Researching RMD (ResMed)

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 58^th 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