able to supply new patients until at least the end of FY22.

In FY23 the broker expects ResMed will retain roughly half the extra sales made in FY22 and a permanent market share gain of 10%. Philips is planning to repair or replace affected devices within 12 months of regulatory approval, which implies a date around September 2022. In the meantime, Philips is selling masks and accessories but no devices.

Morgan Stanley believes the benefit ResMed enumerated for FY22 is likely to be conservative and assesses the stock is approaching fair value – if the potential risk to FY23 when Philips returns is ignored. Still, the broker expects ResMed's premium valuation is likely to be maintained.

Ord Minnett agrees the company will retain some market share, yet when Philips returns in FY23 this will present headwinds to growth while Jarden considers there is a big opportunity for share to be retained, particularly if ResMed can capture new patients entering the system.

Jarden, not one of the seven stockbrokers monitored daily on the FNArena database, has an Overweight rating and $39.64 target. The database has two Buy ratings and four Hold. The consensus target is $39.10, suggesting 11.4% upside to the last share price. Targets range from $36 (Ord Minnett) to $44 (Credit Suisse).

See also, Will ResMed's Market Share Gains Last? on August 24, 2021.

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