Impressive performance from undervalued ASX healthcare company

Highlights:

• Solid Q4 Performance: ResMed (ASX:RMD) reported strong fourth-quarter fiscal 2024 results with a 2% increase in underlying EBIT to USD 400 million and a 62 basis point improvement in gross margin to 59%. Despite these gains, shares are trading 21% below our fair value estimate of AUD 40.50.
• Growth and Market Position: ResMed continues to perform well in the global obstructive sleep apnea market, benefiting from increased mask sales in the US and a shift toward higher-margin products. The market remains underpenetrated, offering substantial growth opportunities.
• Strategic Investments and Risks: The company's investments in digital health and home healthcare software, along with a minority stake in Nyxoah, position it well for future growth. However, potential risks include limited market share gains from Philips’ recall, pricing pressures from Medicare cost-cutting, and unproven returns from new software ventures.

ResMed (ASX:RMD) shares continue to be undervalued following a strong performance in the fourth quarter of fiscal 2024. The company reported underlying earnings before interest and taxes (EBIT) of USD 400 million, a 2% increase from the third quarter, driven by a 2% rise in sales due to higher product demand. The EBIT margin was largely stable at 33%, with a slight decrease of 14 basis points.

Gross margin improved by 62 basis points to 59%, supported by a favorable product mix and reduced manufacturing costs. However, this benefit was offset by rising operating costs. Revenue and earnings for fiscal 2024 aligned with forecasts, and our long-term estimates remain unchanged.

We maintain a fair value estimate of AUD 40.50 for ResMed, with shares currently trading 21% below this value. Mask sales in the US rose 11% sequentially, helping to mitigate weaker device sales, and the company retained its market share in devices. We anticipate margin expansion as ResMed shifts its sales mix toward higher-margin masks and discontinues its older AirSense 10 device. The global sleep apnea market remains underpenetrated, with wearable technologies aiding in early diagnosis.

No significant negative impact from GLP-1 drugs has been observed; in fact, data from 811,000 patients suggests these drugs could increase awareness of sleep apnea.

Business Strategy and Outlook

ResMed's strategy focuses on integrating "smart devices" and Big Data to strengthen its position in the global obstructive sleep apnea (OSA) market. Cloud-connected devices enable physicians to monitor patient compliance, which improves adherence rates and supports reimbursement and resupply. The company also produces clinical data highlighting the benefits of OSA treatment for related health risks.

The global OSA homecare device market is predominantly a duopoly with ResMed and Philips, with ResMed leading in most of the 140 countries it operates in. The market presents significant growth opportunities, especially as penetration in developed markets is low and emerging markets are largely untapped. In the US alone, many of the 22 million diagnosed with OSA are untreated, and an estimated 34 million remain undiagnosed.

ResMed has invested in home healthcare software platforms, including Brightree and MatrixCare, to capitalize on digital health trends. Although returns have not yet been proven, this strategic move aligns with industry trends.

The company also holds a minority stake in Nyxoah, which is developing a neurostimulation implant for OSA. While this presents minimal near-term risk, it provides a hedge against emerging competition.

ResMed Bulls Say:

- The long-term growth potential in respiratory homecare devices is significant due to underpenetration in both developed and emerging markets.

- The focus on cloud-connected devices has enhanced adherence, benefiting reimbursement rates and resupply.

- ResMed could gain from Philips’ product recall and the introduction of its new flagship product, AirSense 11.

ResMed Bears Say:

- Market share gains from Philips’ recall may be limited if customers opt for alternatives or face supply chain constraints.

- Reimbursement rates and pricing are under pressure from Medicare cost-saving measures and emerging treatments like neurostimulation implants.

- ResMed's investment in homecare business management software is still unproven, with current organic revenue growth in the mid-single digits.