F&P Healthcare: Result 2014

Fisher & Paykel Healthcare’s revenue increased 12% to NZ$623m in the year to 31 March, while operating profit increased 27% to NZ$143m. Net profit was NZ$97m, up 26%, due to increased sales of higher-margin products and cost cutting at the company’s manufacturing facilities.

Earnings per share rose 24% to 17.6 NZ cents and the board declared a final dividend of 7.0 NZ cents (ex date 18 Jun 14). This brings the yearly total to 12.4 NZ cents, for a yield of 3.1%. Shareholders from outside New Zealand will also receive a bonus 1.2353 NZ cents per share to offset the effect of New Zealand non-resident withholding tax.

F&P Healthcare’s two product divisions – Respiratory & Acute Care (RAC) and Obstructive Sleep Apnea (OSA) – both performed admirably. Revenue for the RAC division, which sells respiratory humidifiers and accessories, increased 14% in constant currency terms to NZ$337m, helped by a 29% lift in sales for devices used in non-invasive ventilation.   

Revenue for the OSA division increased 15% to NZ$270m, representing a strong comeback after the almost flat result last year. The performance was driven by a 26% increase in revenue from masks, thanks to the increasing popularity of the company's new range, including the Eson, Pilairo Q and new full-face Simplus. Innovation is the cornerstone of this industry so it was also a good sign that research and development spending rose 18% to NZ$54m.  

Tellingly, there was little mention of the company’s continuous positive airway pressure (CPAP) machines, which have had a difficult time competing against the likes of ResMed and Philips Respironics. Flow generator revenue still rose 5%, but it’s a tough market and we’d prefer F&P Healthcare to focus on its profitable niche in the masks and RAC business. 

Management noted that overall revenue growth for the RAC and OSA product groups was ‘about double’ the market. The results 'reflect that hospital clinicians and homecare providers are increasingly using our innovative products to help to improve care and outcomes,' as chief executive Michael Daniell put it.

Margin improvement

F&P Healthcare’s gross margin increased 393 basis points to 54.6%. The operating margin rose 342 basis points to 15.4% and is up from 8% just two years ago. The improved margins have been due to increased sales of higher-margin products, such as the Pilairo Q mask, and cost cutting initiatives at the company’s manufacturing plants.

Shifting some of the company’s manufacturing from Auckland to Tijuana, Mexico, where wages are lower, has been instrumental in reducing manufacturing costs. A further benefit of the move has been to reduce F&P Healthcare’s reliance on foreign exchange hedges by diversifying the cost base (more on this later).

F&P Healthcare’s Mexican facility is part way through a NZ$4m expansion that will increase the size of the plant by two-thirds. Management expects the facility to produce half the company’s consumables within three years.

Hedging headwind

F&P Healthcare incurs the majority of its costs in NZ dollars, which is also its reporting currency. However, the company earns 48% of its revenues in the United States and 24% in Europe. F&P Healthcare uses derivative contracts to hedge against foreign exchange movements and has benefited significantly in recent years due to the rise in the NZ dollar. Hedging gains contributed a whopping $55m, or 38%, of operating profit this year.

But the party’s almost over. As old contracts expire, the company must replace them with new derivatives at today's unfavourable exchange rates. This, as well as lower hedging activity overall, means the company faces an operating profit headwind of about NZ$32m in 2015. Management believes this will be offset largely by continued sales growth and net profit for 2015 is expected to be flat. However, this will be an ongoing battle for at least another few years.

F&P Healthcare is a high-quality company but, with the stock on a forecast price-earnings ratio of 22, it looks expensive for one whose growth will be held back by the hedging roll-off. The stock is up 6% since F&P Healthcare downgraded to Sell from 30 Jan 14 (Sell – $3.71) and is hovering just below our Sell price. SELL.