ResMed Inc. (CHESS) (ASX: RMD) has been one of Australia's best performing healthcare stocks over the past 10 years. According to Morningstar, ResMed has provided long-term investors with an average total annual return (dividends + capital gains) of 13.2% each year over the last 10 years.
The share price hit an all time high of $9.84 earlier this year, before disappointing trial results saw the share price fall below $6.70. The share price has since stabilised and is now trading at around $7.50. Based on the latest share price, ResMed is trading on a price-to-earnings ratio of around 25.
Although the current valuation seems expensive, here are five reasons that justify such a high premium:
1. Global Footprint – ResMed operates in more than 100 countries and that gives it exposure to a huge number of potential opportunities. Although there are other players in the sleep apnoea market, ResMed is a market leader with strong brand awareness and the most extensive product range. Australian investors will benefit from a further fall in the Australian dollar as ResMed earns around 90% of its revenues from the Americas and Europe.
2. Growth Opportunities – The possible target market for ResMed is extraordinarily large with many patients yet to be diagnosed or treated for sleep related disorders. With many chronic conditions now being linked to sleep disorders, ResMed has a huge opportunity to increase the pool of people it can treat.
The treatments that ResMed offer also play a role in preventing the progression of chronic diseases such as asthma, diabetes and obesity. The company has been working hard to increase awareness of sleep related disorders and making treatments more acceptable and accessible to patients.
3. Proven track record – Although a company's past performance is never a guarantee of future performance, ResMed has an excellent track record. Earnings per share have a grown at a compound annual growth rate of 21% over the past five years. Investors can be confident that management are working hard for the best interests of shareholders and this has been reinforced through the continual increase in the dividend each year.
4. Strong gross margins and increasing return on equity – ResMed's third quarter 2015 results showed an impressive gross margin of 59.5%. Even with the emergence of new competitors in the market, ResMed has been able to maintain such large margins through disciplined cost reduction strategies that has seen operating expenses as a percentage of revenue in a downward trend since 2009. At the same time, the return on equity has been increasing steadily and is now approaching 22%.
5. Strong Balance Sheet – ResMed is carrying over $950 million in cash on its balance sheet that will provide it with the capital needed to undertake acquisitions and further product development. ResMed is also carrying a very low debt level and this will enable the company to return more free cash flow to shareholders.
Foolish takeaway
The long-term outlook for ResMed is very positive and the strong underlying fundamentals of the business means it will be well placed to take advantage of growth opportunities in the future.
Although the current valuation looks expensive, I believe ResMed could continue to outperform for many years to come.
