F&P Healthcare: Result 2017

Higher litigation costs from a dispute with ResMed didn't take the shine off this impressive result.

Seven years ago someone at Fisher & Paykel Healthcare had an idea: what if the company moved manufacturing to Mexico? Whoever it was deserves a tequila.

Since then F&P Healthcare’s gross margin has risen from 54% to 66%, including an impressive two percentage point increase in the year to March, while larger competitor ResMed’s has fallen from 60% to 58%.

The improved margin has been due to increased sales of higher-margin products and significantly reduced manufacturing costs due to the shift in manufacturing from Auckland to Tijuana, Mexico, where the cost of making a mask is some 30% lower.

Key Points

  • Mexican plant continues to boost margins

  • Tariffs should not cause disruption

  • No end in sight for ResMed litigation

Mexican manufacturing now comprises just over a third of total output, with the rest still coming from Auckland. In addition to the financial benefit, the move added a layer of insurance – operating from a single manufacturing site in earthquake-prone New Zealand had its share of risks.

The company recently purchased an additional 15-hectare site in Mexico on which it plans to build a second factory to increase production capacity in the region. A fourth building of 30,000sqm is also planned for the existing site. Both projects should be up and running early next year.

However, the expansion projects come at an interesting time (for want of a better word) under Donald Trump’s presidency. Trump’s on-again, off-again proposal to tax Mexican imports to fund a border wall would have significant consequences for F&P Healthcare, which earns almost half its revenue in North America.

‘Tariffs are never good,’ said chief executive Lewis Gradon in a January interview with Reuters. ‘We've got two plants, one in New Zealand and one in Mexico. We have the capacity to supply the United States from New Zealand if that makes more economic sense’.

Strong sales growth

F&P Healthcare reported a good result with revenue up 10% to NZ$894m for the year to March – and up 14% after removing the effect of currency fluctuations. Net profit rose 18% to NZ$169m.

The result was driven by growing use of the company’s products outside of intensive care, such as during surgery or in nasal high flow and non-invasive therapies.

Table 1: FPH result
Year to March 2017 2016 /–
(%)
Revenue (NZ$m) 919 808 14
EBIT (NZ$m) 245 206 19
NPAT (NZ$m) 169 143 18
EPS (NZ cents) 29.5 25.1 18
DPS* (NZ cents) 19.5 16.7 17
* Including a final dividend of 11.25 NZ cents (up 13%), unfranked, ex date 15 June

The real bread winner was the Hospital division, which sells breathing devices for use in hospitals. Sales increased 19% to NZ$500m excluding the effects of currency fluctuations, whereas the Homecare division grew revenue 8% in constant currency terms thanks to increasing demand for the company's new range of masks, including the Brevida nasal pillow mask.

Management seemed particularly proud of growing demand for its myAIRVO humidifier, cementing F&P Healthcare’s dominance of the hospital humidification market.

We were pleased to see the company’s continued effort to pay down debt and improve its balance sheet. F&P Healthcare now has no net debt for the first time since 2006, compared to a peak of NZ$134m in 2013. It speaks to the company’s strong free cash flow, which rose from NZ$79m to NZ$131m.

F&P Healthcare also increased spending on research and development (R&D) by 17%, and management said several new flow generators, masks and monitors are expected to be released in the coming year. The company now spends 9.6% of revenue on R&D, well ahead of ResMed’s 7.0%.

Litigation rolls on

Just under a year ago, F&P Healthcare filed a patent infringement case against ResMed in the US District Court of California. The company alleges that some of ResMed’s continuous positive airway pressure (CPAP) devices and accessories infringe patents held by F&P Healthcare, including ResMed's flagship AirSense 10 and AirCurve 10 range of flow generators, and Swift range of masks.

Anyone with experience of a school playground could guess what happened next: ResMed responded that the patents were invalid and filed a counterclaim asserting that, in fact, some of F&P Healthcare’s products infringe patents held by ResMed. Without too much surprise, F&P Healthcare retorted that those patents are invalid. Similar claims and counterclaims have been filed in New Zealand and Germany.

Furthermore, in August 2016, ResMed requested the US International Trade Commission ban the import of F&P Healthcare’s Simplus and Eson range of masks into the US. Though this exclusion order was withdrawn earlier this month, ResMed has indicated it may file a new claim with the Commission.

It’s too early to tell how this corporate version of ‘he said, she said’ will play out. Management is unable to estimate the financial repercussions – if any – at this stage, though the company has already spent NZ$21m on litigation costs. We will keep you posted as things progress.

In 2018, management expects constant currency revenue to increase around 12% to NZ$1.0bn and net profit of NZ$180m–190m, up 7–12%.

The stock trades on a forward price-earnings ratio of around 31. Relative to ResMed’s forward price-earnings ratio of 22, F&P Healthcare looks expensive. Investors are clearly pricing in a lot of growth. Nonetheless, the company has barely put a foot wrong in years and it continues to take market share from its larger rival.

In 2016, management’s goal was to hit NZ$1.0bn in sales in 2018 and double constant currency revenue every five years. The first part of that goal is now within reach, and we think the company has a decent shot at achieving the second part, too. We’re raising the price guide and continue to recommend you HOLD.

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