Should you buy, hold or sell Resmed shares?

ResMed (ASX: RMD) is a global medical device company that manufactures and distributes equipment to treat obstructive sleep apnoea (OSA) and other respiratory diseases.

The company's primary focus is on supplying continuous positive airway pressure (CPAP) devices and accessories to treat OSA.

It also has a software-as-service (SaaS) business, primarily selling cloud-based applications for durable medical equipment (DMR) distributors to manage back-office functions and product re-supply.

Its roots date back to the late 1980s when Peter Farrell acquired the core CPAP technology from Baxter Healthcare and later listed the company in 2000.

Over the last thirty years it has grown to become the leading global player (with approximately 70% market share) in the CPAP market with a turnover in excess of US$4.2 billion.

It has built its capability and footprint organically and through a series of strategic acquisitions such as Brightree, a cloud-based software for the post-acute care market, and Propeller Health, a digital specialises in respiratory disease management.

An awakening opportunity

Over the last few years ResMed has been the beneficiary of its major competitor Phillip having a product recall of its Dreamstation CPAP flow generator device. This has provided a generational opportunity for ResMed to capture market share.

While COVID disruption and supply chain challenges have constrained ResMed's ability to fully benefit from the recall, it has resulted in clear gains which we expect will deliver a longer-term market share uplift and earnings benefit.

Despite this, ResMed's share price is down close to 20% over the last 12 months, as the market has become concerned about the potential impact of Glucagon Like Peptide (GLP-1) weight loss drugs to reduce OSA prevalence and risk to the addressable market for CPAP therapy and device sales.

We believe this is providing an opportunity to buy a high-quality global leading healthcare business at a discount to its longer-term fundamental value.

Calibrating the impact of weight-loss drugs

GLP-1 drugs have been around for close to 20 years and initially used to target type 2 diabetes, but not been considered efficacious enough to see commercial take-up and be reimbursed for weight loss.

However, advancement in the development, and recent new clinical trial results, for GLP-1s have showed clear efficacy in weight management and reduced cardiovascular indications.

There is also growing expectation Eli Lilly's Surmount GLP-1 phase three trial due for release in early 2024 will show sustained weight loss will reduce the incidence of OSA and with it the need for CPAP therapy.

We expect continued adoption of GLP-1s on the back of further clinical trials results and potential widening of access to weight loss drugs through greater funding.

However, it also needs to be recognised there remains significant uncertainty around the potential clinical adoption, cost-benefit and commercial take-up of GLP-1 drugs and impact on CPAP.

Approximately 60% of OSA patients are estimated to be attributable to obesity.

Of these patients, clinical feedback suggests that only a subset is expected to maintain weight-loss through long term adherence of a GLP-1s.

Further, there is evidence that only a proportion of these patients are expected to sufficiently reduce weight and see a reduction in OSA indication sufficient to cease CPAP therapy.

Consideration also needs to be given to the fact that market penetration of OSA patients that can benefit from CPAP remains modest, presenting opportunities for new patients.

In recent years, growth in OSA diagnosis has been supported by increased awareness amongst primary care physicians, referrals from other specialist (eg cardiology) and increased home sleep testing.

Overall, there is good evidence to suggest the OSA market is expected to continue to grow with obese patients not using obesity drugs and non-obesity related OSA helping limit, and under some scenarios even potentially more than offset, the impact from the uptake of GLP-1s.

The 'obesity drug scare' cannot be ignored, but we believe the current implied reduction in the long-term addressable market for CPAP and derating in ResMed's share price is overly pessimistic.

Based on a range of potential scenarios we see a favourable risk reward to buy a high-quality business at an attractive margin of safety.

ResMed currently trades on a price earnings ratio (PER) of 23.4x 12-month forward consensus EPS, a 20% discount to its 10-year average historical PER.

Taking what we regard as a very conservative perspective and assuming a 30% decline in ResMed's addressable market from GLP-1s we value the company at $25.40, around the current share price.

Breaking down ResMed's patient cohorts we model that a 14% decline in the OSA addressable market (our base case scenario) values ResMed at $33 a share, 20% upside to the current price.

Beyond the impact of the obesity drug concerns ResMed remains well placed to take advantage of a materially improved competitive and position and grow market share with Phillips continuing to face address product recall issues and potential further delays in returning fully to market.

This puts the company in a strong position to maintain and grow earnings given the high-margin nature of the business model.

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