The recent news flow of 'miracle' weight loss drugs has significantly impacted the potential outlook for RMD. The explosion in sales of Novo Nordisk's Wegovy and Ozempic labels have even been cited to have prevented Denmark from falling into a recession, with the company valued at ~A$670bn, now worth more than the entire Danish economy. Whilst it is far too early to attempt to quantify what the potential impact could be for RMD, we instead look at what the current share price is implying, and whether we believe risks are slated to the up or downside.
Miracles can come true. For context, the drug Ozempic was originally manufactured to treat type II diabetes. Semaglutide is the primary active ingredient in GLP-1 agonist drugs, which work by mimicking a naturally produced hormone, glucagon-like peptide 1 (hence the GLP-1 acronym) which is involved in stimulating secretion of insulin and suppressing the 'glucagon' hormone which can reduce hunger. We won't dive into the medical detail in this note, but the latter has been shown to be effective in treating obesity, with Wegovy receiving FDA approval to be used in weight loss treatments. The drugs are prescribed along with a low-calorie diet and exercise.
Can they really? Whilst initial study results are positive and that weight loss drugs are effective and a great step forward in treating obesity, the drugs can be prohibitively expensive and also do require a healthier lifestyle. The cost of using Wegovy is not yet largely covered by insurance in the US for weight loss. Without insurance, the drugs may cost up to ~US$15,000 per year.
It's important to note that in order to maintain weight loss, patients will require to stay on the drug for a long time, as it can be very easy to put the weight back on once the hunger is no longer suppressed. After all, the drugs were originally designed to be taken for life treating diabetes. A 2021 study (Rubino et al) looked at what happened after half the patients switched to a placebo after 20 weeks of receiving a weekly shot of semaglutide, with those continuing with the drug losing further weight, and those on the placebo gaining weight that they had lost.
There are significant potential side effects with taking GLP-1 drugs, which may deter many people who are not actively prescribed the treatment for medical reasons, rather than aesthetic motivations. The drugs are likely to have the largest effect on those who are at the extreme end of obesity. These patients are highly likely to also suffer from OSA. There is limited current evidence that suggests people have had remissions from OSA after taking the weight loss drugs.
There is however strong evidence that weight loss treatment through GLP-1 does reduce the severity and number of episodes of sleep apnea, where according to a 2015 study (Amin, Simakajornboon and Szczesniak) 70% of patients saw a ~44% episodes by 44%. Therefore if GLP-1 drugs become much more prevalent and are successful in the overall treatment of weight loss, there is a genuine risk to RMD's core market.
Obstructing sleep. One of many side effects of obesity is the increased prevalence of Obstructive Sleep Apnea (OSA). In the USA, OSA is present in ~40% of obese adults (BMI >30) and studies have shown that ~70% of OSA patients are obese. The market is therefore concerned that the rising commonality of weight loss drugs would present a meaningful impact to RMD's core product. Whilst we believe the GLP-1 drugs will have some potential impact, we don't believe it is as meaningful as the current share price is suggesting. OSA is one of the most undiagnosed conditions, with up to ~25% of the adult population potentially having the condition. This provides a meaningful tailwind of growth for RMD even if some of the population no longer suffer from OSA.
What's being priced in? Accurately forecasting the impact of weight loss treatments on the OSA market remains just an exercise given the extreme range of potential outcomes. We prefer to instead look at what the current share price is implying, and identifying if the risks lie to the up or downside. At <$24.00, using consensus free cash flow estimates and a risk free rate of 4% and an average AUD/USD of $0.70, the market is assuming that the terminal growth rate for RMD is less than 1%, which is likely below GDP and inflation. We believe this current level of pricing is far too bearish given that it is unlikely the weight loss drugs will significantly impact RMD's growth profile, given that we expect both CPAP treatments and weight loss drugs to co-exist in the market.
Historic revenue for RMD over the last 10 years (from 2013 to 2023) has grown at an compound annual growth rate (CAGR) of 10.8%. EPS has also grown strongly at 10.1%pa over the same period. FY23-FY27e forward CAGR for revenue and EPS are expected to be 8.9% and 12.3% respectively as RMD returns to improving operating leverage. On 2030 forecasts, the current share price is implying over ~20%+ loss of market share.
Figure 1: RMD valuation at different terminal growth rates
Figure 2: Significant difference between valuations
What do we need to see for RMD to re-rate? Novo Nordisk and Eli Lilly both manufacture GLP-1 drugs which have had significant sales boosts. The market has become much larger than expected and both share prices have taken off in August. RMD has moved in the opposite direction. For RMD to re-rate, we would need to see some of the enthusiasm come out of the weight loss drug stocks before the market would start rotating back into RMD. That being said, given we believe fears are likely overblown in the current share price, investors with a long term time horizon who are willing to look through the short term noise should be rewarded. We are not one to get in the way of short term momentum, but on a 12 month or longer time horizon, RMD should be able to prove that it is unlikely to lose the significant market share that the market is implying.
RMD at its next quarterly will also need to prove that its margin recovery is back on track given the slight hiccup at its 4Q/FY23 result. The market has lost faith in management which will need to be restored. It will therefore likely be a slow burn for RMD to begin re-outperforming.
Figure 3: Eli Lilly and Novo Nordisk share prices have taken off, whilst RMD has been left behind
RMD's PER has taken a hit given there have not been any real material short term earnings downgrades, with the impact on earnings likely seen in later years. RMD has not traded at PER levels in the low 20s since 2017. We believe those investors who are willing to look through the short term noise will be rewarded.
Figure 4: RMD's PER is well below -1SD of its long term average, levels not seen since ~2017
Figure 5: RMD's share price has dropped well below its 12month forward EPS
Investment View
RMD was fairly punished for a poor 4Q result, where it did not deliver on the margin expansion management had promised in the 3Q result. RMD then found itself in a significant headwind of talk of miracle weight loss drugs being ready for everyday consumption. Whilst there will likely be some disruption to RMD's core products, we see the fears as being largely overblown in the current share price. CPAP treatment will still be required given the significant number of undiagnosed cases, as well as the difficulty in effectively treating an incredible number of people with the weight loss drugs. There is little current evidence to suggest that GLP-1 drugs can be effective for a significant portion of the population, given prohibitive cost as the drug will need to be continually taken and that it needs to be coupled with a complete lifestyle change.
RMD has not traded at PER levels since 2017, presenting a compelling opportunity for longer term investors to begin building a position in a high quality growth company. We note that short-term momentum will likely continue to take its toll, so longer horizons are required.
Risks to Investment View
Weight loss drugs may be far more effective and become cheaper than anticipated, leading to lower patients diagnosed with OSA. There are clinical risks, competition, technical innovation and change of practice factors to be considered. Changes in demand, pricing and costs also weigh on future earnings potential.
Recommendation
We maintain our Buy rating.
