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Opportunity for ResMed in Philips recall

Nicki Bourlioufas  |  29 Sep 2021Text size  Decrease  Increase  |  
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Shares in ResMed soared to record highs this month after a major competitor was forced to recall its sleep device products. The incident has given the medical equipment company a 'rare opportunity’ to expand its market share, analysts say, after diagnosis rates lagged during the pandemic.

ResMed peaked at around $40 in late August, the highest price the company has seen in two decades.

Morningstar analyst Shane Ponraj said ResMed’s recent run was driven by the recall of up to 4 million Philips sleep apnea devices and mechanical ventilators in July, leading to strong demand for ResMed products. He anticipates Philips will take over 12 months to replace all affected units.

"While affected customers can wait for a replacement or buy an alternative Philips product, such as the recently launched DreamStation 2, we think ResMed will see considerable elevated demand from a portion of these customers switching, as well as new customers doubting Philips’ reputation," he says.

The only thing likely to constrain RedMed is the current global chip shortage as demand outstrips supply, Ponraj says.

Ponraj has increased Morningstar’s fair value estimate to $34; ResMed’s shares are currently trading around $37.29, up 37 per cent over the year, after striking a record high of $40.79 in August. Growth, he says, will also come from the launch of its new flagship product, AirSense 11, and the recovery of diagnosis rates to pre-pandemic levels.

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“Narrow-moat ResMed's fiscal 2021 earnings before interest and tax (EBIT) of US$904 million was in line with our expectations, but the real focus of the result was current unprecedented demand due to Philips' recent product recall," Ponraj says.

“As a result, management guided to US$300 million-US$350 million in additional global device revenue in fiscal 2022 on top of originally planned growth. The midpoint of guidance alone implies a 21 per cent uplift on fiscal 2021 global device sales, excluding coronavirus-related ventilator sales.”

“The opportunity to structurally gain market share over the next two years is more significant than we previously credited and is the largest driver of the 68 per cent increase in our fair value estimate to $34 at current exchange rates.

RedMed’s June quarter revenue jumped 10 per cent (on a constant currency basis) to $US876.1 million, with full-year 2021 revenue rising 6 per cent to US$3.2 billion. Operating profit for the year jumped 12 per cent to US$993.8 million in 2020-21. The jump in sleep device and mask sales helped to offset a fall in Covid-19 related demand for its ventilators, which had boosted revenue in 2020.

Market share expansion

Analysts at Ord Minnett say ResMed has been gifted a rare opportunity to expand its already leading position in the sleep apnea market.

“This should allow ResMed to expand its market share, with the near-term opportunity potentially worth more than US$500m,” the stockbroker said in a research note.

“We estimate ResMed’s sales figures will improve a modest 5 per cent above our previous forecasts due to the competitor’s product recall, offset somewhat by supply constraints. We expect the gains to be held in the medium term despite the expected recovery in the competitor’s ability to supply by the end of FY22.”

“We maintain our ‘accumulate’ recommendation and have raised our target price to $32.00 from $28.50.”

Andrew Tang, equity strategist with Morgans, adds the recent fall in the Australian currency has boosted ResMed’s local share price to record highs. Morgans has revised up ResMed’s FY2021 to2023 expected earnings by 18 per cent and boosted its target price on the stock to $41.34.

“We estimate the recall gain [for ResMed] is 40 per cent of Philips’ sleep device revenue (US$780m), or 13 per cent of its market share (assuming it holds 33 per cent share of a US$2.3 billion market),” says a Morgans note.

“That said, the sustainability of potential market share gains is difficult to game, given the uncertainty around not only Philips’ response and more limited industry diagnosis capacity … but also ResMed’s ability to fully benefit from pent up demand as it needs to debottleneck global supply chains.”

Citi is also confident of ResMed enjoying a sustained increase in market share. “The company has well defined long-term strategic plans to enable it to continue to grow the market and its market share within that. We believe the launch of the AirSense 11 this year, alongside the recall of the Philips DreamStation device will enable ResMed to increase its long-term market share by 10 per cent.”

Mixed year for other healthcare stocks

Other healthcare stocks have had a mixed year. While Covid-19 helped boost the fortunes of those involved in the nationwide testing and vaccination effort, the sector's largest company suffered, dragging down the rest.

CSL has seen disappointing blood plasma collections due to Covid-19 restrictions, as well as rising costs for collection increasing due to new hygiene measures. In contrast, strong performances have been staged by Sonic, Cochlear and Healius, all trading around record highs

“The clear Covid-19 benefactors this year have been pathology providers Sonic and Healius (formerly Primary Health Care) with elevated Covid-19 testing persisting,” says Morningstar analyst Shane Ponraj.

“However, we think the overall effect of Covid-19 on the healthcare sector is broadly neutral and continue to see the winners and losers of Covid-19 revert to their prior trajectories.

"For example, pandemic-induced demand for Ansell’s single-use gloves and Fisher & Paykel’s hospital hardware is normalising while CSL’s plasma collections are recovering to pre-pandemic levels.”

The healthcare sector is considered defensive as long-term demand for health products and services is relatively inelastic and underpinned by basic human need, says Ponraj. As a result, the healthcare sector in Australia and globally is less volatile than many other sectors of the share market.

Morgan Stanley global healthcare analysts like Medibank Private for its expanding healthcare presence and its role as Australia’s largest private health insurer.  Medibank is trading just below its all-time high at $3.55, a premium to Morningstar’s fair value of $3.30.

“If Medibank Private’s new hospital model is successful, we see a price-earnings) P/E re-rating, and over a five-year period, our sensitivity analysis suggests the stock could double. We have a [price target] of $3.80, we see a 4 per cent-plus dividend yield in FY22, and an ungeared balance sheet that supports healthcare service expansion,” says a Morgan Stanley research note.

Morningstar Analyst Nathan Zaia says Medibank, which has a narrow moat, has boosted its profitability and offers investors an attractive margin.

“Medibank's fiscal 2021 profit increased 40 per cent to $442 million, beating our forecast by 14 per cent. The earnings beat and jump in profit is largely driven by volatile investment income, and the impact of the coronavirus on [reduced] claims. The underlying result is sound and there's plenty in it to support our narrow moat rating,” he said.

“Expenditure on healthcare is expected to grow in the long term, underpinned by an increasing and ageing population. Operating in a heavily regulated industry, Australian health insurers typically produce stable and defensive earnings and, in our opinion, Medibank is well placed to produce solid long-term earnings growth,” says Zaia.

Other stocks that represent good growth prospects include regenerative medicine company Avita, according to Morningstar’s Ponraj. “We think Avita had a good result with fourth-quarter commercial revenue up 45 per cent sequentially as burn-related accidents in the US normalise and its device is seeing greater utilisation.  We think there’s a path to profitability by fiscal 2024 and remains undervalued for long-term investors with higher risk tolerance.

“Other stocks in our healthcare coverage that we think are undervalued or trading near fair value are Sigma, Blackmores, and Ansell,” says Ponraj.

 

is a Morningstar contributor.

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