Across client portfolios that have elected the ‘Growth’ Australian equities option we are purchasing Resmed, funded by the sale of AMP Limited

Purchase of ResMed (RMD)

ResMed is a leading developer, manufacturer and distributor of medical equipment for treating, diagnosing, and managing sleep-disordered breathing (“SDB”) and other respiratory disorders.  SDB includes a spectrum of respiratory disorders ranging in severity from snoring to obstructive sleep apnea (“OSA”), the latter occurring when the airway temporarily collapses during sleep, preventing or restricting breathing for up to ten seconds or more. Such events can occur several hundred times a night severely disrupting sleep and negatively impacting health.

Some research suggests that SDB affects around 20% of the adult population, making it as widespread as diabetes or asthma. Historically awareness of OSA has however been low with the majority of sufferers remaining undiagnosed and untreated. This is changing though due to ongoing education, which combined with an increasing understanding of the morbidity and mortality caused by SDB means ResMed is operating in one of the fastest growing segments of the respiratory industry.

We like ResMed because:

• The company is the market leader (with market share of circa 40%) in an industry that provides enormous quality of life and health benefits yet remains underdeveloped with scope for significant growth;
• The balance sheet is very strong with around $620m in net cash. This provides the company with the flexibility to inter-alia continue pursuing its emerging market growth strategy and/or buying back its own stock;
• The trend to increased home sleep testing (“HST”) is leading to more sales of higher margin machines as HST produces a less accurate diagnosis thus requiring use of more expensive automatic machines. During 4Q13 HST accounted for around 30% of US volumes with expectations that this will increase to 40% within 12 months and potentially 60% over time;
• The company continues to invest heavily in R&D with between 7-8% of revenue spent on research annually. The result is that ResMed has a strong pipeline of new products to be released in 2014 with the next-generation devices expected to help drive volume growth; and
• It recently released a new machine to help with chronic obstructive pulmonary disease, the number 3 killer in the Western World. We expect that this product will be a medium term driver of growth.

 

Purchase of the shares are obviously not without risks which include:

• National rollout of competitive bidding in the US by the Centers for Medicare & Medicaid Services on products they reimburse could negatively impact both volumes and average selling price. About 10% of the groups revenue is exposed to competitive bidding, but the latest Round 1 rebids seem to indicate more rational bid behaviour by suppliers going forward; and
• The company has recently lost share in the nasal mask category, though we expect this to be largely arrested following the release of the company’s latest nasal mask offering launched in September.

 

Sale of AMP

AMP has significant operations in funds administration, funds management, financial advice and life insurance. AMP’s flagship wealth management operations are the largest in Australia and New Zealand with a network that includes around 4,200 aligned and employed financial advisers and planners.  It is the largest domestic life insurer in Australia and the Group’s funds management business, AMP Capital Investors, currently has FUM of circa A$130bn.

 

While AMP is well placed to take advantage of the growing pool of superannuation assets, enjoys strong brand recognition and has an excellent distribution network, we decided to sell AMP due to the following:

• Wealth Protection is experiencing negative margin pressures due to higher than expected claims and policy lapses in the life book. Uncertainty remains around the success of management initiatives to address these, with the risk of further lapses in excess of current allowances skewed to the 2nd half of the year due to annual age and CPI rate increases;
• The Group continues to lose market share with the latest insurance industry data showing that AMP had the lowest in-force premium growth amongst the ten largest players;
• Leverage to higher FUM in Wealth Management in the first half of 2013 was slightly disappointing due to higher rebates paid to fund managers and product/fee mix changes as new inflows move onto lower fee platforms;
• AMP Capital fund flows continue to disappoint, with the mature book driving outflows; and

• The announced $320m (pre-tax) investment over the next 3 ½ years to achieve business efficiencies and strengthen its competitive advantage will be excluded from underlying earnings.  When this cost is added to the $550m (pre-tax) related to the AXA integration and compliance costs which AMP has also charged ‘below-the-line” (i.e. excluded from underlying earnings), it raises questions around the adequacy of AMP’s recurring project/investment spend.

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