The market’s propensity to latch on to the latest fads and fantasies never surprises.
Start with longevity. The Economist magazine’s recent cover story trumpeted the potential to live to 120 as new longevity drugs are developed.
The report had an excellent package of stories, including one about entrepreneurial companies promoting longevity drugs and services. No doubt some of these ventures will raise capital and list on exchanges to cash in on longevity hype and investor interest.
Readers of this column know I follow the ageing megatrend. Last month, I wrote on the Blue Zones documentary on Netflix and highlighted two ways to play the longevity trend through affordable property developers for downsizers.
Companies, such as Lifestyle Communities in Victoria and Summerset Group Holdings in New Zealand, are real companies with real earnings that have successfully leveraged the ageing population trend for years.
When investing for megatrends, the best bet is usually quality, simple businesses with years of growth ahead. The worst bet is falling prey to hype about the latest trend and punting on speculative firms that inevitably destroy capital.
Weight-loss drugs are another example. Offshore broking firms are busily promoting stocks that can benefit from the Ozempic craze. Prescriptions for Ozempic have reportedly soared. Some global pharmaceutical stocks that are developing weight-loss drugs, which might not be approved, have rallied.
Nobody doubts the potential demand for weight-loss drugs or the money at stake. The trouble is, investors too often buy into the megatrend at the peak of initial hype, only to be burned. Then they give up on the megatrend just as it (and company valuations) gets interesting. I’ve seen this pattern too many times.
Moreover, investors often overlook the losers from megatrend hype. The real companies that could be hurt by weight-loss drugs, in this example.
Megatrend hype not only drives prices of potential winners too high; it can also drive prices of potential losers too low. That’s usually where the best risk/reward trade-offs occur, in my experience.
Sleep-apnea stocks are an example. ResMed Inc has tumbled this year because investors believe demand for its devices could fall as weight-loss drugs reduce the incidence of obesity. Many sleep-apnea patients are overweight or obese and need help to breathe at night from air pumped into their mouth or nose.
Other companies with sleep-apnea products have taken a beating. Fisher & Paykel Healthcare has fallen from a high of $26.08 to $19.86. SomnoMed, which makes dental devices that are an alternative to Continuous Positive Airway Pressure (CPAP) machines, has more than halved from its 52-week high.
As more weight-loss drugs are developed and approved, and more patients use them to treat obesity, demand for sleep-apnea devices could fall.
I briefly used a ResMed CPAP machine over a decade ago, to combat mild sleep apnea and resulting morning tiredness. I hated the feeling of air pumped into my mouth at night, so stopped using the (then) noisy device. Losing some weight through exercise and diet meant the device was no longer needed.
For prospective investors, the question is whether valuations have already priced the threat of weight-loss drugs into sleep-apnea stocks. I think valuations have fallen too far as the market overreacts to the impact of weight-loss drugs on sleep-apnea stocks.
Weight-loss drugs are costly, and some have had supply shortages. It’s a long way from developing a drug to getting it approved in various markets onto medical-rebate schedules, more doctors prescribing it and into the hands of sleep-apnea patients.
Also, losing 15% of weight, on average, by taking weight-loss drugs will still leave many patients in the obese category and in need of their CPAP machine. Those with serious sleep breathing disorders might find a small amount of weight loss is not enough for them to give up a machine they rely on each night. There’s also the risk that they put on more weight if they stop taking weight-loss drugs.
Obesity is not the only cause of sleep apnea. For some patients, jaw and tongue issues are significant contributors to the problem. For others, it’s psychological. I just can’t see weight-loss drugs causing a huge drop in demand for CPAP machines in the next few years, particularly in emerging countries as obesity rates rise.
Here are two sleep-apnea opportunities to consider at current valuations:
- ResMed Inc (ASX: RMD)
ResMed, among the highest-quality healthcare stocks on ASX, has fallen from a 52-week high of $ $36.37 to $23. The company’s one-year total return (including dividends) is almost negative 30%. Over three years, the return is barely positive.
For a company that has delivered impressive long-term returns (the annualised return over 15 years is 16%), ResMed has had a tough few years by its standards.
ResMed should be in a sweet spot. Its main competitor, Koninklijke Philips, a Dutch company, is still suffering from a costly, high-profile product recall. Supply constraints during the COVID-19 pandemic (for example, chip shortages) are behind ResMed and it continues to grow through market-leading innovation.
I doubt the market fully appreciates the value of the patient ‘ecosystem’ ResMed has developed and how this creates barriers to entry for rivals and higher switching costs for users who decide to give up their CPAP devices.
In addition to the main CPAP machine, ResMed sells higher-margin masks and other accessories that need more frequent replacement. ResMed also provides a range of data and software products that aid physicians and enable patients to monitor their breathing performance and seek interactive coaching.
Again, I can’t see large numbers of ResMed customers who are embedded in this product/data ecosystem giving up their device quickly, thanks to costly weight-loss drugs that might not solve their problems and have other side effects.
Morningstar believes weight-loss drugs will have a modest impact on ResMed’s revenue and are already priced into its valuation. I agree. Morningstar’s fair value of $39 suggests ResMed is materially undervalued at the current $23.
I’m not quite as bullish as Morningstar but see latent value in ResMed for long-term investors after heavy price falls this year. It was interesting that ResMed held up in this week’s heavy market sell-off on Tuesday. I suspect some fund managers are using that volatility to initiate or build a position in ResMed at the current price.
Chart 1: ResMed Inc
- SomnoMed (ASX: SOM)
I’ve followed SomnoMed on and off for almost two decades. It produces and sells oral treatments for sleep-related disorders, using dentists as a key distribution channel. Some I know swear by SomnoMed’s products, including those who struggled to adapt to CPAP machines at night.
SomnoMed has two main products: the SomnoDent oral device for obstructive sleep apnea; and SomnoBrux, a mouthguard that protects against teeth-grinding at night. The SomnoDent product sells in 28 countries
Like my medical-device makers, SomnoMed has had a tough year. In its FY23 annual report, the company noted challenging business conditions, increased competition and unexpected changes to Medicare reimbursement rules.
But SomnoMed still grew its revenue by 15% to $83.6 million in FY23, a touch below the growth rate in the previous year and in line with revised guidance.
A recent $15.5 million equity capital raising will reduce debt, strengthen the balance sheet and provide working capital to grow the business.
SomnoMed’s market is people who struggle with CPAP machines. It believes its dental devices are equally as effective as CPAP machines and that there are millions of sleep-apnea patients who could use its devices.
I’ve always thought SomnoMed has potential. The company continues to grow its revenue in good and bad markets, has a high-margin product, and solves a problem for people who have mild sleep apnea and cannot use CPAP machines.
SomnoMed has rallied a few times over the years, but like many nano-cap stocks (it is capitalised at $76 million) has struggled to attract more broking coverage and has a low market profile (it seems to be doing more on investor relations).
SomnoMed suits experienced investors who understand the features, benefits and risks of investing in nano-cap stocks that can be thinly traded.
Yes, SomnoMed has many challenges, but not enough to warrant a more than halving of its valuation over 12 months (at the 69-cent share price).
Investors will need patience: sleep apnea is a hard market to crack and SomnoMed is a steady rather than spectacular performer.
Chart 2: SomnoMed
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 4 October 2023.
