ResMed takes a breather

Have you ever had one of those cars that wouldn't stop stalling at intersections? You might get a similar feeling from ResMed. 

Revenue growth slowed compared to last year but sales still increased 11% to US$1.2bn for the six months to December after removing the effects of currency fluctuations. Worse things have happened to companies than 11% revenue growth, so to understand the problem we need to split that growth into its components. 

The company's high-growth software-as-a-service business - led by Brightree and the recently acquired MatrixCare - increased revenue by a hearty 44%. Software, however, only accounts for around 10% of sales so barely moves the needle.

ResMed's real breadwinner is its continuous positive airway pressure (CPAP) device and masks business. Here, sales were decent in the US, Canada and Latin America, where revenue rose 9%. 

Unfortunately, European and Asian sales came to a standstill in the final three months of the year, with device sales falling 2% on a constant currency basis. The poor result was attributed to a lack of device sales in Japan and France, where a rush of purchases following the introduction of government incentives earlier in the year began to subside.

In early 2018, France and Japan introduced new reimbursement models that favoured remote monitoring technology for sleep apnea patients as a way to encourage adherence and reduce healthcare costs. Patients received a higher rebate when they were compliant with their therapy. ResMed experienced a wave of purchases early in the year from patients looking to take advantage of the savings; but with that initial rush now out of the way, it looks like sales have flatlined.

Management said: 'While we have been thrilled with the digital reimbursement changes in France and Japan during 2018 and they will have great long-term benefits of increased adherence in those geographies, we expect that the impact in France and Japan will be present for the next few quarters.'

Margin improvement

Were it just a matter of government incentives and slowing growth, we wouldn't be so concerned. However, it was discouraging to see a fourth consecutive year of declines in average selling prices in 2018, mostly due to a price battle with Fisher & Paykel Healthcare and other competitors (see ResMed: Managing costs to stay ahead). 

The combination of falling prices in the US and falling sales in Europe suggests a highly price-conscious customer base. What's more, both factors support our theory that management's recent acquisition of MatrixCare for US$750m reflected a desperation to grow the company at any cost (see ResMed's latest eyebrow raiser). 

To protect itself from competitors, ResMed needs to distinguish its machines - and it's trying to do that not by adding bells and whistles but by establishing a software footprint in various care settings, such as hospitals and aged-care facilities.

This will make patient record keeping easier and help with analysis. Essentially, ResMed wants to make life simpler for the doctors, who will - hopefully - then be more inclined to recommend ResMed's devices. The strategy sounds good on paper but it isn't yet clear whether it can deliver results. 

Falling prices this half were thankfully offset by keeping a lid on general and administrative expenses - which have fallen as a proportion of revenue from 33% to 25% over the past 10 years - so ResMed's gross margin increased from 58.2% to 58.9%. We commend management for its ongoing cost control, but we're mindful that a business only has so many costs it can cut before the quality of its product starts to fade. 

Underlying net profit rose 10% to US$261m and the stock trades on a forward price-earnings ratio of 28 based on consensus estimates for 2019 earnings. 

We'll leave the price guide unchanged for now, but a price-earnings ratio in the high 20s is becoming harder to justify without clear signs that the company's software strategy is supporting sales growth and selling prices. ResMed has now spent more than $2.0bn pivoting to its software-as-a-service business over the past few years. For now, our recommendation remains HOLD.