Shares in narrow-moat ResMed (ASX: RMD) remain undervalued following a strong third-quarter fiscal 2024. Underlying earnings before interest and taxes (“EBIT”) of USD 394 million was 8% higher than second-quarter fiscal 2024, with sales up 3% and the underlying EBIT margin expanding 145 basis points to 33%.

Sales growth was largely driven by new patient demand while gross margins expanded significantly due to reduced freight and manufacturing cost improvements. Given the quicker-than-expected margin improvement, we increase our fiscal 2024 underlying EBIT forecast by 5% to USD 1.47 billion. Our long-term earnings estimates increase more modestly by roughly 2%. We raise our fair value estimate by 2% to USD 264, or $40 per CDI (ASX listed shares) at current exchange rates.

Improving patient flow and availability of devices continues to support strong sales. We also anticipate further margin expansion as ResMed’s sales mix shifts to higher-margin masks, and cost inefficiencies of simultaneously producing its older AirSense 10 device cease. Our midcycle 34% EBIT margin forecast is broadly unchanged.

Our forecast five-year revenue compound annual growth rate increases to 10% from 9% prior. The global sleep apnea market remains largely untapped and more than big enough for ResMed to remain a meaningful part of the solution. A key trend we think is helping boost new patient diagnoses is wearable technology such as the Apple Watch that can track and indicate signs of sleep disorder breathing.

There continues to be no negative impact from GLP-1 drugs. ResMed has gathered data on 660,000 patients who have been prescribed a GLP-1 drug and have a sleep apnea diagnosis. It was found that participation rates for positive airway pressure therapy were 10.5 percentage points higher in the sample population versus patients who have not been prescribed a GLP-1 drug. In addition, mask resupply rates in the sample population were 3.1 percentage points higher one year after the PAP setup and 5.0 percentage points higher two years after the PAP setup.

Business strategy and outlook

ResMed is taking a “smart devices” and Big Data approach to further entrench itself as one of the two leading players in the global obstructive sleep apnea, or OSA, market.
With cloud-connected devices, physicians can monitor patient compliance and encourage continued use. Higher adherence supports both reimbursement rates from payers and the resupply of masks and accessories.

ResMed also plays a key role in producing clinical data that demonstrates treatment can minimize related risks such as hypertension, stroke, heart attack and Alzheimer’s disease. Through its own testing devices and education, ResMed seeks more widespread diagnosis and treatment of OSA.

The global OSA homecare device market, is a two-player duopoly with over 80% estimated market share split between ResMed and Philips, with ResMed the market leader in the majority of the 140 countries it competes in.

The market offers a large global growth opportunity as penetration within developed markets is estimated at one fifth of the roughly 15% prevalence, and emerging markets are essentially untapped. In the US, we estimate roughly half of the 22 million people diagnosed with OSA are treated with continuous positive airway pressure, or CPAP, with another 34 million remaining undiagnosed. ResMed operates in over 140 countries with over 900 million people estimated to have sleep apnea globally, indicating the long runway for growth.

ResMed has made acquisitions of home healthcare software platforms as it seeks to leverage the trends of digital health and providing care in a lower-cost setting. Brightree, acquired in 2016, and MatrixCare, acquired in 2019, offer business management software for a range of home health providers. ResMed is currently directing significant capital to this area, and although high returns have largely been unproven, we think the move has been strategically sound given the structural industry tailwinds.

ResMed has a minority stake in Nyxoah who are developing a neurostimulation implant to treat OSA. Although we see little near-term risk from this therapy due to the higher cost and invasive surgery needed, ResMed’s minority stake hedges some risk from emerging competition.

Moat rating

Learn more about how to identify companies with sustainable competitive advantages.

We award ResMed a narrow moat rating based on switching costs and intangible assets, which have helped the company achieve high customer adherence rates and above-average industry growth.

In fiscal 2020, both ResMed and Philips reported selling over 10 million total cloud-connectable medical devices globally to date. In fiscal 2021, ResMed crossed the 15 million mark. These newer-generation devices enable physicians to remotely monitor the patient’s usage and breathing performance, entrenching ResMed as a preferred provider with all three users of the data.

For the patient, the device feedback encourages usage and allows them to get individualized care from the physician, leading to better clinical outcomes. For the physician, trust in recorded data and grown familiarity with the software is likely to reduce switching to a different provider.

For the payor, evidence of patient compliance informs continued reimbursement support. The duopolistic nature of the market is also in the best interest of durable medical equipment, or DME, suppliers as it limits the number of device manufacturers they deal with.

These factors have contributed to ResMed reporting up to 87% adherence rates when the physician is using its cloud-based patient monitoring system, AirView, compared with the estimated industry average adherence rate of 50%. A higher adherence rate benefits both device upgrades as well as masks and accessories revenue as the physician reminds the patient of when they should be replaced.

ResMed typically earns 40% of group revenue from the resupply of masks and accessories. Although these are interchangeable with other brands, competitors would be challenged to offer original products that are comparable in quality and comfort without infringing on ResMed’s plethora of patents, while also having to compete with its entrenched relationships.

ResMed’s intangible assets, namely its brand and patent portfolio, have also contributed to above-average industry growth and helped maintain its commanding market share. ResMed typically spends roughly 7% of revenue on research and development each year, which has ensured consistent product launches.

Despite growing off a much smaller base, Fisher & Paykel’s competing homecare segment has a trailing five-year revenue CAGR of 5%, lagging ResMed’s 10% over the same period. We think ResMed’s intangible brand has also enabled significant price premiums over less well-known peers.

While Philips and ResMed are comparatively priced, we estimate ResMed’s pricing to be roughly 15% higher than the remaining peer average across the automatic positive airway pressure device category and 30% higher in the CPAP category. This may reflect higher reimbursement support. In addition, we think ResMed’s patent portfolio of over 8,200 granted or pending patents, will likely assist ResMed in maintaining its market share with less than one third expiring in the next five years.

Due to its significant market share and high gross margins in a structurally growing industry, ResMed has posted an average return on invested capital, or ROIC, of 20% over the last decade. We anticipate the company’s ROIC to far exceed its weighted cost of capital of 7.4% over our explicit forecast period, even in our bear-case scenario.