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Date : 05/11/2021

ResMed

ASX :

RMD

Market Cap : $52.06 Billion

Dividend Per Share : $0.15

Dividend Yield : 0.42 %

Buy

52 Week Range : $23.48 - $40.79

Share Price : $35.87

Top quality stock that delivers consistent year-on-year returns to investors. We recommend a "Buy".

Company Analysis

ResMed (ASX: RMD) is huge. Dual listed on the NYSE and ASX and selling their products in over 140 countries. ResMed develops, manufactures, distributes, and markets medical devices and cloud-based software applications for the healthcare markets. The company primarily operates in the Sleep and Respiratory Care segment, and quite recently, they are even operating a SaaS platform to manage patient outcomes, provide customer and business processes, etc.

Given their sheer strength in scale of operations and market leading products, ResMed is a proven long-term winner. We recommended ResMed over a year ago, back in October 2020 at a price of $25.51. Since then, RMD shares have returned 40.6%. During this time, ResMed shares have outperformed the ASX 200 Healthcare Industry by a massive margin. In the past year, RMD shares have returned 28%, while the ASX 200 Healthcare Industry has returned 8.9%. The outperformance can be seen in the chart below and it just goes to show the strength of ResMed as a global leader in what they do.

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Source: Tradingview.com

While Covid19 has ravaged certain businesses, it looks like ResMed has benefitted from the pandemic. The shift towards tele-medicine and out-of-hospital care has accelerated ResMed’s strategy of serving 250 million people by 2025 through its out-of-hospital healthcare.

The demand for ventilators has soared because of the pandemic, and the firm has increased its manufacturing capacity by 3.5x compared to the previous year in order to accommodate. ResMed has produced over 150,000 ventilators in the 6 months of Covid19 outbreak.

Operationally, The company is now cycling elevated quarterly and annual prior year numbers. During the midst of COVID-19, ResMed incurred an abnormal spike in demand for ventilators totalling $125 million. This demand has now subsided to $20 million in sales.

Management noted the ongoing recovery of sleep apnea and COPD patient flow across the business as markets reopen. Some countries remain at 75% whereas others are back up to 95%.

Furthermore, the company is driving accelerated adoption across its digital health solutions, which keep patients out of hospitals thus reducing the total cost of care. Subsequently, software-as-a-service revenue increased 5%.

Therefore, FY2021 was a remarkable year for ResMed, especially Q4 FY2021. During the June quarter, ResMed derived incremental respiratory care revenue from COVID-19 related demand of approximately $20.0 million whereas the prior year quarter included incremental revenue of approximately $125.0 million. Excluding the impact of the incremental respiratory care revenue associated with COVID-19, revenue increased by 29% on a constant currency basis.

Revenue in the U.S., Canada, and Latin America, excluding Software as a Service, grew by 18%, driven by increased demand for the company’s sleep devices and masks, including recovery of core sleep patient flow that was previously impacted by COVID-19 and increased demand following a recent product recall by one of ResMed’s competitors, partially offset by decreased COVID-19 related demand for our ventilators.

Rival Royal Philips has a €250 million problem with deterioration of the sound abatement foam used in its first generation DreamStation flow generators for people with obstructive sleep apnoea (OSA), which is likely caused by unapproved cleaning methods and higher humidity environments. This enabled ResMed to step in despite manufacturing bottlenecks and take advantage of the situation, leading to increased sales for FY21 and beyond.

Revenue in Europe, Asia, and other markets grew by 2% on a constant currency basis, primarily driven by strong sales across their mask product portfolio, partially offset by lower device sales due to the incremental COVID-19 respiratory care revenue generated in the prior year quarter. Excluding the impact of the incremental respiratory care revenue associated with COVID-19, revenue increased by 35% on a constant currency basis.

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Source: ResMed

Software as a Service revenue increased by 5%, due to continued growth in resupply service offerings and stabilizing patient flow in out-of-hospital care settings. Gross margin decreased by 230 basis points and non-GAAP gross margin decreased by 260 basis points, mainly due to an unfavourable product mix, specifically a proportional increase in lower-margin Sleep devices, lower average selling prices, and unfavourable foreign currency movements. These minor impacts normalise in the long-run and hence is not a reason of concern for long-term investments.

Looking at the segmented revenue chart above, the distribution has not changed much since FY2020. This means that the core of the business is very strong and all their segments, that is, Devices, Masks, and SaaS are performing extremely well and growing consistently.

By geography, it’s a similar story. The Americas continues to be the largest market for ResMed, followed by Europe and Asia. The USA SaaS market also contributes to 12% of overall revenues. Geographically, the distribution has remained the same since FY20, which is a characteristic of a mature firm that knows exactly what it is doing operationally.

