Researching RMD (ResMed)
October 16, 2009
ResMed (RMD) manufactures medical devices to treat and manage sleep-disordered breathing, primarily sleep apnea. RMD’s latest Investor Update explains that Q4 2009 is the 58th consecutive quarter of revenue growth for the company.
Company Background:
- ResMed’s primary focus is sleep apnea which occurs when a person’s airway temporarily collapses while asleep, therby restricting breathing and interrupting their sleep repeatedly throughout the night. RMD’s products include airflow generators and breathing masks that introduce the airflow and pressure needed to prop open the respiratory pathway during sleep.
- According to its 2009 10-K Report, ResMed estimates that its global market is $2.5 Billion which is less than 10% penetrated. In the U.S., RMD estimates 40 million people, about one in five adults, have some form of sleep apnea with less than 10% diagnosed or treated.
- RMD’s 10-K mentions studies that show sleep-disordered breathing is present in about 80% of patients with drug-resistant hypertension, 72% of patients with Type 2 diabetes, and some 80% of patients with congestive heart failure.
- In March 2008, The Center for Medicare and Medicaid as well as Aetna Insurance approved home testing to diagnose patients with sleep-disordered breathing which RMD sees as a major opportunity for growth.
- Morningstar reports that ResMed was the second company to enter its field (Respironics, now part of Phillips Electronics, was first) and that RMD has had to differentiate itself with technically superior products which have tended to make patients more comfortable and loyal.
** As of June 2009, RMD had 2100 patents and 1100 design registrations granted or pending; in FY 2009, it invested 7% of its revenues (about $63.1 Million) in research & product development according to its lastest 10-K.
- Morningstar was unhappy with the perks and compensation given to RMD’s Chairman and other executives, such as: personal use of company aircraft; club memberships; and very expensive cars. Also, the Chairman received $2.8 M in compensation last year after stepping down as CEO.
- The one-click Annual Report spreadsheet by Bob Adams gives RMD’s 2009 A.R. a 68 out of 100 with 17 green flags, 12 caution flags, 1 red flag, 8 Bullish results and 8 Bearish results.
** The Bullish-good things include increasing sales that are also increasing faster than the cost of sales; growing gross profit margin; good return on free cash flow. The Bearish-not so goods include inadequate return on equity; return on assets should be higher; increasing accounts receivable. The one red flag is that the price to sales ratio is high.
** You can get this super-duper spreadsheet and an explanation of its many features by going to my Favorite Links page and scrolling down: click here.
Discussion:
The table below compares the SSG by CarolT, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. The only difference between Armin-1 and Armin-2 is that they use different EPS estimates (13.00% and 16.00%). After the table, I discuss issues identified by the comparison.
ResMed (RMD) |
CarolT | Armin-1 | Armin-2 | Take Stock |
| Date | 9-28-09 | 10-5-09 | Same | Same |
| Data | S&P | Same | Same | Hemscott-Morningstar |
| Price | $44.00 | $43.18 | Same | Same |
| 52 week High & Low Price | $44.65 & $28.90 | Same & Same | Same & Same | Not Included |
| Last Q of Reported Data | Q4 ending 6-30-09 | Same | Same | Same |
| Software Used | TK 6 | TK 5 | Same | TS Online |
| Project Growth From End of | Last Q | Same | Same | Last FY |
| Sales Growth | 15.00% | 13.00% | Same | 10.00% |
| EPS Growth | 15.00% | 13.00% | 16.00% | 10.00% initial 08.34% final |
| High PE | 26.0 (2009, lowest in last 5 yrs) | 25.0 | Same | 30.0 |
| High EPS | $3.90 | $3.57 | $4.07 | $2.88 |
| High Price | $101.40 (12% > VL) | $89.20 | $101.80 (12% > VL) | $86.53 |
|
Value Line Estimated High Price = $70-90 as of 8-28-09 |
||||
| Low PE | 15.0 (2009, lowest in last 5 yrs) | Same | Same | 18.5 |
| Low EPS | $1.93 (TTM) | Same | Same | $1.92 |
| Low Price | $28.90 | Same | Same | $35.52 |
| Upside/Down | 3.6 | 3.2 | 4.1 | 5.7 (imputed) |
| Total Return | 17.9% | 15.6% | 18.7% | 14.9% |
| SSG Buy Under | N/A | $43.98 | $47.13 | $43.27 |
| RV/PRV | 80.2/69.8 (no outliers) | 94.9/83.9 (3 yrs out) | Same/81.7 (Same) | Not Included |
| RV/PRV (no outs) | 80.2/69.8 | 77.8/68.7 | Same/67.0 | Not Included |
| Quality | N/A | B+ | Same | 3.2 (unacceptable) |
| PTPM – 5 yr ave | 22.3% Trend even | Same Same | Same Same | 20.7% Trend N/I |
| ROE – 5 yr ave Ending Equity | 12.5% Trend up | Same Same | Same Same | Not Included |
| ROE – 5 yr ave Starting Equity | N/A | 15.4% Trend down | Same Same | 13.7% Trend N/I |
| Debt to Equity – 5 yr ave | 10.9% Trend down | Same Same | Same Same | N/I |
Estimating Sales Growth:
- RMD’s Sales growth has been trending down from 22.8% five years ago to 15.1% three years ago to 10.2% last year. Sales growth dropped to 7.1% in the last quarter.
