Resting easy with ResMed

Scott Olsson

Firetrail Investments

ResMed is a US$30 billion healthcare company that is working towards helping the roughly 1.5 billion people around the globe who suffer from respiratory medical diseases. 

We invested in ResMed last year because it was, and remains, a focused market share winner in a growing market at a reasonable price. It doesn’t fit the mould of some of our contrarian ideas, but we still see significant underappreciated upside.

In this wire, we discuss three reasons why we believe ResMed is set for future growth, including a growing customer base, a focus on driving penetration, and a shift in consumer behaviours in the post-COVID-world. 

Key numbers over the next few years:

  • We see revenue growth in high single digits (7-9%).
  • We assume flat gross margins, but operating expenses growing slightly below revenue growth.
  • Earnings per share growth in the low teens.

A growing addressable market

There are three key groups of people ResMed is focused on:

 1) Sleep Apnoea sufferers 

  • 936 million people 
  • Sleep apnoea occurs when you stop breathing for 10 seconds or more because your airway becomes blocked or has collapsed. Sleep apnoea can result in high blood pressure, heart attacks and daytime fatigue. 

2) Chronic obstructive pulmonary disease (COPD) patients 

  • 380 million people 
  • Lung disease that causes obstructed airflow from the lungs. 4 out of 5 patients are smokers. 

3) Asthma sufferers 

  • 340 million people 
  • Asthma cannot be cured, but symptoms such as breathing difficulty and triggered coughing can be managed.

The above is based on ResMed quoted addressable markets. While we think they are overstating the opportunity by capturing cohorts with very mild symptoms, we do agree that the opportunity is very large. As an example, our bottom-up estimates for the sleep apnoea addressable market is 401 million people, based on: 

  • Worldwide obesity growing with the percentage of population tripling since 1975. In 2016, according to the WHO, 39% of adults were overweight, while 13% were obese. 
  • Sleep apnoea affects about 3% of ‘normal’ weight people but impacts more than 20% of obese people. 

Beyond that, ResMed believes that penetration currently sits below 20%, meaning more than 80% of the large addressable market is up for grabs. Putting it together, the key drivers of ResMed's end-market growth will be: 

  1. Population growth – more people in the world 
  2. Obesity growth – continued growth in obesity and prevalence of sleep apnoea 
  3. Penetration – awareness and treatment growing from current <20% levels

A focus on driving penetration

Of the three key drivers, penetration is the lever that ResMed has the most control over. There are two main ways that ResMed is pushing to drive penetration: 

1) Home sleep testing 

a. Traditionally, if you think you have a sleep disorder, you get referred to a sleep lab. It is not sexy. See here

b. Prior to COVID, around 60% of studies were in sleep labs, but 40% were using ‘in-home’ sleep studies. 

c. Results show that 'in-home' sleep testing is effective, although the sleep lab will always have a place in the market given the use of a physician generating more reliable results (and currently more favourable reimbursement). 

2) Digital investment 

  • You know the 10k steps on your phone or smartwatch? People with sleep apnoea are doing the same thing with sleep scores. 
  • You can wake up and see how your sleep was (see below for app screenshot) and try to improve. 
  • Increasing digital feedback will create stickier, more engaged customers, growing the market over time as well as opening up new opportunities. 
  • ResMed has invested organically as well as through acquisitions to be the undisputed leader in digital versus its competitors.

The impact of COVID-19

ResMed is both a COVID winner and loser! The win came from ventilator sales through COVID (ResMed manufactures ventilators) and during COVID hospitals stocked up big time. While not disclosed separately for the US, we have made an estimate below. The largest impact was during the June 2020 quarter, but as we see now, there is limited contribution. It is over. 

The loss came from sleep diagnosis slowing down, with sleep labs (where people go to get diagnosed) closed or running below capacity. But again, consider the chart above to see where US sales finished for the December 2020 quarter; on a high.

ResMed may also win in some other areas as we get beyond COVID, although these are less clear. In all three cases we see upside risk, not downside risk: 

  1. Respiratory focus – COVID gets us to focus more on respiratory care, driving penetration for the market. 
  2. Digital – increasing penetration of digital everywhere. 
  3. Home Sleep testing – if it is easier to diagnose a sleep disorder, we could see increasing penetration. 

What do you pay for?

Every company has a price and it is hard to find a big rerate on ResMed. However, we think the market has become overly focused on no ventilator sales in CY21 and are not paying enough for some stellar operating results. 

Why it is worth paying a premium for ResMed:

  • Large global health care market with structural growth and low penetration.
  • Digital leadership leading to high-quality earnings and more market share.
  • Low gearing of 0.7x ND / EBITDA and are likely to be net cash in 18 months’ time (have started talking of a potential recommencement of buyback in CY21). 

We see 28% upside to the current share price which assumes a 35x PE ratio in three years’ time, a significant premium to the market, but one which we believe is warranted as outlined above.

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Analyst
Firetrail Investments

Scott is an Equity Analyst at Firetrail Investments. Scott’s primary sector responsibilities include Financials, Healthcare and Telecommunications. Scott has over 15 years industry experience.

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