ResMed: Interim result 2016

Why do you love your iPhone? Chances are, it's not just because it's well made or has a nice interface – it's because it also connects seamlessly to your MacBook, iPad, Apple TV and other iProducts.

Apple's products communicate with each other and wirelessly sync data, share applications, and offer a similar interface across devices so that users have an easier time learning to use their latest purchase. And that means that once you have a few products, you start to think twice about buying something from a competitor.

Apple's strongest competitive advantage today isn't better hardware, or even software. It's the Apple 'ecosystem'. And ResMed is slowly building one of its own.

Strong performance in the company's North American business helped to increase total revenue by 7% to $455m for the three months to December, up 13% after removing the effects of currency fluctuations. 

The result was powered by a 23% increase in North American flow generator sales – mainly the AirSense 10 and AirCurve 10 products, which treat obstructive sleep apnea using continuous or variable positive airway pressure, respectively. North America now accounts for 59% of total sales.

Cloud nine

ResMed's 'Air Solutions' cloud-based software platform has six key product 'plugins' – including AirSense and AirCurve – which cover diagnosis, monitoring and treatment, and constantly feed information and patient data back to the healthcare provider wirelessly. The company's main competitor, Respironics, is building its own ecosystem, but so far ResMed seems to be winning the race with a market share of around 45% compared to 35% for Respironics.   

'We've taken significant market share … I think we've now clearly proven to our customers that we can drive efficiencies in their business with the [Air Solutions] platform,' said management. 'We led the industry 15 months ago with 100% cloud-connected medical devices. And now, our competition has had to follow.'

North American sales of masks and accessories, on the other hand, weren't as impressive as flow generator sales, though still managed a respectable 11% increase. Management noted that the market for masks is significantly more competitive than for flow generators. However, sales received a boost from the company's automated resupply program and recent acquisitions Jaysec and CareTouch. ResMed's resupply program allows customers to manage their ongoing need to purchase masks and accessories using automated text, email or 'interactive voice response'.

Combined revenue in Europe, the Middle East, Africa and the Asia Pacific region was $185m, a 4% decrease compared to the prior corresponding quarter. Management noted that a recently failed clinical trial was still a headwind for its Adaptive Servo-Ventilation (ASV) products, particularly in Europe (see ResMed's heart failure trial disappoints). However, after removing the foreign exchange effect, sales increased 7% – an improvement compared to the 5% growth achieved last quarter, so things at least seem to be moving in the right direction.

Oxygen

ResMed recently announced its acquisition of Inova Labs, a Texas-based company, which builds oxygen concentrators. ResMed has historically focused on positive airway pressure therapies and this is the company's first foray into the portable oxygen concentrator market. 

The acquisition has significant potential. The total oxygen therapy market is worth around $1.2bn globally, with about $200m spent on portable oxygen concentrators each year. What's more, management believes the market is growing in the mid- to high-single digits.

Once a suitable scale of production is reached, ResMed should have no trouble funnelling the oxygen concentrators through its enormous distribution network, which spans 100 countries. Inova currently sells its products in only 5–10 countries, so there's plenty of room for expansion.

Supplemental oxygen, which is necessary to treat various respiratory conditions, is occasionally used to help treat sleep apnea, though CPAP is the preferred method.

Oxygen therapy is a natural progression for ResMed and we expect the integration of Inova will be smooth. Management noted the potential for Inova's products to eventually plug into its existing healthcare informatics platform, further strengthening the Air Solutions 'ecosystem'.

Gross margin

Despite the strong growth in sales, the company's gross margin fell from 62.2% to 58.1%, which resulted in earnings per share being roughly flat. The margin decline was due to a fall in average selling prices and a higher proportion of low-margin products in the sales mix. Respironics has been lowering prices too, so we'll be watching magins closely in coming quarters to see that this isn't the start of a price war (though it seems unlikely, given the CPAP machine market is more or less a duopoly).

Research and development (R&D) costs came in at US$29m for the quarter. Product innovation is the ultimate determinant of success for any manufacturer of medical technology so we were pleased to see R&D increase 14% on a constant currency basis.

ResMed's share price is up 5% since ResMed: Q1 2016 result on 26 Oct 15 (Hold – $7.79), putting it on a current price-earnings ratio of 23. HOLD.

Note: The Intelligent Investor Growth portfolio owns shares in ResMed. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.