ResMed released strong Q2 2018 sales +11% y/y and adjusted EPS +37%. Our patience in Resmed early last year paid off, as the prior production issues have been resolved, lifting mask sales in the double digit range. The company will benefit from the US tax reform this year, lifting EPS by 13%. However this is a one-time event as FY19 will be impacted by the Australian taxation. We are raising our price target to $97 and maintaining our position in the stock.
Current Price: $87.5 Price Target: $97 (new, increased from $77)
Position Size: 2.16% TTM Performance: +37.6%
Thesis intact. Key takeaways from the quarter:
1. RMD reported strong top line and EPS growth
a. Overall sales up 11% ex-FX
i. Masks sales up 13.3% (12.2% in US, helped by the end of year growing prevalence of high deductible health plans), well above market growth rate in the high-single-digit
ii. Devices sales up 9% (12.6% in US), well above the mid-single-digit market growth rate as the company is taking share
iii. Brightree (software) sales +14.5%
b. Gross margin of 58.2% saw a 10bps decline sequentially due to lower selling prices, but partially offset by better procurement and manufacturing efficiencies
c. Adjusted EPS growth was +37%
d. Share buyback to offset share issuance throughout the year
2. FY18 guidance
a. Gross margin ~58.2% for the year, lower than our expectations as we were initially hoping for a lift following new masks introduction. However, the company is guiding to better operating leverage, lowering SG&A to 25-26% vs. 26-27% it guided to 6 months ago (and 27% it had in FY17)
b. We like the 7% spend in R&D, supportive of innovation (and thus potential growth longer term)
c. FY18 tax rate of 15-16%, due to new tax regulation on foreign earnings repatriation, lifts FY18 EPS by 13%. However FY19 EPS should see a return to historical levels of 21-23% due to the Australian taxation
3. Price target raised to $97 after incorporating better sales growth
a. Top line growth rate is sustainable as RMD is increasing market share in devices, and finally showing a pickup in new masks sales. We do not forecast a return to prior peak gross margin of 31% as the company invests in price to gain market share, but operating leverage from scale provides a lift in operating margins
b. The stock is supported by a ~3% FCF yield, and a stable dividend (current yield 1.6%)
c. The balance sheet is strong (net debt/EBITDA at 0.26x)
Thesis on RMD:
• Leading position in the underpenetrated sleep apnea space
• Duopoly market
• New product cycle
• Returns of capital to increase: ~1% share buyback/year (back in FY18), dividend yield of 2%