Connected Care Working Well For ResMed

This story features RESMED INC. For more info SHARE ANALYSIS: RMD

After a strong FY19, sleep apnoea specialist ResMed is expected to make further inroads into market share in FY20 with its "connected-care" strategy.

-Stable pricing environment signal strong growth in US masks and devices
-Software-as-a-service revenue could present upside risk to growth outlook
-Earnings dilution in the near term likely from Propeller Health and the Verily JV
 

By Eva Brocklehurst

Strong market conditions are expected to prevail for ResMed ((RMD)) after the sleep apnoea product franchise extended its leading position in FY19. Revenue rose 13%, ahead of expectations.

Credit Suisse believes ResMed has benefited from having the broadest product portfolio and the launch of three new masks in the past 12 months. There are limited new competitive pressures on the horizon as well. Hence, there is an opportunity for further gains in market share.

The broker is also upbeat on the company's ability to to use data to improve the quality of care to patients in the home setting and increase its penetration rate within the sleep and COPD (chronic obstructive pulmonary disease) markets.

The sleep business grew 8% in the June quarter, ahead of rival Philips. Mask sales grew 15%, driven by share gains and better re-supply rates. While US growth was in line with the trends, the rest of the world cycled difficult comparables, specifically in France and Japan.

The next round of competitive bidding in the US is now open and the ultimate impact of changes on product prices will not be known until these are finalised. As the next round does not come into effect until 2021, with a stable pricing environment, Credit Suisse expects continued strong growth in US masks and devices.

Connected Care

Morgan Stanley is increasingly confident that the company's connected-care strategy will drive market share gains and higher rates of re-supply sales. The broker also envisages less pressure on gross margins versus the previous five years. The company has guided for gross margins in FY20 to be in line with the fourth quarter, at 59.3%.

Upside could come from penetration of the COPD market via portable oxygen concentrators and Propeller Health. The Verily JV may also lead to higher diagnosis rates of OSA (obstructive sleep apnoea) sufferers and support long-term CPAP (continuous positive airway pressure) device growth.

Wilsons believes the decision to combine its software-as-a-service business (Brightree, HEALTHCAREfirst and MatrixCare) into interoperable ecosystem is creating leverage and opportunities for greater market share.

Ultimately, the company's strategy will support market share gains for the core medical device businesses. Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, maintains a Buy rating and lifts the target by 17% to $21.05.

While the company has the objective of growing sustainable software-as-a-service revenue by double-digits no timeframe has been provided. Hence, Citi forecasts high single-digit organic revenue growth in FY21 and beyond, but acknowledges this could represent a source of upside to forecasts if the company can achieve its goal.

Citi assesses the business is fairly valued, noting there are a number of one-off items that made comparisons in the results difficult. The one-off items include restructuring costs in Germany as well as software-as-a-service.

Macquarie is less enthusiastic, believing forecasts are already capturing opportunities from the increased penetration of the potential OSA population and further improvements in relation to mask and accessory re-supply. The broker also envisages the current share price is ascribing limited risk in relation to reimbursement changes.

While mask and accessories revenue growth impressed, devices growth was slightly weaker than the broker expected in the Americas, and the rest of the world more materially so. Macquarie was also not so impressed with the restructuring charges, which arose from the workforce planning review and the respiratory care business as well as the closure of an R&D facility in Germany.

ResMed has tentatively agreed with the US government to resolve the Department of Justice investigation for payment of US$39.5m relating to issues around re-supply. The settlement is expected to be finalised before the end of 2019 and the cash outlay is likely to occur, in Citi's estimates, in the fourth quarter of FY20. The settlement relates to investigation dating back to 2016.

Management has signalled confidence in its numbers and does not expect any significant change to the way it operates. Macquarie notes the Department of Justice has also requested information regarding leasing arrangements with customers as well as the provision of diagnostic devices/master medical providers and the diagnostic auto-scoring function.

Headwinds

It remains too soon to know when Propeller Health will become profitable and, hence, no contribution is incorporated into Citi's earnings estimates. The broker expects ResMed will continue to publish results from studies to continue proving the value of this offering.

Management has previously indicated it will invest in the Verily joint venture at current levels for two years, having guided to a loss of -US$7m per quarter in FY20. Citi is a little sceptical about the modelling and requires further clarity.

Morgan Stanley suspects both Propeller Health and Verily will cause earnings dilution in the near term. Device segment growth is also likely to be low, outside of the Americas, as periods which benefited from favourable reimbursement changes are cycled.

There are four Buy ratings, two Hold and one Sell (Macquarie) on FNArena's database. The consensus target is $17.95, signalling -4.7% downside to the last share price. Targets range from $15.35 (Macquarie) to $20.10 (Credit Suisse).

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