- Morningstar estimated 14.00% Sales growth for RMD through FY 2013 while Zacks estimated a whopping and unbelievable 22.87% for the next 5 years.
- CarolT estimated 15.00% which became important because she decided to use it as an upper limit for her EPS estimate.
Estimating EPS:
(A) CarolT’s SSG
- Carol checked EPS estimates from Value Line and NASDAQ which, when I looked, were estimating 15.00% and 19.00% for long-term EPS.
- She decided to estimate 15.00%, the same as her estimate of Sales growth for the next five years. Carol wrote: << Matching the sales growth at 15% seemed reasonable. >>
(B) Armin’s SSG-1 and SSG-2
- When I did my SSGs, the six different analysts I always check were estimating long-term EPS at an average of 16.81% with Reuters.com high at 21.00% and YahooFinance low at 11.87%. FactSet CallStreet via CNN Money.com was 16.00%, Zacks.com was 18.00%, and S&P was 19.00%.
- FactSet’s 4 analysts ranged from a high of 32.00% to a low of 16.00%; Reuters’ 5 analysts also ranged from a high of 32.00% to a low of 16.00%.
- YahooFinance’s 11.87% looks like an outlier and the average becomes 17.80% after I disregard it. That average less 1 Standard Deviation = 15.41% and less 2 SDs = 13.03%.
- Because relatively few analysts contributed to these consensus estimates, and because they varied substantially (SD = 2.39 without Yahoo, 3.23 with), I decided to estimate 13.00% EPS (the average without Yahoo less 2 SDs) for Armin-1. For Armin-2, I used 16.00%, the lowest EPS estimate by FactSet and by Reuters.
- For a more thorough discussion of how I estimate EPS, see: Estimating EPS
(C) Take Stock
- Take Stock initially estimated 10.00% EPS which, like Carol, was limited by its Sales growth estimate. Then, Take Stock lowered it to 8.34% based on its Business Model which is another name for the NAIC/BI Preferred Procedure.
- Here, Take Stock’s 8.34% estimate seems patently unreasonable compared to the average of the 13.03% from 5 analysts less 2 SDs. Even the average less 3 SDs (10.64%) is way greater than Take Stock’s EPS. For how to determine what’s reasonable and what’s not, see: Determining What’s Reasonable and What’s Not: An Update
Pre-Tax Profit Margin (PTPM) & Return on Equity (ROE):
(A) PTPM
- With S&P data, RMD is much better than its industry average in terms of its 5 year average Pre-Tax Profit Margin (22.30% vs 16.48, Health Care Equipment industry).
- Moreover, RMD’s trend is even (a down trend would be a red flag warning sign, but not an even trend).
(B) ROE
- Carol expressed concern that ResMed’s average ROE was low compared to other companies in its industry which ranged, she wrote, from the low teens to the low twenties.
- With S&P data, I found that RMD’s average of 12.5% was only slightly below its industry average of 13.7%. However, the industry average was somewhat distorted by Kinetic Concepts (KCI) with a 5 year average ROE of 62.7%.
- More importantly, ResMed’s ROE is currently trending up!
- Carol poses a difficult question to answer because the industry data available to the public is so limited and confusing:
** The S&P data used by the Online SSG at the Better Investing website places RMD in a different industry (Electromedical & Electrotherapeutic Apparatus Manufacturing) than the S&P data subscription I get from BI (Health Care Equipment). That discrepancy seems nuts to me;
** The 13.7% ROE industry average I found was from the Mid-Michigan BI Chapter which posts S&P industry data on its website, but the Online SSG with its different S&P industry for RMD shows a 15.82% ROE industry average.
** Unlike the Hemscott data at the Stock Central website, none of the S&P data is broken down by company so outliers that distort the average cannot be identified.
Final Results:
- Carol got a SSG Buy with a 3.6 Upside/Downside Ratio and a 17.7% Total Return. The NAIC/BI Buy criteria are a minimum 3.0 U/D and a 15.0% TR.
- Both Armin-1 and Armin-2 also satisfied the SSG Buy criteria. Armin-1 with its 13.00% EPS estimate is a conservative SSG while Armin-2 is more optimistic.
