RMD - Why ResMed Is One Of My Top Picks In 2024

2024-01-22 00:41:37 ET

Summary

• I opine RMD is now attractively valued given its long-term stability and its product is highly demanded.
• ResMed's product is in high demand in the modern obesity epidemic.
• A new weight loss drug will have little effect on the Company.

I anticipated a significant likelihood of a mild recession occurring in 2024.

Stock picking becomes crucial in order to mitigate potential risks of possessing devastating losses in our portfolios. With this in mind, I have formulated three rules to guide preparation for my 2024 watchlist:

1. Seek for undervalued and underperforming stocks. Unpopular stocks may turn around in the next cycle, and undervalued stocks possess better safety of margin.
2. Steer clear of businesses with futuristic vision as they tend to tumble when their popularity fades.
3. Avoid cyclical businesses in an economic downturn.

ResMed ( RMD ) perfectly aligns with all three rules and thus I initiated a Buy rating on this healthcare stock.

ResMed is a healthcare company, which provides innovative solutions to people with sleep apnea, COPD, and other chronic diseases worldwide. More than half of its income was generated from devices such as continuous positive airway pressure (CPAP) and automatic positive airway pressure (APAP) devices. Mask systems and other accessories also generated 35% of ResMed's revenue in the latest financial quarter.

ResMed's Product is Highly Demanded in the Modern World

ResMed believes that its position on sleep and respiratory care is still globally under-penetrated.

Obesity is considered a dominant factor leading to the development of obstructive sleep apnea. Fat surrounding the upper airway causes increased collapsibility of the upper airway, leading to higher apnea risk.

CPAP is the chief treatment for patients suffering from OSA. ResMed estimated that there are over 1 billion global OSA patients right now.

New weight loss drugs brought worries to investors of ResMed. Earlier in 2023, the FDA approved a weight loss drug from Eli Lilly ( LLY ) called tirzepatide or Zepbound. Patients taking highest dose in the drug trial lost a whopping 18% of their body weight.

Obesity has a close relationship with obstructive sleep apnea . So if the drug manufacturer succeeds in tackling obesity, it will be a societal victory, despite which may lead to a decline in respiratory care products.

Indeed, weight loss is a more effective way than CPAP treatment when tackling OSA.

However, research in 2019 revealed nearly half of the U.S. adult population will have obesity by 2030.

You may argue the research paper was published before these powerful weight-loss drugs were available. But I strongly believe that even with these magical medications accessible, obesity will still be a modern world epidemic and thus pushing the demand for sleep care products up.

Why new weight loss drug can't stop the obesity epidemic

The drugs are expensive.

Zepbound is starting with a list price of around $1,060 for a four-week medication, according to Eli Lilly. Real Median Household Income in the United States was $74,580 in 2022. Assuming a patient was prescribed Zepbound for one year, it will take up more than 15% of its annual income, exerting enormous financial burden on an average household, let alone to the underprivileged.

It was proven that the underprivileged have a higher population with obesity.

Food Foundation revealed that the poorest 10 percent of households need to spend almost 75 percent of their income on food. In order to save money, they tend to purchase cheap industrialised food., rather than raw food (which is more healthy).

This is not the first time new weight loss medications become available on the market.

In 2010, FDA approved Qnexa , which claimed to reduce 10 percent of body weight when taking maximum dosing. The Authority had a good vision when approving this drug. They mentioned: The approval of this drug, used responsibly in combination with a healthy diet and lifestyle, provides a treatment option for Americans who are obese or overweight and have at least one weight-related comorbid condition.

But the trend of obesity's ever-worsening situation continues.

Data from National Health and Nutrition Examination Survey confirmed the trend. From 1999 to 2018, the prevalence of both obesity and severe obesity increased among adults. In 1999, about 30% of the population aged over 20 were found to be obese. In 2010, it increased to 35.7 percent and further accelerated to 42.4% in 2018.

There is a huge room for ResMed to expand in this massive industry

The figure from the company showed the significant gap between estimated number of obstructive sleep apnea patients and the quantity of ResMed devices sold. It unveils the potential tailwind that ResMed could have.

Also, ResMed offers comprehensive software platforms that support healthcare providers in settings outside of the hospital. Research led by Pamela Saenger disclosed patients' preference to receive treatment at home as the environment is more comfortable and they can be closer to family.

This part of ResMed's business is fast growing. In the previous financial quarter, it achieved a 32% year-over-year growth, partly contributed by the acquisition of Medifox Dan in 2023. Still, the management saw a pathway to stable double-digit organic growth across the SaaS business.

Valuation Right now is Attractive

The stock performance of RMD over the past three years is far from satisfying.

It currently trades at about 50% below its all-time high, with a PE ratio of 26.22 (as of 19 Jan 2024).

Looking back at its historical data, its revenue consistently grew above 10% every year, and diluted EPS also improved over 10% CAGR from 2014 to 2013. It also increased its dividend for 11 years in a row.

The company also has consistent ROE, ROIC, and a solid balance sheet.

The major challenge that constrains RMD's earnings growth is the declining margins, which dropped from 58% in 2020 to 55.8% in the previous year. This was contributed by escalating component and manufacturing costs and supply chain issues.

But Brett Sandercock mentioned below in the earnings conference call for Q1 2024:

We do feel that we're going to see improvements in our gross margin over FY24...We're seeing stabilized component costs now, that was a headwind even for this quarter.

With the stock trading at 30% below its 5-year PE ratio average, I opine RMD is now attractively valued given its long-term stability, and its product is highly demanded.

Please feel free to leave a comment below to share your view. Thanks for reading.

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