ResMed (ASX: RMD) has had a tremendous March quarter, where the firm saw increased demand for its sleep and respiratory care devices. The lower competition also helped the company sell more of its product – boosting revenues.
ResMed makes products to help treat sleep apnoea, chronic obstructive pulmonary disease, and asthma. It also makes cloud-based software products to support patients and clinicians. ResMed requires semiconductors to manufacture their products, and during 2021 and 2022, high demand for consumer electronics parts made it expensive and also hard to come by.
With the rising cost of living, car and consumer electronics sales have seen double-digit declines. The slowing down of the economy has helped ResMed as they have secured supply of semiconductors and sorted out their manufacturing and, ultimately, sales volumes.
Patients Rebound to Pre-Pandemic Levels
ResMed primarily focuses on selling continuous positive airway pressure (CPAP) devices and masks. This business had a remarkable quarter, with a 43% surge in new device sales. The significant increase was attributed to working through order backlogs, resulting in the total number of new patients served surpassing pre-pandemic levels.
During the third quarter, ResMed significantly increased the production and delivery of their cloud-connected flow generator devices to meet the high demand from customers. This led to strong sales growth of devices across global markets. They now have complete global availability of their connected AirSense 10 platform and are working to ramp up production and availability of the AirSense 11 platform in more regions. This means that they can now provide CPAP (continuous positive airway pressure) and APAP (automatic positive airway pressure) devices to the entire sleep device market worldwide.
How much of this market ResMed penetrates remains to be seen. Fisher & Paykel is a strong competitor that we have also recommended in the past. Another major competitor in this space is Philips, who has been out of the market for almost two years after the company was forced to recall devices in June 2021. Both ResMed and Fisher & Paykel have benefitted by gaining Philips’ market share.
There was also strong growth in their mask and patient interface businesses globally, which shows their commitment to patient adherence and resupply. Their software-as-a-service business outside of hospitals achieved high-single-digit growth organically and double-digit growth with the contribution from their MEDIFOX DAN acquisition, which they completed in November.
Revenues Rise but Costs bite into Margins
Revenue grew by 31% on a constant currency basis, driven by increased demand for ResMed’s sleep and respiratory care devices as well as reduced competitive supply.
Revenue in the U.S., Canada, and Latin America, excluding Software-as-a-Service, grew by 32%, primarily due to the factors discussed above.
Revenue in Europe, Asia, and other markets, excluding Software-as-a-Service, grew by 28% on a constant currency basis. Software-as-a-Service revenue increased by 35%, reflecting incremental revenue from the acquisition of MEDIFOX DAN and continued organic growth in the SaaS portfolio.
Gross margin decreased by 150 basis points, and non-GAAP gross margin decreased by 200 basis points, mainly due to an unfavourable product mix and higher component costs, partially offset by an increase in average selling prices.
Selling, general, and administrative expenses increased by 28% on a constant currency basis. SG&A expenses improved to 20.5% of revenue in the quarter, compared with 21.1% in the same period of the prior year. These changes in SG&A expenses were mainly due to increases in employee-related expenses and increases in travel expenses.
Income from operations increased by 28%, and non-GAAP income from operations increased by 27%. Net income for the quarter was $232.5 million, and diluted earnings per share was $1.58. Non-GAAP net income increased by 28% to $247.8 million, and non-GAAP diluted earnings per share increased by 27% to $1.68, predominantly attributable to strong sales, partially offset by gross margin contraction.
Operating cash flow for the quarter was $282.6 million, compared to net income in the current quarter of $232.5 million and non-GAAP net income of $247.8 million. During the quarter, ResMed paid $64.6 million in dividends – translating to 4.6 cents per share.
ResMed Targets 3 Industries
ResMed is targeting a vast market that covers Sleep Apnea, Chronic obstructive pulmonary disease (COPD), and asthma, where they are a leading player in all three industries. The recent impact on their major competitor, Philips, has significantly boosted the demand for ResMed’s products. These market segments are all related to respiratory illness and have a large number of undiagnosed patients worldwide, according to the World Health Organization. Due to the long-term effects of Covid19, the general population is becoming more aware of respiratory issues, leading to an expected gradual uptick in diagnoses. ResMed’s products are sold globally, including developing markets like India and Brazil, which are likely to see an increase in diagnoses in the coming years.
There are over 100 million largely undiagnosed COPD sufferers in high-growth markets such as China, India, Brazil, and Europe, with large acute treatment costs to healthcare systems, amounting to €48B per year in Europe and ~$50B per year in the USA. ResMed’s Total Addressable Market in the COPD segment is estimated to be 380 million patients.
Sleep Apnea is where the majority of growth lies, even in developed markets. It is a largely undiagnosed issue that contributes to several chronic illnesses, with over 80% of sufferers still undiagnosed. ResMed estimates their Total Addressable Market for Sleep Apnea to be 936 million patients.
Asthma is the most common respiratory illness, but diagnosis is a problem in developing markets. The Total Addressable Market for Asthma is approximately 330 million patients.
ResMed’s Growth is Priced-in
ResMed is a $52 billion market cap company that is listed on the NYSE and the ASX. They attract significant investor interest, particularly in the current market cycle that benefits healthcare as investors turn defensive and look for earnings resilience.
The company has now had two consecutive quarters of revenue coming in ahead of expectations. Consequently, we have seen the RMD share price trade with good momentum. RMD shares have returned 13% year-to-date and 23% over the past 1-year.
As for what lies ahead, the market expects ResMed to continue growing its revenues. Based on management commentary, ResMed has sold 156 million devices to patients and is making good progress towards its target of reaching 250 million people by 2025. This suggests that the company has been successful in penetrating a large addressable market that is still in its early stages of adoption.
Markets have priced in 18% revenue growth for FY23, 9.5% for FY24, and 7.4% in FY25. Margins are also expected to increase. ResMed is expected to hit EBIT margins of 29%, 30%, and 31% in FY23, FY24, and FY25, respectively. However, we are yet to material margin expansion. In fact, quarter results show that costs have increased and margins have marginally contracted.
The story that the markets are telling us is that ResMed will benefit from the global economic slowdown and the gap left by Philips. The big question now is how long this growth will last. We expect ResMed’s revenues to continue growing in the short term and then begin to revert to its mean of mid-single-digit growth by FY26. This is exactly what the markets are pricing-in at current levels. RMD shares are now trading at 36x forward FY23 P/E and 32x FY24 P/E. This is fairly priced, in our opinion.
ResMed is benefitting from the global economic slowdown. The company can now access more semiconductors to produce its products and is therefore manufacturing and selling more. RMD has taken advantage of major competitor Philips’s absence from the market – leading to high growth quarters and increased market share.
While ResMed sells more and generates more revenue, margins have yet to expand. Costs have increased, as is the case with manufacturing firms in an inflationary cycle. We can expect revenue growth to normalise by reverting to its mean over the next 3-year period and margins to expand as inflation subsides. This is being priced in, and we think ResMed is fairly valued at current prices.
RMD’s share price has once again reached the strong resistance level of $36 (the blue line on the chart). This resistance level has reversed the share price multiple times in the last 18 months, and this time’s price action to the level is again indicating the price is not likely to break above the strong resistance in the short term. From a technical analysis perspective, the big black candle formed in the weekly time frame (pointed with the arrow) is an indication of high conviction on the side of sellers and substantially reduces the chances of share price advances above the $36 resistance level in the short term. We recommend investors with exposure to ‘Hold‘ positions.
Resmed, Weekly Chart in Semi-log Scale (Source: Metastock)