- Armin
Measuring Medtronic (MDT)
October 3, 2009
[AF addendum: Jay P's SSG and First Cut write-up, discussed below, are also summarized in the December 2009 issue of Better Investing magazine]
- Medtronic is the world’s largest medical technology company with FY 2009 revenues of $14,599 B, up a satisfying 8%. MDT operates in seven segments: Cardiac Rhythm Disease Management (34% of FY 09 revenues: pace-makers and implantable defibrillators); Spinal (23%: artificial spinal discs); Cardiovascular (17%: heart valves, stents); Neuromodulation, (10%: implantable stimulation devices); Diabetes (8%: insulin pumps), Surgical Technologies (6%); and Physio-Control (2%: defibrillators for hospitals and public access).
Company Background:
- MDT is a global company that manufactures and sells its devices in more than 120 countries. Its primary products include those for cardiac rhythm disorders, cardiovascular disease, neurological disorders, spinal conditions and musculoskeletal trauma, urological and digestive disorders, diabetes, and ear, nose and throat conditions.
- Morningstar reports that Medtronic has successfully expanded its business away from MDT’s traditional reliance on heart disease and is now developing products for a wide variety of chronic diseases. Revenues from investments in neuromodulation, diabetes, and spinal products have increased from 25% of total sales in FY 2000 to 41% in FY 2009.
- Significant future growth is expected in three areas: MDT’s spinal bone graft product, one-of-a-kind in its market, and from atrial fibrillation and transcatheter heart valves.
- The one-click Annual Report spreadsheet by Bob Adams gives MDT’s 2009 A.R. a 55 out of 100 with 16 green flags, 2 red flags, 10 Bullish results and 8 Bearish results.
** The Bullish-good things include increasing sales that are also increasing faster than related costs; growing gross profit margin; good free cash flow. The Bearish-not so goods include increasing inventories and shares outstanding; and high debt to equity which is also one of the red flags.
** You can get this super-duper spreadsheet and an explanation of its many features by going to my Favorite Links page and scrolling down: click here.
- Legal matters:
** MDT just paid $442 M to settle a long-standing patent lawsuit involving drug coated stents that substantially reduced its 1Q earnings;
** The FDA, in July 2008, issued a warning letter to doctors regarding MDT’s Infuse Bone Graft product and reports of life-threatening complications from unapproved use;
** MDT’s latest Annual Report mentions that it incurred four litigation charges in 2009 totaling $714 M, all of which involved patent or royalty disputes.
** MDT’s A.R. also mentions that some 1250 personal injury lawsuits are pending, including 37 class actions, involving the company’s Sprint Fidelis defibrillator leads which it recalled in 2007. Wikipedia explained these leads sometimes malfunctioned and were implicated in several deaths.
Discussion:
- The following table compares the SSG by JayP, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. Armin-1 uses S&P data from the Better Investing while Armin-2 uses the same judgments, but with Hemscott-Morningstar data from Stock Central.
| Medtronic (MDT) | JayP | Armin-1 | Armin-2 | Take Stock |
| Date | 9-21-09 | 9-23-09 | Same | Same |
| Data | S&P | S&P | Hemscott-Morningstar | Same |
| Price | $37.48 | $37.04 | Same | $37.35 |
| 52 week High & Low Price | $54.02 & $24.86 | $52.97 & Same | Same | Not Included |
| Last Q of Reported Data | Q1 ending 7-31-09 | Same | Same | Same |
| Software Used | TK 5 | Same | Same | TS Online |
| Project Growth From End of | Last Q | Same | Same | Last FY |
| Sales Growth | 08.00% | 10.00% | Same | 07.90% |
| EPS Growth | 09.00% | 10.00% | Same | 07.90% |
| High PE | 21.8 (last 3 yr ave) | 20.4 (2008) | 17.8 (2008) | 23.1 |
| High EPS | $4.31 | $4.56 | $5.12 | $4.65 |
| High Price | $94.00 | $93.00 | $91.10 | $107.19 |
| Value Line Estimated High Price = $80-100 as of 8-24-09 | ||||
| Low PE | 14.4 (last 3 yr ave) | 08.6 (2008) | 07.7 (2008) | 17.3 |
| Low EPS | $2.80 (last FY) | $2.83 (TTM) | $3.22 (TTM) | $3.22 |
| Low Price | $24.10 (recent severe low) | $22.20 (60% x current price) | Same | $55.71 (higher than current price) |
| Upside/Down | 4.2 | 3.8 | 3.6 | impossible to calculate |
| Total Return | 21.1% | 21.1% | 20.8% | 25.5% |
| SSG Buy Under | N/A | $39.92 | $39.43 | $58.51 |
| RV/PRV | 72.9/67.1 (2004 & 2005 out) | 72.4/65.7 (Same) | 56.7/51.5 | Not Included |
| Quality | N/A | A- | Not Included | 3.2 (unacceptable) |
| PTPM – 5 yr ave | 30.0% Trend down | Same Same | 30.5 Same | Same Trend N/I |
| ROE – 5 yr ave End Equity | 24.7% Trend even | Same Same | 26.2% Trend up | Not Included |
| ROE – 5 yr ave Start Equity | N/A | 26.9% Trend even | 28.5% Trend up | Same Trend N/I |
| Debt to Equity – 5 yr ave | N/A | 46.1% Trend up | 45.2% Trend up | Not Included |
Estimating EPS:
- Jay estimated 9.00% EPS and his First Cut write-up says that it was “in line” with Value Line and with 25 analysts who follow MDT.
