- Strong Aussie dollar hurting ResMed - Revenues and margins weaker in March quarter - Broker views remain divided on the stock

By Chris Shaw

Sleep disorder group ResMed ((RMD)) delivered third quarter results last week, the result showing expected weakness in revenues and some margin pressures given adverse movements in the Australian dollar relative to the US currency.

Also hurting revenues were disappointing bi-level flow generator sales, as ResMed's current bi-level platform is a generation older than that of Respironics, its main competitor. This trend should reverse in coming quarters as ResMed rolls out its new S9 bi-level product in global markets.

Assuming foreign exchange rates stabilise and as ResMed releases new higher margin products, Credit Suisse expects ResMed's margins will recover in coming quarters. Less discounting should also help, as UBS notes all major variants within the S9 roll-out have now been released.

The margin pressures meant earnings for the period of US$53.4 million, while up 9% compared to the previous corresponding period, fell short of consensus estimates. The result was not all disappointing in the view of Macquarie, as masks and accessories posted strong global growth and the S9 generator delivered double-digit sales growth.

Mask and accessory growth remains a key in the view of BA Merrill Lynch, as the ever growing installed client base continues to consume more replacement cushions and tubing. This gives BA-ML greater confidence sales growth numbers for the Masks division can be sustained.

As well, Macquarie notes the March quarter result showed home sleep testing continues to grow solidly, while ResMed continues to push into the invasive and hospital breathing device market with the launch of the Stellar 150 device.

Post the quarterly there have been relatively modest adjustments to earnings estimates for ResMed. The FNArena database shows earnings per share (EPS) estimates now range from US14c-US16.8c for FY11 and US15c-US20.9c for FY12.

Small changes in market earnings estimates have seen some adjustments in price targets, the consensus target according to the database declining to $3.63 from $3.74 previously.

JP Morgan's view of the March quarter result was less flattering, the broker being surprised by the 4% decline in US flow generator sales and the 252-basis point sequential decline in gross margins. As well, JP Morgan suggests the revenue decline in the period, despite double-digit growth in AutoSets, implies some loss of market share.

This leaves JP Morgan cautious with respect to ResMed's ability to plug deteriorating US revenues with the S9 bi-level model, particularly as flow generator platform life cycles appear to be shortening dramatically.

For JP Morgan this is enough to justify a downgrade on ResMed to Neutral from Overweight, as the growth concerns make it questionable whether the stock deserves a current earnings multiple of around 20.7 times.

JP Morgan's earnings forecasts reflect this cautious view, the broker forecasting EPS of US14.8c for FY11 and US15.9c for FY12. These are among the lowest in the FNArena database.

The downgrade in rating by JP Morgan was the only change according to the FNArena database, which shows ResMed scoring four Buy ratings and four Hold recommendations. Southern Cross Equities is not in the database but also ascribes a Hold rating to ResMed, having downgraded from Accumulate previously.

The downgrade reflects concerns over the ongoing strength in the Australian dollar, as this continues to weigh on earnings. As a result, Southern Cross suggests ResMed's share price will remain weak until the US dollar strengthens.

BA-ML is also among those rating ResMed as a Hold, reflecting some concerns whether Home Sleep Testing growth is shrinking growth elsewhere and whether the S9 is good enough to cannibalise other sales. If this proves to be the case, BA-ML suggests there would be a fall in the speed of any top-line recovery in VPAP ventilator sales.

Citi is more positive, expecting new product launches will support good growth for ResMed, while leverage to any depreciation of the Australian dollar against the greenback offers another source of possible upside.

Citi's numbers suggest a 12-month forward earnings multiple of around 17 times, which is viewed as attractive given forecast EPS growth of 15% in FY11. With ResMed holding net cash of almost $600 million at present, Citi retains a Buy rating.

Shares in ResMed today are slightly weaker and as at 11.20am the stock was down 2c at $2.93. Over the past year ResMed has traded in a range of $2.85 to $7.97. The current share price implies upside of around 24% to the consensus price target in the FNArena database.

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