By Chris Shaw

Strong flow generator and mask sales helped sleep disorder group ResMed ((RMD)) deliver a strong full year profit result, with its earnings of US$190.1 million representing a 30% increase from the FY09 result.

According to Macquarie the gains in sales for new products are being driven by market share increases and given the S9 product was only released late in FY10, the broker suggests the market response has been impressive.

BA Merrill Lynch expects the top line gains will continue as the S9 has only been rolled out globally for one quarter so far. The broker sees scope for some positive margin impact from the success of the S9, though it points out the S9 is a lower gross margin product at about 50% compared to around 70% margin for masks.

Further success for the S9 is likely to be weighted to the second half of 2011 onwards from an earnings perspective in BA-ML's view. It can find a positive in this as well, noting greater S9 success increases the installed base for mask sales and so supports ResMed's long-term growth outlook.

Goldman Sachs is also positive on the outlook for sales from S9, as it points out coming quarters should see product upgrades in the lower-priced CPAP segment of the market.

The other positive with respect to mask sales, according to BA-ML, is ResMed has recently launched its wireless data upload module to attach to the S9. What this module does is improve patient compliance, which in turn means more masks are consumed. Given the higher margins on masks this is viewed as a positive for earnings growth overall.

Citi takes the view margins could have been a little better given the cost of goods sold in the S9 are lower than for previous products. Overall though Citi saw the margin outcome as solid given there are a number of moving parts in its composition.

The other positive for ResMed is ongoing developments in home sleep testing generally. Macquarie notes home testing remains an attractive alternative for diagnosing sleep disorders given it is significantly cheaper than the patient going to a sleep lab.

What the increased effectiveness of home testing could also achieve in Macquarie's view is to highlight the incidence of sleep disorders in the US. The broker sees this as helping grow the sleep testing market overall.

In Citi's view the earnings momentum ResMed has enjoyed in recent quarters should continue, as it is translating into improved operating leverage for the group. But one issue for Credit Suisse is market expectations for ResMed are now very high, so the fact fourth quarter sales largely met estimates means there may be some disappointment given earnings in the previous two quarters were well above forecasts.

Post ResMed's full year result changes to broker earnings estimates have been relatively modest, with Macquarie lifting its estimates by around 4% in both FY11 and FY12 and Citi cutting its forecasts by around 5%.

Southern Cross Equities also trimmed its earnings forecasts post the result, the changes reflecting a tough Australian dollar position at present. Consensus earnings per share (EPS) for ResMed according to the FNArena database stand at 31c and 37.4c respectively for FY11 and FY12.

The changes to forecasts see some changes to price targets, with the database showing an average target now of $8.34, down from $8.48 prior to the result. Recommendations are unchanged, with ResMed being rated as Buy eight times and Hold twice.

Morgan Stanley is not part of the FNArena database but the broker did downgrade ResMed post the profit result, moving to an Equal-weight rating from Overweight previously. Its sector view remains at cautious.

According to Morgan Stanley margins are in fact an issue for ResMed, as while revenues were in line with market estimates gross margins are falling short of what is required to meet the market's earnings per share expectations.

For these expectations to be met Morgan Stanley estimates ResMed needs to expand gross margins by around 170 basis points, something it sees as unlikely given sales growth for the S9 is not delivering the same numbers as when the S8 series was introduced in 2006.

Southern Cross Equities counters the Morgan Stanley view by arguing what is more important in increasing shareholder value in ResMed is not sales growth but gains being achieved in both working capital and cost discipline.

Success here should see margins improve, though Southern Cross suggests current adverse currency positions mean this may not be fully reflected in FY11 earnings. Southern Cross rates ResMed as Accumulate, with a price target of $8.00. Southern Cross is not a part of the FNArena database.

Shares in ResMed today are slightly weaker and as at 11.30am the stock was down 4c at $7.19. This compares to a range over the past year of $4.89 to $7.97 and implies upside of better than 16% to the average price target in the FNArena database.

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