** VL was actually estimating 10.00% and the 25 analysts were not identified nor were there estimates revealed. The MDT website lists 18 analysts who follow the company, but no estimates are set forth.
- When I did my SSG on 9-23-09, the six analysts I always check were closely estimating long-term EPS at an average of 10.43% with FactSet CallStreet via CNNMoney.com high at 11.00% and Value Line low at 10.00%. Thomson-Reuters via YahooFinance.com was 10.23%, Zacks.com was 10.31%, S&P was 10.40%, and Reuters.com was 10.62%.
** I had SSGed MDT on 8-24 and only FactSet and Value Line remained the same. The average then was 11.04% with S&P the largest reduction from 13.40 to 10.40% and the others going down only slightly.
** I continued to estimate 10.00% EPS which was the lowest estimate of the six by VL.
Forecast High PE:
- Jay eliminated 2004 & 2005 as outliers and used the resulting three-year average of 21.8 as his Forecast High PE.
- I also eliminated those two outliers, but saw that the trend was downward so I used 2008 (20.4, the lowest in the last 5 years) as my Forecast High PE.
- Take Stock is not programmed to look for trends and always eliminates the five highest High PEs in the last 10 years and uses the resulting average (23.1) as its Forecast High PE. This is equivalent to the Alt-M command in TK 5 and TK 6.
Forecast High Price:
- Take Stock at $107.19 was the only analysis to exceed Value Line’s estimated High Price of $80-100.
- I never want to substantially exceed VL and Take Stock’s 7% excess doesn’t seem unreasonably high to me. For how I determine if SSG judgments are reasonable, see: Determining What’s Reasonable and What’s Not: An Update
Forecast Low Price:
- Jay used MDT’s recent severe low price of $24.10 while I used $22.20, 60% of MDT’s current price.
- Take Stock, on the other hand, got a much, much higher Forecast Low Price of $55.71 which substantially exceeded MDT’s current price of $37.35.
** While this is a SSG NO-NO according to the BI/NAIC SSG Manual, this is one of several issues where Take Stock is deliberately designed to be different.
** I think it’s absurd to have a Low Price that’s high, especially when it exceeds the stock’s current price, and constitutes a serious defect in my judgment.
Pre-Tax Profit Margin:
- MDT’s Pre-Tax Profit Margin is trending down, which Jay did not mention, and which is usually a red-flag warning sign to consider abandoning the SSG.
- However, using S&P data, MDT is way better than its industry average (30.0% vs 16.4%, Health Care Equipment industry) and also way better with Hemscott data (30.5% vs 16.6%, Medical Appliances & Equipment industry). Moreover, MDT ranks 8 out of 118 companies with Hemscott data. Soooooo, I would not cease any analysis because of MDT’s PTPM trend.
- To learn more about using Industry Info, see: Investigating Industry Info
Quality:
- S&P gave MDT an A- for quality (which doesn’t show on Jay’s PDF copy) while Hemscott has no quality rating. S&P uses an eight-point scale with A+ the highest score.
- Take Stock rated MDT a 3.2 which is unacceptable as 3.4 is the minimum required to pass muster and 6.7 is desired.
Final Results:
- Jay and my two SSGs are very close: all got a Total Return of around 21% as well as an Upside/Downside Ratio of between 3.6 and 4.2. A TR > 15% and a U/D >3.0 means that MDT is a SSG Buy.
- Take Stock’s Forecast Low Price exceeded MDT’s current price which meant that it was impossible to calculate and compare our U/Ds. Take Stock also gave MDT an unacceptable quality rating while S&P gave it an A-.
Final Thoughts: [Addendum]
- While the SSG does not ask about legal issues, they can influence whether we make optimistic or pessimistic judgments, and also whether we Buy, Hold or even Sell the stock.
- Medtronic and other medical equipment makers (like Stryker and Zimmer) are in a risky business: bad news about patient injuries, governmental investigations, and/or new class actions can cause the stock price to plummet.
- Armin
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*** By the way, I've added links to my Table of Contents located in the Blog's "Home" page in order to make navigation easier.]
