A Healthcare Stock With an Interesting Value Proposition (Part I)

Kanak is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

ResMed (NYSE: RMD) is a very interesting company. It develops medical equipment that you can use yourself at home to treat a breathing disorder that occurs during sleep. This disease, called SDB, results from obesity, sleep apnea, diabetes, and cardiovascular diseases, and in turn, causes or enhances a few of them, for example, heart problems and diabetes. So, in effect, treating SDB also assists in treating these other diseases, thereby vastly enhancing ResMed’s market potential.

Another interesting aspect of ResMed is that its market is almost equally distributed across the U.S. and the rest of the world. While the U.S. helps it generate a lot of revenue and protects it from its more globally entrenched competitors, its market across the world acts as a hedge against American market pressure, both actual and potential.

In the last 12 months, ResMed has jumped 32%. Based on the following factors, I think ResMed will continue to add value to investors’ portfolios in medium to long term.

  • Strong position in the growing SDB market
  • Additional indication like COPD to boost business growth across geographies
  • New therapies and monitoring in heart failure open up opportunities for the company
  • Positive performance on account of products sales drives growth
  • Solid dividend policy

About ResMed
Primarily, ResMed develops, manufactures, and distributes medical devices for patients with respiratory problems while sleeping. The company has an attractive product portfolio across its diagnostic and therapeutic segments. ResMed sells products in various countries through its subsidiaries and independent distributors. The products include airflow generators, diagnostic products, mask systems, headgear, and other accessories.

The company operates in two segments: Flow generators and Masks and accessories, which comprise 55% and 45% of the overall business, respectively. This equal focus on multiple complimentary segments seems to be a trademark of ResMed. This sort of business approach makes it an intelligent investment.

In Flow generators, ResMed produces Continuous Positive Airway Pressure (CPAP), Variable Positive Airway Pressure (VPAP), and AutoSet system for the treatment of SDB. Masks systems are the key element of the SDB treatment process. The CPAP technology was developed primarily by one of the founders of ResMed. The company has continued to develop and market the technology for almost 25 years.

ResMed’s strong position in the SDB Market
SDB is present in patients with hypertension (83%), diabetes (72%), obesity (77%), and congestive heart failure (76%). It includes all diseases that cause breathing problem during sleep such as obstructive sleep apnea (OSA), central sleep apnea (CSA), and hypoventilation syndromes. Of these, OSA is the most common form of SDB. As per the American Journal of Epidemiology, around 26% of adults aged 30-70 have sleep apnea. 16% suffer from mild sleep apnea and 10% from moderate to severe sleep apnea.

Approximately 40 million people in the U.S. alone suffer from OSA and one in five adults has some form of OSA. Less than 20% of those with OSA have been diagnosed or treated. Though a number of devices are marketed for the treatment of OSA, however, most of them are only partially effective. CPAP systems are considered as one of the treatment options for OSA.

The SDB market will continue to grow with rising demand for home-based diagnostic and increasing awareness of the role of SDB treatment in the management of cardiac, neurologic, and metabolic diseases. ResMed has a comprehensive range of products, including air flow generators, masks, and other accessories to support patients with SDB. It also undertakes wide ranging awareness programs that not only help people understand the disease, but also help to soft-sell its products.

Additional indications boost business growth
Another way for ResMed to target emerging markets is to explore treatment options for diseases congenital to these areas. One of these diseases is COPD, which, according to the World Health Organization, strikes some 80 million people worldwide. Many of these are in the emerging markets like China, India, and Brazil, and they suffer from moderate to severe COPD and the primary reason is due to obstruction of breathing.

ResMed’s VPAP is a first line respiratory device approved by the FDA to treat patients suffering from COPD. VPAP provides an option for COPD patients to stay out of hospitals. The company’s products in respiratory care improve the patient’s quality of life while providing variety of support systems including ventilator, masks, and other related accessories.

New business opportunity – Cardiovascular disease
OSA is associated with increased risk of cardiovascular disease and death resulting from heart attack and stroke. Clinical research has proved the high prevalence of OSA in patients suffering from different heart diseases. OSA may increase the risk of developing cardiovascular disease and heart failure. CPAP systems can be used to improve the functional status in patients with heart failure and sleep apnea.

Solid dividend policy
ResMed paid dividends separately to shareholders according to the exchanges it is trading in. The company paid in U.S. dollars for holders of common stock on the NYSE and in Australian dollars for holders of CHESS Depository Instruments (CDIs) trading on the Australian Securities Exchange (ASX), based on a ratio of 10:1 between CDIs and NYSE shares. During 4Q 2013, dividend was increased 47% to $0.25 per share compared to the same period prior year. The dividend payout ratio was 40%.

What next
In the next section, I will discuss how ResMed is successfully conducting business across different geographies, thus hedging itself against local market problems. I will also discuss its two competitors, Philips (NYSE: PHG) and CareFusion (NYSE: CFN) and show how ResMed has captured a large segment of the global SDB market.

Recently, Philips CEO Frans van Houten said that the company is facing tough times in the U.S. However, healthcare orders have been on the rise, and Philips expects to achieve full year targets. Philips has come up with various contracts, joint ventures, and agreements for the coming years. In order to implement its policy of creating affordable healthcare solutions, Philips entered into a 15-year $300 million alliance with Georgia Regents Medical Center.

Set at pre-determined monthly operational costs, thereby ensuring regular inflow of cash for the company, this alliance will deliver medical equipment, consulting, and other services to Georgia Regents. 

CareFusion recently released earnings where it missed Street estimates. However, it expects to achieve revenue growth of 3% in the next fiscal, as well as meeting EPS estimates of $2.36 per share. CareFusion has given a guidance for 2014, where it projects total revenue growth for the medical systems sector to be between 1% and 4%. It expects adjusted diluted EPS to be between $2.30 and $2.40. This year should see operational cash flow of $500 million and a fixed capital expenditure of $110 million. The company also announced a share buyback program of $750 million.

In the next part, I will discuss these companies in more detail.

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Kanak Kanti De has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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