Resmed – 3rd quarter results

Resmed – 3rd quarter results

Resmed has just announced another record quarterly result. For those unfamiliar with Resmed, the company is a manufacturer of flow generators and masks for sufferers of Obstructed Sleep Apnea (OSA). OSA is a condition that causes the airways to temporarily close while sleeping (apnea means “without breath”).

At Montgomery Investment Management, we believe that Resmed is an extraordinary company that is comparable to Cochlear and CSL. Indeed, the company has just announced their 73rd consecutive quarter of earnings growth!

We hold Resmed in the Montgomery Private Fund and the Montgomery Fund. Subscribers to ‘Locked Content’ here at the insights blog (you can join by clicking the SUBSCRIBE FOR FREE button on the right hand side of the page) will receive a detailed article about the company in our next exclusive content release. For now let’s take a look at their latest results.

The beauty of Resmed is the clarity of their financial metrics, which provides investors with a clear awareness of the company’s financial position. Management has once again achieved these metrics to great effect – earnings per share has grown by 31 per cent over the quarter. Let’s break this down.

Revenues are derived from sales of flow generators and masks. Globally, flow generator sales increased by 14 per cent, while mask sales increased by 5 per cent. America has been the primary drive of growth, with flow generator sales up 21 per cent, while mask sales were up by 8 per cent.

Mask sales have been a little soft, particularly outside of America. This is partly due to two competitors (Fisher & Paykel and Philips Respironics) releasing new masks during the quarter. Resmed is stealing market share primarily through flow generators, and is expected to increase their mask sales with a range of upcoming product launches. Management has announced that it will introduce two new masks in the fourth quarter, and that many more products will be announced in the coming financial year.

The strong product pipeline will also provide a buffer against the impact of Medicare reimbursement cuts in the US. For those not familiar with this issue, the US health care system is very inefficient – Medicare has reportedly paid three to four times more than the price that pharmacies or retail stores charge for the same medical equipment. As a result, Medicare has recently announced that reimbursement rates will be cut by up to 47 per cent. Medicare reimbursements are estimated to comprise 12 per cent of Resmed’s revenue base, and it is thought that the extent of these cuts may force Resmed to decrease their own prices by around 5 per cent. For the third quarter, competitive bidding does not appear to be applying pressure to Resmed’s sales in America, but we are mindful of the impact they will have as they are introduced in FY14.

The amazing thing about Resmed is their gross profit margin, which has historically been above 60 per cent. As a comparison, Philips has a gross margin of 40 per cent on a firm-wide basis, while Cochlear and CSL have gross margins of 56 per cent and 48 per cent respectively. In the third quarter, Resmed achieved a gross profit margin of 62.4 per cent.

This margin expansion can be attributed to their increasing production capacity in Singapore. Management has stated that around 60 per cent of production occurs in Singapore, and we expect that this will increase over time. Producing in Singapore frees up Resmed’s working capital, decreases its cost base, and provides an effective tax rate of 21 per cent (the tax rate in Singapore is 15 per cent, compared with America’s tax rate of 30 per cent rate).

Resmed has two critical operating expenses that are efficiently managed relative to sales. Management’s core focus is managing Research and Development expenditure in order to produce superior products. While management has stated that they are not officially targeting a margin of R&D expenditure relative to sales, the market has come to expect expenditure of 8 per cent relative to sales, and this margin was once again achieved in the third quarter. The other key operating expense is Selling, General and Administrative, and this has once again been maintained in its historical range of 28 to 29 per cent of sales.

Finally, the company has amassed sizeable cash holdings. Cash holdings surpassed $1 billion this quarter, while net cash increased to $671 million. This will enable management to continue repurchasing shares, which in turn will increase earnings per share in the future. We are curious about what management are going to do with such massive cash reserves though…

Over at Montgomery Investment Management, we are very comfortable with Resmed’s recent results – the company is expanding their share in a market which is also expanding. We are mindful that future quarters may produce softer numbers, but we believe that the company has a product pipeline and supply chain that will sufficiently insulate these impressive returns from future shocks.

Montgomery Funds own shares in Resmed.