1Q sales solid – masks regain strength and devices remain strong
1Q adjusted earnings were in line with our expectations (NPAT US$94.1m, +7.3%), as was adjusted operating profit (US$124.3m, +12%). However, revenue surprised, coming in above expectations (US$523.7m, +11% vs Morgans estimate of US$503m), on improved patient volumes, with the underlying business (ex-Brightree) putting up market leading growth (+10.3 in constant currency) and ongoing strength in the Brightree informatics platform (+15% to US$38.1m; +13% organic). The Americas (US$296.6m, +11%) and Rest of World (US$189m. +11% in constant currency) moved higher due to stellar mask growth (+13% in Americas, +14% in ROW) and devices remained strong (+8% in Americas, +9% in ROW).
Adjusted Gross Margin (GM) gained 20bp quarter on quarter to 58.4%, above guidance (c58.2%), supported by manufacturing/procurement efficiencies, Brightree and improved product mix, partially offset by 'normal' Average Selling Price declines. Operational Cash Flow improved 9% to US$94m, on solid underlying earnings, supporting a 6% year on year dividend uplift (US$0.35).
Leverage should start to become evident
We are encouraged by the improvement in underlying patient volumes, which management expects to 'grow steadily', along with the 'unconstrained' ability to now supply masks, unlike prior quarters, driving category growth (+14%) to 4 year highs. While sustainability of this growth pace is unlikely and strong translation of sales to the bottom line is lacking, we take comfort that underlying earnings growth is tracking the top line and we continue to believe leverage is likely to improve given:
- a strong mask/device portfolio supported by cloud-based connectivity;
- upside from relaunched portable oxygen concentrator Activox, noninvasive and life support ventilators, and the travel airMini (which has shown growth 'above expectations');
- 'steady' reimbursement;
- Gross Margin tailwinds; and
- expanding Brightree connected-care offerings to support low to mid teen growth.
Momentum looks set to continue
We have revised FY18-20 estimates, modestly increasing our sales (up to 2.4%) and margins assumptions, which sees NPAT increase up to 3.7%. We characterise 1Q as a solid quarter with masks the standout, clearly leaving prior supply constraints in the past and portending improving operating leverage and a solid earnings trajectory.
With >10% upside to our share price target, we maintain our Add recommendation.
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