Stock Story: ResMed

Airlie Funds Management

October 2023

ResMed is the global leader in sleep and respiratory care primarily focused on the development and sale of positive airway pressure devices and accessories for the treatment of obstructive sleep apnoea (OSA). ResMed's share price has fallen 30% since the release of its FY23 results in August largely in response to concerns GLP-1 (Glucagon-Like Peptide-1) drugs may reduce its addressable market. In this article, we discuss the business in more detail and why we think the GLP-1 concerns are overdone.

What is Obstructive Sleep Apnoea (OSA)?

Obstructive sleep apnoea is a chronic illness that occurs when the muscles that support tissues in the back of the throat relax during sleep, blocking or narrowing the upper airway. This obstruction leads to impaired breathing for a short period (usually 10-20 seconds), which results in lower oxygen in the blood. The brain senses the impaired breathing, causing the individual to subconsciously rouse from sleep in order to reopen the airway. The severity of OSA is characterised by the number of events per hour: Normal < 5; Moderate 15-30; Severe > 30.

Continuous Positive Airway Pressure (CPAP) devices are the accepted standard of care for treating OSA, delivering a stream of pressurised air through a mask to prevent the collapse of the upper airway during sleep. ResMed is the largest manufacturer of these products and we estimate the company currently has ~80% market share with its major competitor Philips out of the market for the past two years due to an FDA-imposed product recall. 

Large, undiagnosed addressable market

The OSA market is large and mostly undiagnosed. According to the company, there are 936 million people globally with sleep apnoea and 424 million of these suffer from severe sleep apnoea. The size of the addressable market is evidenced by the fact ResMed had grown its device revenue at over 9% p.a. in the six years prior to the Philips recall (FY13-FY19). Recent growth rates have been even higher. ResMed estimates that penetration currently sits at 20% in the US and well below this percentage globally, which implies a long runway for future device and mask sales. 

Figure 1 - ResMed device revenue (US$)

Source: Company filings

One of the highest-quality companies on the ASX

As with any new position, we tested ResMed against our key investment criteria and consider the business to be high quality based on the following factors:

• Financial strength: ResMed has a strong balance sheet with less than 1x ND/EBITDA 
• Business quality: ResMed has a dominant market position (~80% share), sells defensive products that improve patient quality of life and are reimbursed by Medicare/health insurers in the US, and earns high returns on capital (22% average over last 5 years). 
• Management quality: We consider ResMed a "founder-led" business. Founder Peter Farrell is Chair Emeritus, and his son, CEO and Chair Mick Farrell, has presided over an exceptional track record in product development and market share gains in his 10+ years as CEO. 

GLP-1 concerns and valuation

ResMed has historically traded on a forward multiple of 28x PE but is currently trading on less than 21x PE due to market concerns about GLP-1 drugs reducing ResMed's addressable market. 

Figure 2 - ResMed NTM Rolling PE

Source: FactSet

GLP-1 drugs (branded as Ozempic, Wegovy and Mounjaro) act by mimicking hormones that are released into the gastrointestinal tract in response to eating. These drugs were initially developed to target type 2 diabetes by stimulating more insulin production but have evolved to potential applications in weight management and cardiovascular indications. Given obesity is a key risk factor for OSA (see Figures 3 and 4), there is a view that significant weight reduction from taking GLP-1s may result in reduced demand for CPAP therapy.

Figure 3 - OSA severity by AHI (>5 mild) and (>15 moderate)

Figure 4 - Prevalence of sleep apnoea in morbidly obese patients who presented for weight loss surgery evaluation

      
Source: Goldman Sachs Research

While we are not medical experts, we consider the significant de-rate to be an overreaction for the following reasons:

• GLP-1 drugs have been around for almost a decade in managing blood sugar, and other competing therapies such as oral devices and bariatric surgery have not been able to displace CPAP as the standard of care. We note CPAP also has the advantage of being able to track patient adherence and compliance through cloud-connected devices. We believe this data is valuable to third-party payors.
• While we acknowledge weight gain is a leading risk factor in developing OSA, it is not the only cause. Based on our conversations with sleep physicians and the company we estimate one-third of OSA patients are not obese. While the remaining two-thirds of the patient pool is highly likely to test GLP-1 drugs (as they become more accessible and affordable) we don't expect adherence to be 100% given the potential for side effects such as nausea and the impact on lifestyle. We also don't expect GLP-1s to fully eliminate OSA in all cases (the drugs may simply reduce severity). As a result, we think it's more likely you could have a scenario where a combination of GLP-1 drugs and CPAP therapy are prescribed as treatment.
• Finally, these drugs with an average retail price of ~US$1,000/month are currently unaffordable for most patients. Pricing will need to come down significantly to attract broader reimbursement and mass adoption.       

Conclusion 

Overall, we think the uncertainty as to the potential penetration and success of these drugs in treating OSA has created a rare opportunity to invest in one of the highest quality companies on the ASX. While we are unlikely to pick the bottom, we believe the company is trading well below its intrinsic value.

By Vinay Ranjan, Senior Equities Analyst

Funds operated by this manager:

Airlie Australian Share Fund

Important Information: This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation.  This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

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Hedge Clippings | 17 November 2023

No sooner had the RBA hiked interest rates for the 13th time (unlucky for some) to 4.35% in the face of falling - but persistently higher than they'd like - inflation, than the US posts some encouraging news for their October inflation figure of 0.0% month on month, taking the 12 month number to 3.2%, down from 3.7% the previous month, both numbers being 0.1% below expectations. Core CPI increased 0.2% month on month, and 4.2% over 12 months, again below the market's expectations. Much of the drop was the result of falls in energy prices, with notoriously volatile fuel prices falling, in spite of increased global tensions. In any event, expectations of a rate hike in the US evaporated, hitting the US$, and boosting the little Au$$ie battler.

That's all well and good for the US, and will of course give the RBA some encouragement that the worst is over, at least globally. However, the RBA board wouldn't have been as happy with the inflationary outlook based on the release of Australian wage data, which grew 1.3% over the September quarter, the largest increase in the 26 year history of the ABS Wage Price Index, which was also higher than the local inflation rate of 1.2% over the same period. In other words, wages grew faster than inflation at a time when the RBA is trying to dampen demand, not fuel it.

Then along come employment figures for October at 3.7%, flat on trend terms, and up slightly seasonally adjusted. Prior to being appointed to the top job at the RBA Michele Bullock indicated an unemployment rate of 4.5% would be required to tame the inflation dragon, but maybe as that didn't appear to be eventuating she felt the need to cause pain elsewhere?

Either way, and as we've noted before ad nauseam, both unemployment and interest rates only affect a proportion of the population, and in the case of interest rates, unevenly at that. Added to which is the lagging effect of higher mortgage rates, and the fact that higher interest rates benefit a different group of consumers, generally those less impacted by inflation to boot!

We're in agreement with the RBA that inflation is far too persistent, and not only for the sake of the economy, and the welfare of those most affected, and least able to bear the cost. On a purely selfish level, in addition to seeing increases of 20 to 25% in the price of our daily caffeine fix, we're sick of writing about it every Friday! In times gone by there were political characters who were easy targets for Hedge Clippings' brand of cheap humour, or local or global political issues to have a crack at.

The world is sadly in far too serious a place for that kind of stuff, and opinions on both sides are too entrenched, and intolerant, to venture onto that stage, or soap-box.

Where's Scomo, Boris, or even The Donald when you're looking for a little light-hearted fun and cynicism to end the week? The answer of course is that Donald hasn't really gone, he's just gearing up for another tilt at the White House, which isn't looking as far fetched as it might have been four or five years ago!

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