Selling, general, and administrative expenses increased by 4% on a constant currency basis. SG&A expenses improved to 20.7% of revenue in the quarter, compared with 21.5% in the same period of the prior year. These changes in SG&A expenses were mainly due to increases in employee-related expenses, partially offset by a reduction in doubtful debt expenses.

Income from operations increased by 8% and non-GAAP income from operations increased by 7%. Net income grew by 10% and diluted earnings per share grew by 9%. Cash flow from operations for the quarter was $226.5 million, compared to net income in the current quarter of $195.1 million.

For the full year FY21, ResMed delivered:

  • Revenue growth of 8% to $3.2 billion; up 6% on a constant currency basis
  • Gross margin of 57.5%; non-GAAP gross margin contracted 70 bps to 59.1%
  • Income from operations growth of 12%; non-GAAP operating profit up 12%
  • Diluted earnings per share of $3.24; non-GAAP diluted earnings per share of $5.33

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Source: ResMed

ResMed has thus delivered fantastic value over the last 5 years to investors. From the chart above, we see that revenues have grown by a CAGR of 12%, Operating Income by a CAGR of 16%, and EPS by a CAGR of 15%. ResMed has been able to deliver these consistent performances due to their consistent growth and innovation in respiratory care and investments in R&D.

Company Updates – FY22 off to a flyer

Following on from a tremendous FY21 performance, ResMed has kicked off the new financial year very positively.

Key highlights from the first quarter ending 30 September include:

  • Revenue of US$904.0 million, up 20% year-on-year (YoY) and 3% quarter-on-quarter (QoQ)
  • Gross margin of 57.2%, contracting 260 basis points
  • Operating profit of US$261.9 million, up 21% YoY and 8% QoQ
  • Diluted earnings per share of US$1.39

ResMed continues to benefit from a product recall by major competitor Philips in addition to the rising demand for sleep and respiratory care devices. ResMed CEO Mick Farrell noted on the investor call that the recall is “tenfold higher than any in the industry to date”. The benefits from the increase in demand can be seen in the charts below. Revenue growth compared to the previous corresponding period has sky-rocketed in Q1 FY22.

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Source: ResMed

Revenue grew by 19% on a constant currency basis, driven by increased demand for our sleep and respiratory care devices and increased demand following a recent product recall by one of our competitors, partially offset by decreased COVID-19 related demand for ventilators.

The quarter did not include material incremental respiratory care revenue from COVID-19 related demand whereas the prior year quarter included incremental revenue of approximately $40.0 million. Excluding the impact of incremental respiratory care revenue associated with COVID-19 in the prior year quarter, revenue increased by 25% on a constant currency basis.

Revenue in the U.S., Canada, and Latin America, excluding Software as a Service, grew by 22%, primarily due to the factors discussed above and recovery of core sleep patient flow that was previously impacted by COVID-19. Excluding the prior year impact of incremental respiratory care revenue associated with COVID-19, revenue increased by 28%.

Revenue in Europe, Asia, and other markets grew by 21% on a constant currency basis, primarily due to the factors discussed above and strong sales across our mask product portfolio. Excluding the prior year impact of incremental respiratory care revenue associated with COVID-19, revenue increased by 29% on a constant currency basis. Software as a Service revenue increased by 6%, due to continued growth in resupply service offerings and stabilizing patient flow in out-of-hospital care settings.

The revenue distribution is unchanged, emphasising the strength once again.

Income from operations increased by 21% and non-GAAP income from operations increased by 18%. Net income grew by 14% and diluted earnings per share grew by 14% as well. Non-GAAP net income grew by 20% and non-GAAP diluted earnings per share grew by 19%, predominantly attributable to strong sales.

Operating cash flow for the quarter was negative $65.7 million and was impacted by a payment to the Australian Tax Office of $284.8 million, which was the settlement amount of $381.7 million net of prior remittances. After adjusting for this payment, our operating cash flow for the quarter was $219.1 million, compared to net income in the current quarter of $203.6 million and non-GAAP net income of $222.0 million.

Setting up for Growth

During Q1 FY2022, ResMed Introduced the AirSense 11 in the U.S., ResMed’s next-generation PAP (positive airway pressure) device designed to help millions of people worldwide with sleep apnea start and stay on therapy to treat and manage obstructive sleep apnea.

ResMed also announced the promotion of Bobby Ghoshal to president of ResMed’s SaaS business. The firm presented new research at the European Respiratory Society (ERS) International Congress 2021 including the landmark ALASKA study, “CPAP Termination and All-Cause Mortality: a French Nationwide Database Analysis,” that concludes people with obstructive sleep apnea who continue PAP therapy are 39% more likely to survive than OSA patients who don’t.

