ResMed's one-off tax troubles
Recommendation
It seems like yesterday that we were excitedly reading ResMed's 2017 third-quarter financial statements and declaring it ‘the result we've been waiting for'. A year on and those numbers look more like a deviation than a genuine turning point for the company.
To recap, ResMed's margins had been falling in the four years to 2017 as costs outpaced revenue growth, which was anchored by falling sales prices. We were happy to see the gross margin jump from 57.3% in 2016 to 58.3% in 2017, suggesting that an end to the runaway costs and revenue drought was here.
Key Points
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Software sales are strong
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Gross margin declines again
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Underlying net profit growth impressive
However, for the three months to March, ResMed's gross margin fell from 58.3% to 58.2%. Again, the culprit was declining average selling prices more than offsetting cost cuts in manufacturing. A ten basis point change in gross margin isn't worth crying over, but it's disappointing that last year's strong surge didn't continue.
Notwithstanding the fall in average selling prices, revenue still managed to increase 15% to US$591m, though sales in the core US and Canadian market grew more modestly at 7%. Most of the growth occurred in Europe and Asia, where sales rose 16% after adjusting for currency fluctuations.
The Brightree division, which sells software to homecare providers, also had a strong quarter with revenue up 14% to US$40m. ‘Our cloud-connected medical device strategy is succeeding; the major markets for our sleep business are adopting remote monitoring systems, which plays to the strength of our offerings,' said chief executive Mick Farrell.
How one-off?
Net profit rose 25% to US$110m, mainly due to the company keeping admin expenses steady despite rising sales. After adjusting for changes to US tax rates earlier this year, litigation, acquisition and other one-off expenses, underlying net profit rose a hearty 32% to US$133m.
Three months to March | 2018 | 2017 | /(–) (%) |
---|---|---|---|
Revenue (US$m) | 591 | 514 | 15 |
EBIT (US$m) | 136 | 107 | 27 |
NPAT (US$m) | 110 | 88 | 25 |
EPS* (US cents) | 7.6 | 6.2 | 23 |
*US cents per ASX-listed CDI |
Unfortunately, we suspect at least some of those ‘one-off' expenses are going to keep showing up for some time yet. ResMed is currently being audited by the Australian Taxation Office (ATO) for alleged unpaid taxes between 2009 and 2013. The ATO claims ResMed owes $152m in additional income tax and $38m in accrued interest. Yikes.
Unsurprisingly, ResMed disagrees with the ATO's assessment but has agreed to pay half the additional assessed tax while it is taking legal action. With so much owed to the ATO, we expect ResMed to keep defending itself in higher courts until it either gets its way or reaches the end of the line. That could take years and a lot of money, so prepare for plenty more 'one-off' legal expenses.
The stock trades on a forward price-earnings ratio of 27 based on consensus estimates for 2018 earnings. We're raising our price guide slightly but, with a new recommended Sell price of $15, ResMed is still closer to a downgrade than an upgrade. Nonetheless, this was a good result and we're happy to HOLD.
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