Big Potential in the Growing Market for a Better Night's Sleep

Gagging... gasping... and snoring like a freight train.

That's the reality for millions of people every night, as they struggle with sleep apnea.

The condition happens when the throat repeatedly closes and opens while a patient sleeps.

Once the throat closes, oxygen levels in the body drop. Blood pressure rises. So do carbon dioxide levels. Lips and skin can start to turn blue. Some patients may not breathe for a full minute, and their hearts can even stop.

The brain eventually jolts the body awake enough to take a breath, but most folks are so tired that they immediately fall back asleep, which starts the cycle over again.

The condition used to be treated with a permanent tracheotomy – where doctors would have to insert a tube in the throat to bypass the airway. But in 1980, Dr. Colin Sullivan found a better way to treat it.

Sullivan took a vacuum-cleaner engine and rigged up some plastic tubes to a diving mask. He strapped it to a patient's face and sent him off to sleep. Sullivan reversed the vacuum's flow and fiddled with a system he created to control the air pressure.

With the right amount of air flowing into the mask, it pushed the patient's airways open. He breathed comfortably and quickly fell into deep REM sleep – sleep the patient had been missing for years.

This was an early version of the continuous positive airway pressure (or CPAP) device. Today, millions of people use these devices to sleep every night.

In 1989, Sullivan and Peter Farrell paired to start a company to provide respiratory medical devices to the world.

Thirty years later, that company is known as ResMed (NYSE: RMD).

The CPAP machine has come a long way since Sullivan's original device. The machines have gotten quieter and smaller. The masks are more comfortable and come in all shapes and sizes.

And ResMed's AirSense 10, released in 2014, has been a top seller. Then in 2017, the company released the AirMini, which offers the same technology in a much smaller package for travel. The products consistently get top reviews.

Now, like many pharmaceutical and medical companies, there can be problems with people not using the device as prescribed.

But ResMed has connected devices that can help with this...

It has a system called U-Sleep that monitors patients for CPAP usage. If the patient falls behind, U-Sleep sends text messages and e-mails to help them get back on track.

And through this system, ResMed has amassed billions "sleep-nights" of data, which it uses to improve its machines.

Just like how Google is the best search engine because it learns from its customers' searches, ResMed is building a trove of CPAP data. The lessons it learns from its machines won't be available to upstart competitors.

This advantage should help the company continue to grow market share. And this means good things for ResMed's profits and shareholders...

ResMed has grown from nothing to around $2.6 billion in sales per year. All the while, ResMed has managed the business side well.

The company has maintained a gross margin of around 60% for the last decade. And it produces solid EBITDA margins of more than 20%.

These are remarkably stable numbers for a medical-device company.

More impressive, the company earned positive free cash flow in 2000, just five years after its initial public offering, and it hasn't turned back since.

In its last fiscal year, which ended in June, ResMed produced $390 million of free cash flow. That was equal to 15% of its total sales.

Despite being a growing company with plenty of challenges, it has maintained positive cash flow – the cleanest measure of true profitability – for nearly two decades... all as it continued to grow its sales.

Even now, it only has about $1.2 billion in debt. If you consider the $147 million in cash on hand and the $400 million in annual net income, it could pay off all it owes in just about two years. The balance sheet is as clean as it can get.

Revenue grew 11.4% in the past year. While many growth companies focus on growing at the expense of returning money to shareholders, ResMed pays a dividend, buys back shares, and has been reducing its debt.

And there's still a large, growing market for CPAP devices.

According to the American Journal of Epidemiology, about 26 out of every 100 people have sleep apnea... but only four of them know it.

Even though sleep apnea is a well-known problem and CPAPs are a widely accepted treatment, the penetration numbers are low.

For instance, of the roughly 24 million people with moderate-to-severe apnea in the U.S. alone, ResMed estimates only about 20% have a CPAP machine. That suggests the U.S. market can grow five times over from here.

And that means that ResMed could be set to continue growing from here.

The stock's performance has been just as impressive as its business. RMD shares have nearly doubled over the past two years, and the stock just hit a new all-time high.

ResMed's devices are helping change and save lives. Combine that with its strong balance sheet, and this stock is set for more gains in the years to come.

Sometimes investing is simple.