During the quarter, ResMed concluded the settlement agreement with the Australian Taxation Office (“ATO”), which fully resolves the transfer pricing dispute for all prior years since 2009. ResMed previously recognized a tax reserve in fiscal year 2021 in anticipation of the settlement. The net impact of the settlement was $238.7 million ($381.7 million gross less credits and deductions of $143.0 million). The settlement provides closure for historic Australian tax matters and greater clarity into the future. As a result of the ATO settlement and due to movements in foreign currencies, recognized a $4.1 million reduction in tax credits during the quarter, which was recorded as an increase in income tax expense.

Industry Analysis

ResMed is targeting a very large market across Sleep Apnea, Chronic obstructive pulmonary disease (COPD), and Asthma. What they have going for them is the fact that they are leading the market across all 3 industries. The impact on their major competitor, Philips has significantly boosted the demand for ResMed’s products.

All 3 of these market segments are related to respiratory illness and have a lot of undiagnosed patients according to the World Health Organisation. Given the long-term impacts of Covid19 and the fear it has set into the general population, we expect there to be a gradual uptick in the amount of diagnosis as people become much more aware. ResMed’s products are sold globally and there are several developing markets such as India, Brazil, etc that will see this trend of more diagnosis emerging in the next few years.

The largely undiagnosed COPD sufferers in high-growth markets such as China, India, Brazil, and Europe is greater than 100 million. Acute treatment costs to healthcare systems are large: Europe: €48B per year and USA.: ~$50B per year. ResMed mentions that their Total Addressable Market in the COPD segment is 380 million patients.

When it comes to Sleep Apnea, this is where a majority of the growth lies. Even in developed markets, this is a largely undiagnosed issue and one that is gaining the attention of sufferers fairly quickly. Sleep Apnea is a leading indicator and a contributing factor to several chronic illnesses. With over 80% of sufferers still undiagnosed, ResMed says that their Total Addressable Market is 936 million patients.

Asthma is the most common of all the respiratory illnesses. However, the diagnosis problem arises in developing markets once again. The Total Addressable Market here sits at about 330 million patients. Again, quite a large number for ResMed to benefit from.

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Tying all of these together, ResMed’s SaaS platform and digital innovation positions the firm for continued treatment following diagnosis. Why is this important? Because it enables ResMed to generate recurring revenues – a hallmark characteristic of any service based business model. Continued therapy is how ResMed will keep a hold of their market leading position.

To boost their market dominance and ensure that more patients are being diagnosed, ResMed has opened up new channels by partnering with companies such as CVS Health. This will allow ResMed to expand their penetrative ability and serve more patients in the long-term.

Investment Thesis

We believe that the sleep apnea and respiratory care markets will continue to grow in the future due to a number of factors, including increasing awareness of OSA, CSA and COPD, improved understanding of the role of sleep apnea treatment in the management of cardiac, neurologic, metabolic and related disorders, improved understanding of the role of non-invasive ventilation in the management of COPD, and an increase in the use of digital and product technology to improve patient outcomes and create efficiencies for customers and providers.

We expect ResMed to capitalize on the growth of the sleep apnea and respiratory care markets, as well as growth in out-of-hospital care settings by:

Continuing Product Development and Innovation in Sleep Apnea and Respiratory Care Products. In addition to the new products coming out, ResMed has not been shy of acquisitions. There have been noteworthy acquisitions in both – Sleep Apnea segment and the COPD segment.

Broaden digital health technology foundation – Digital enablement is central to ResMed’s strategy. The cloud-based digital health applications, along with our devices, are designed to provide connected care to improve patient outcomes and efficiencies for their customers, allowing fewer professionals to manage more patients and empower patients to track their own health outcomes. The combination of continued product development, product and technology acquisitions and innovation are key factors to the ongoing success.

Expand Geographical Presence – ResMed already sells their products to over 140 countries to sleep clinics, home healthcare dealers, patients, and third-party payors. The firm intends to increase sales and marketing efforts in principal markets, as well as expand the depth of their presence in other high-growth geographic regions. In 2016, ResMed acquired Curative Medical to invest in the Chinese market and expanded their growth potential in sleep apnea, COPD, and respiratory care in China. In 2019, ResMed acquired HB Healthcare, a privately owned HME that serves both reimbursed and cash-pay customers of sleep and respiratory care devices in South Korea. In 2021, acquired Tong-il, another leading sleep and respiratory care HME provider in South Korea, reinforcing both – commitment and capability to serve millions of South Korean patients living with sleep apnea, COPD, and other chronic respiratory diseases.

