I spent my pre-teen summers tending my uncles' cotton fields in central Texas. My citified parents thought my brother and I needed to hone a work ethic in the Texas sun. In the silent night air, under the Milky Way, the little wood farmhouse would start rattling with the sound of my two uncles' dueling snore-fest. I might as well have been in the combine shed with the big machine on "high picking."
While dragging our long sacks through the cotton rows, my brother and I would entertain ourselves imitating the giant farm boy snores. At the time we were not aware that the obstruction that caused those noises was apparently a genetic defect passed down on the male side of our family. My two dear uncles went to the big dance hall in the sky in their 60's as a result of this problem.
This article is about Sleep-Disordered Breathing (SDB) problems and five medical equipment companies that are doing something to solve them.
People that have Sleep Apnea really don't like to talk about it. Some are in denial because they have never actually heard themselves snoring. Others are embarrassed to admit that their libido has gone south from constant fatigue. Others still are stunned that their former near-nymphomaniac high-school sweetheart is now insisting on a separate bedroom. Levity aside, it is estimated that 20% of the adult population of the U.S. has at least a mild case of this problem, and 7% of the population has moderate to severe sleep apnea. That is a huge market for companies that produce products to help victims return to normal sleep patterns.
SDB can cause a variety of serious health problems in addition to a restless nights sleep and a tense family life. External symptoms include headaches, daytime sleepiness and impaired concentration among others. This can be catastrophic for both blue-collar equipment operators as well as attendees of marathon board meetings. Internally, SDB problems include hypertension, arrhythmias and strokes.
The most common type of SDB is obstructive sleep apnea. This occurs when the upper airway collapses, completely or partially, obstructing the passage of air. The sleeper continues to attempt to sleep, but is frequently aroused, sometimes gasping for air. While sleeping, the vibration of the obstruction causes loud snoring. This condition is frequently associated with obesity, and a high percent of type 2 diabetics also suffer from sleep apnea.
ResMed (RMD) is the market leader in the production and sale of continuous positive airway pressure (CPAP) systems. Basically, this is a pump that provides a modulated pressure to an airtight mask over the mouth and nose. The pressure maintains the airway passage open so the user can sleep uninterrupted. These systems can sell for less than $1000 or up to several thousands of dollars. A basic system, including the diagnostics and accessories, can be had for less than $2000, and insurance companies generally cover a good portion of this, as the CPAP prevents many expensive maladies. Most of ResMed products are for the home health care market.
RMD annual revenues are growing at about a 10% pace and the price-to-earnings ratio is a little under 20. The stock is selling about three times sales and nearly three times book value, so we do not consider it a value proposition. Although it is the undisputed leader in their market, they are not alone and the technology is not so specialized to prevent others from entering the market. They primarily sell their products in the US, Europe and Australia.
CareFusion (CFN) provides a variety of medical infusion, respiratory and dispensing systems to hospitals. It also provides surgical and disposable products. It sells ResMed CPAP systems for use in the hospital environment. They also sell other respiratory ventilators for more severe breathing problems, as well as masks and accessories.
CFN is growing revenues about 3 - 5 % per year and they carry a PE of 14. They have good value metrics with a price equal to book value and 1.5 times sales. CFN is establishing the goal of increasing the growth to 5 - 10%, but that may be difficult given the competition for most of their products, and analysts are predicting another mundane year for 2013. Despite the solid value, we do not see much impetus for the stock to go higher, and it trades in a narrow range with no dividend.
Electromed, Inc. (ELMD) produces and sells a different type of airway obstruction appliance. It combats chronic lung problems with the SmartVest system which consists of a pneumatic therapy garment and an electronic pulse generator, which generates high frequency chest wall oscillation. This solution can facilitate breathing and sleep for after-surgery patients and those with chronic problems, such as bronchial conditions and repeated episodes of pneumonia, which result in fluid buildup. This system is particularly child-friendly.
As an equity investment, ELMD is interesting as a tiny, but profitable, enterprise of $24MM market cap, with only 8MM shares. The stock sells now at about $3 and that gives it a PE of about 25. Sales and book value indicate real value, and ELMD could be a home run if their SmartVest gains popularity with healthcare professionals.
Unfortunately, their growing revenue and earnings over the past year have been interrupted by a contraction in the last quarter. The company explains this as a problem with the sales force, resulting in termination of several sales reps. Expectations are that the effect of this will carry into subsequent quarters.
I may miss the investment of the year, but my read is that ELMD is a one-trick pony, twenty-years old that lost traction because of a supposedly underperforming sales force. At this point in its development, that seems like little headwind to stop ELMD in its tracks. If the product itself is losing traction, this stock is on ventilation. I have this one in my radar, but I am not buying.
Dehair Medical (DHRM) is a Chinese microcap that develops, assembles and sells its own CPAP machines. Dehaier's technology is based on six patents and five software copyrights. It recently received European CE Mark approval to sell its sleep apnea diagnostic equipment and CPAP machines in Europe. DHRM sold ResMed machines in China previously. DHRM also assembles and sells infusion and anesthetic equipment based on French patents that they had purchased.
DHRM is selling at about $2.50 per share and is half as large as Electromed in market cap of only $11MM, with 4.2 MM shares outstanding. Like many beaten down Chinese stocks, DHRM has crazy value metrics if you can believe them: book value of $6 a share and earnings over $1 per share. The last quarter was flat at $.31 per share, and they should announce annual earnings anytime. They expect to have growth primarily come from their own branded CPAP machines, which they just launched in July 2011. They also are investing in R & D to bring out their "second generation" CPAP machines in mid 2012.
The last few weeks have been very busy for Dehair. They hired The Equity Group as their PR firm. That was followed up with announcements that they were certified as a "high tech" company in China which allows them to reduce their tax rate from 25% to 15%, and makes them eligible for low-interest government loans. They also received a small subsidy as a result of this certification. Finally, they were given a BBB+ credit rating by a Chinese rating association.
The history of too-good-to-be-true Chinese scams is enough to make one take a skeptical stance on DHRM. The annual report is going to be very, very interesting, and I am taking a flyer on this company that they are not doing all this PR in advance of a sleepy annual report.
Masimo Corp. (MASI) develops, manufactures, and markets noninvasive patient monitoring products worldwide. Sleep clinics are popping up all over the world to determine the severity of the sleep apnea and the calibration of the CPAP machine. Various sensors to monitor heartbeat, blood pressure and oxygen in the blood system are attached to the patient. Masimo makes the products to monitor these activities. They also sell their monitors to hospitals.
As one would expect, the revenues have been growing at about 10% annually for MASI. They have a forward PE of about 18. The market cap is about 3 times sales and 4 times book, although the balance sheet is debt free. We should expect Masimo to continue to grow, but for the immediate future MASI appears to be priced fairly. I am putting MASI on my watch list in the event of a drop in price.
If you know someone that is suffering from sleep apnea, the technology of these companies can change their life. You might say, "you snooze ... you win."
Disclosure: I am long DHRM.