ResMed posts disappointing result

ResMed has announced a lacklustre financial result for the three months to 30 September, with sales up 13% to US$465m after removing the effect of currency fluctuations. However, that was significantly boosted by the recent acquisition of software maker Brightree. Excluding acquisitions, revenue was only up 5%.

Excluding Brightree, revenue from North America increased 5% compared to the prior year due to increasing demand for the company's AirSense 10 CPAP machines. Combined revenue from ResMed's other main markets – Europe, Middle East, Africa, and Asia Pacific – also increased 5%.

With the overall continuous positive airway pressure (CPAP) device market growing at around 7–8% a year, the result implies that ResMed is losing market share to competitors, such as Philips Healthcare and Fisher & Paykel Healthcare.

Management said a new media partnership is in place to improve awareness of ResMed's products. The result was also helped by recently published clinical trial data that showed non-invasive ventilation significantly reduces the risk of death or re-hospitalisation for chronic obstructive pulmonary disease.

Expenses were kept in check due to cost-cutting initiatives in manufacturing, which boosted the company's gross margin from 57.2% to 57.8%.

Lower margin sales

Unfortunately – and echoing the previous few results – management said fewer sales of high-margin products and lower average selling prices partially offset the cost-cutting.

As we explained in our update on ResMed's full-year result, the respiratory care industry is becoming increasingly price competitive as customers receive less favourable government subsidies.

Things are also likely to get worse before they get better because US Medicare reimbursement rates for sleep therapy products were reduced by about 14% in July. This effectively increases a patient's out-of-pocket expense to get therapy. We expect the lower reimbursement rate will make what little revenue growth ResMed has even harder to achieve in coming years.

Pricing pressure makes innovation and having unique products more important, so it was encouraging to see a 21% increase in research and development (R&D) spending to US$34m. R&D investment now represents 7% of revenue, though this is still some way below the 9% allocated by smaller competitor Fisher & Paykel Healthcare.

Net profit fell 8% to US$76m due to a jump in amortisation, courtesy of the Brightree acquisition, and a steep 15% increase in administrative expenses. Even if we generously remove some one-off expenses and the effect of Brightree, net profit still only rose 4%.

We're starting to see a recurring and discouraging theme for ResMed. Revenues continue their march upward but costs are rising faster, and customers are shifting to lower-margin products. This is squeezing margins and causing profit growth to flatline, even while the market as a whole is growing.

ResMed trades on a price-earnings ratio of 26 and an unfranked dividend yield of 1.4%. Were the company growing as fast as Cochlear or CSL, today's valuation wouldn't concern us, but with each quarterly result we're finding it harder to justify paying up for ResMed without more growth.

We sold the holding in the Intelligent Investor Growth Portfolio yesterday, to provide funds for the purchase of Crown Resorts. If you have other stocks you're keen to buy, then ResMed, at closer to our Sell price than our Buy price, is one you might use to make way. For those disinclined to tinker, however, our recommendation remains HOLD.