Given the strategies at work and the favourable operating environment with ResMed’s biggest competitor impacted, we expect the firm to grow its revenues by 17%-18% in FY22 and by about 7% in FY23. The Net Profit Margin of ResMed has been climbing recently, however, the expectation is that growth here will lag due to two factors:

  • The bottlenecks in the manufacturing process
  • Increased shipping costs that continue to hamper export

While these impacts will be at large, we do expect the substantial demand to offset some of the impacts – resulting in ResMed continuing to grow its profits and also increase its Net Profit Margin, albeit modestly.

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The Balance Sheet of ResMed is rock-solid. The solid revenue stream supported a strengthening balance sheet. During FY21, ResMed decreased its debt by more than 31% year on year. ResMed’s principal sources of liquidity comprise its ample cash position, cash generated from its operations and access to its revolving credit facility. ResMed primary uses of cash have been for research and development activities, capital expenditures, strategic acquisitions, and investments, along with dividend payments.

As of the end of FY21, ResMed had a cash position of $276.1 million and $295.3 million of cash equivalent which is abundant to support the company’s working capital over the next few years.

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We have compared the Return on Equity of ResMed with two of its competitors, HRC and CNMD in the US market. We have found that RMD on a trailing twelve-month basis outperforms both of its peers with an ROE reading of 18% compared to HRC and CNMD with 14%, and 9%, respectively. Extending our analysis, we have computed the average and the median ROE over the last 5-year period, and we have been pleased to see that ResMed still has by far has a better return on equity compared to its competitors with an average ROE of 20% and a median ROE of 19%.

The valuation of ResMed may seem high. However, the stock has been pricing in the substantial increase in revenue and earnings that are coming ResMed’s way. ResMed’s market dominance is also another factor that makes its way into the multiples.

With ResMed expected to grow its revenues by around 18% in FY22, its operating similar to a growth Tech stock, rather than a healthcare stock. Given the prospects and outlook, we are comfortable with the 41x P/E and the 28x EV/EBITDA for FY22.

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Technical Analysis

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Trend

Another revenue jump was not enough for investors to pile onto Resmed since the company released its earnings report on the 29th of October. Shares in the global medical device company Resmed are sliding by 6.2% since then.

At the time of writing, Resmed shares rebounded marginally by 1.13% closing the day at $35.73 apiece. What exactly drives the company’s price action? Resmed came in with a quarter that was ahead of analyst expectations, exhibiting a period of decent growth throughout its income statement. For instance, the company’s revenue grew by 20% year-on-year to US$904 million, around $46 million above the consensus of analyst estimates for its Q1 sales. This has been reflected in the company share price that appreciated by almost 50% from early 2021 to September 2021. By September 2021, Resmed reached its all-time high at $40.79 per share.

Yet, despite the growth, the company’s gross margins contracted by around 270 basis points to 56%. This was the result of higher shipping and manufacturing costs across the board during the calendar year 2021 to date. This was negatively received by the market which weighed on Resmed’s share price pushing RMD down to its 38.2% Fibonacci level at $35.5. As of today, RMD is trading about 12.4% below its all-time high.

Key price levels

RMD has found some support at its near-term floor at $34.5, which coincides with the 38.2% Fibonacci level. RMD share prices are currently capped in the $34.5 – $36.9 range. If a clear breakout occurs at the top of the range, there would be an opportunity for the next bull run towards the level around the $39 per share which saw tremendous volume on the 17th of September with more than 6 million shares exchanged. This is a relatively positive sign that could lead to another all-time-high breakout towards our price target of $43 per share.

Volume and momentum

Volume slightly increases since the last 200-day with the 20-day volume average up by 4.2%. The price action remains bullish in the near term, evolving in a range between $34.5 and $36.9 per share.

Trade consideration

  • Market participants might be interested to enter a key support level of $34.5 per share.
  • Primary target price above $43 per share
  • Secondary target price at $45 per share
  • Consider reducing exposure below $34 per share
  • It is recommended exiting the trade below $32 per share

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Recommendation

ResMed has been a solid performer since the last few years. The firm has delivered consistently and is hence one of the top quality growth stocks on the ASX. In the past 5 years, ResMed has grown its EPS at a CAGR of 15%. We expect this to continue with a favourable operating environment that the company now finds itself in. ResMed dominates the market, is looking to expand its already sizable footprint, continues to push the product development and innovation boundaries and is estimated to grow its revenues by 18% in FY22. Given the robust outlook, the solid balance sheet, and the excellent operating metrics over its peers, we continue to recommend long-term investors to “Buy”.

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