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Why ResMed Inc (CHESS) still offers investors big potential

The ResMed Inc. (CHESS) (ASX: RMD) share price could come under pressure this morning after the sleep therapy specialist reported a flat quarter ending March 31 2017.

On an adjusted basis the San Diego-based company posted a profit up 3% to US$100.7 million compared to the prior corresponding period, while the unadjusted profit was down 3% to US$87.8 million. The adjusted profit excludes expenses related to acquisitions, restructuring and amortisation of acquired intangibles.

The amortisation of acquired intangibles dragged down the bottom line on an accounting (non cash) basis by US$11.4 million due to the amortisation expense associated with the US$800 million Brightree acquisition. The other big excluded costs for the quarter were US$11.5 million in expenses associated with employee equity grants and associated employee remuneration expenses as is common with U.S. tech companies.

On an operating basis ResMed continues to perform well in its goal to become the world’s leading tech-driven medical device company. For the quarter revenues were up 6% to US$479.2 million on an adjusted basis, or 13% to US$514.2 million including the contribution from its Brightree acquisition.

The revenue growth is pretty solid and supported by rising gross margins that hit 58.3% this quarter compared to 57.3% in the prior corresponding quarter. The gross margins benefiting from the capital-light nature of the digitally driven and software-as-a-service related Brightree acquisition, while the company also stated it benefited from some manufacturing and procurement efficiencies.

When it comes to leading medical device companies, margins matter. Rising margins traditionally being interpreted as a buy signal by Wall Street analysts as they’ll commonly translate into rising profits and share price gains. Whereas falling margins spell trouble, competitive pressures, downsizing, and a potential sell signal for analysts.

ResMed for example is facing competitive pressure from New Zealand-based rival Fisher & Paykel Health Care Corp Ltd (ASX: FPH) and in 2016 both companies took each other to court in fierce legal disputes over product patent infringements in an indication of how fiercely each will fight to preserve the market-leading nature of their products.

Unfortunately for ResMed its gross margin growth is also being heavily outpaced by rising research, development, and SGA expenses. SGA expenses climbing 16% over the prior quarter to US$137 million, with R&D expenses blowing out 25% over the prior quarter in a result unlikely to impress investors.

Outlook

For ASX investors ResMed remains a great growth stock given its market-leading nature, founder led management team, and overseas exposure it offers investors.

The company has a bulletproof track record of revenue growth thanks partly to the large addressable global markets it operates in and demographic tailwinds supporting the business.

After its second quarter results in January 2017 I commented that the stock looked a buy at $8.40 and the share price has since climbed around 14% to $9.54. Evidently the value on offer is not as great now, although if the market marks down the stock on the basis of its most recent quarter it is likely to produce another good buying opportunity for investors focused on the long term.

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Motley Fool contributor Tom Richardson owns shares of ResMed Inc.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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