ResMed (RMD) is the market leader in continuous positive airway pressure (CPAP) machines, which improve the quality of sleep for apnea patients. Sleep apnea is much more than annoying, loud snoring. It is the fundamental inability to get enough oxygen during sleep. ResMed sells machines and facemasks to treat it, along with software solutions to track patients’ biometric data, writes Doug Gerlach, editor of Investor Advisory Service.
Sleep apnea correlates with both weight and age. Its prevalence in the underlying population has increased, along with awareness of the condition. ResMed has enjoyed a steadily growing market throughout its history, and investors have often paid sky-high valuations for its seemingly bulletproof growth profile. The P/E has often been in the 40s, a level normally reserved for hypergrowth companies, not consistent, low-double-digit growers.
In 2021, competitor Philips Respironics was forced to recall its CPAP devices due to the risk of insulation coming loose and entering patients’ lungs. Philips’ time out of the market has driven demand for ResMed’s devices. There has been a small negative effect on mask sales, but the overall impact has been positive for ResMed.
Sentiment has turned much more negative recently. For starters, competitor Philips is on a long road to returning to the market and might need to discount its products to win back market share. This would potentially be negative for ResMed’s unit sales and its gross margins.
Meanwhile, investors are suddenly looking for losers in what they imagine will be a slimmer future, thanks to a new generation of weight loss drugs such as Ozempic and Wegovy. This concern feels a little fanciful and may present an opportunity to “buy low” when the popular narrative creates a window of opportunity.
Efforts to grow outside of the core CPAP machine and mask market have been only moderately successful. ResMed acquired a small stable of software and data analysis companies to track patient outcomes and treat sleep disorders more holistically.
Segment growth tends to hover in the high-single digits, which is respectable but hardly looks like the up-and-coming growth engine that the company probably envisioned. Relatively cheap wearable devices have come to perform some of the functions that ResMed planned to provide.
Still, the growth bona fides are solid. Gross margins hover around 55%. Revenue has grown in the mid- to high-teens, mostly organic, along with earnings leverage. Free cash flow is fairly solid, although the balance sheet has recently accumulated notable increases in inventory and accounts receivable which have analysts asking pointed questions about earnings quality.
We model 12% EPS growth, a big discount compared to published consensus estimates of 20%. Our growth rate could produce earnings of $10.86 in five years. Attaching a capped high P/E of 30, the upside price is $326, or a 16.1% annualized rate of total return through 2028.
