Somnomed : SOM An eye on RSS channel conflict but the core offering to prevail in US direct market, Wilsons – 24.2.17

Date

24 February 2017

Theme

Financial Results

Company

SomnoMed (SOM)

Recommendation	BUY
12-mth target price (AUD)	$4.50
Share price @ 23-Feb-17 (AUD)	$3.07
Forecast 12-mth capital return	46.6%
Forecast 12-mth dividend yield	0.0%
12-mth total shareholder return	46.6%
Market cap	$176m
Enterprise value	$163m
Shares on issue	57m
Sold short	0.0%
ASX 300 weight	n/a
Median turnover/day	$0.0m

An eye on RSS channel conflict but the core offering to prevail in US direct market

We maintain a BUY rating and 12-month price target of $4.50 per share. SomnoMed has reported its 1H17 earnings detail and reiterated its FY17 guidance. The RSS sleep centre roll-out in America is reporting volume ramp profiles similar to those seen in the "S3" centres in Texas, on which the RSS model is based. Push-back from "direct" customers remains a near-term potential headwind which we are monitoring carefully. We don't expect this to have a materially adverse impact on SomnoMed's US device business, believing that the core offering (price, quality, reimbursement access and turnaround times) will underpin US business performance through this marketplace transition. RSS is up and running, and is going to be a permanent fixture in the US sleep market from this point. Key points 1H17 result. Core medical device unit sales were 33,309 over the 1H (up 14.9% on pcp) which was broadly in line with our forecasts but ~5% below the run-rate implied by full-year guidance (70,000+). Revenue of $23.8m grew 11.5% on pcp noting ~4% pcp currency headwinds on both EUR and USD sales. SomnoMed's global medical device business reported underlying EBITDA of $1.4m (Wilsons: $1.3m) driven by Europe, primarily, which was up again by 18% in volume terms (segment profit +20%). SomnoMed's full-year EBITDA guidance for its global medical device business is $4.0m (Wilsons: $3.6m). The new Renew Sleep Solutions (RSS) business recorded a 1H EBITDA loss of $1.0m which compared well with our forecast. Forecasts, outlook. No changes to our forecasts which remain modestly below company guidance. Guidance is unchanged, the most important element being the EBITDA outlook ($4m for SomnoMed and -$4m for RSS). The key variation between guidance and our forecasts is in the US business, where we have allowed for some continued softness in direct demand as the customer base digests and responds to the potential competitive impact of RSS on their practices. This reaction will occur and resolve as RSS rolls out over the next few years - but we think SomnoMed's offering (price, quality, access, turnaround times) will underpin reliable demand growth over forecast period. $4.50 price target. Our DCF valuation is based on consolidated model of SomnoMed's global device biz + dominant equity interest in the RSS business. Risks and catalysts Catalysts: a) quarterly volumes; b) US managed care progress; c) margin improvement; d) RSS centre roll-out.Risks: a) execution on US strategy; b) competition; c) average sales price erosion; d) RSS roll-out difficulties; e) working capital and liquidity pressure; f) adverse reimbursement outcomes.

Shane Storey [e-mail] Tel. [phone]

12-mth price performance ($)

4. 45

4. 00

3. 55

3. 10

2. 65

2. 20

Feb-16 Jun-16 Oct-16 Feb-17

SOM	XSI Rebased
1-mth	6-mth	12-mth
Abs return (%)	-15.4	-5.3	23.7
Rel return (%)	-16.0	2.2	16.2

Earnings forecasts
Year-end June (AUD)	FY15A	FY16A	FY17F	FY18F	FY19F
NPAT rep ($m)	0.6	0.2	-1.6	4.6	11.5
NPAT norm ($m)	0.6	0.2	-1.4	4.6	11.5
Consensus NPAT ($m)	-1.1	5.0	12.2
EPS norm (cps)	1.2	0.3	-2.5	8.0	20.1
EPS growth (%)	-55.3	-73.3	-877.5	421.1	151.1
P/E norm (x)	255.8	958.7	-123.3	38.4	15.3
EV/EBITDA (x)	187.2	110.4	-1730.6	20.4	8.4
FCF yield (%)	-0.8	0.1	-2.1	-0.3	3.6
DPS (cps)	0.0	0.0	0.0	0.0	0.0
Dividend yield (%)	0.0	0.0	0.0	0.0	0.0
Franking (%)	0	0	0	0	0
Source: Company data, Wilsons estimates, S&P Capital IQ

Key changes
27-Jan	After	Var %
NPAT:	FY17F	-1.3	-1.4	N/A
norm	FY18F	4.6	4.6	0.0%
($m)	FY19F	11.5	11.5	0.0%
EPS:	FY17F	-2.4	-2.5	N/A
norm	FY18F	8.0	8.0	-0.1%
(cps)	FY19F	20.0	20.1	0.5%
DPS:	FY17F	0.0	0.0	0.0%
(cps)	FY18F	0.0	0.0	0.0%
FY19F	0.0	0.0	0.0%
Price target:	4.50	4.50	0.0%
Rating:	BUY	BUY

Wilsons Research

Issued by Wilsons Advisory and Stockbroking Limited ABN 68 010 529 665 - Australian Financial Services Licence No 238375, a participant of ASX Group and should be read in conjunction with the disclosures and disclaimer in this report. Important disclosures regarding companies that are subject of this report and an explanation of recommendations can be found at the end of this document.

Price target
Valuation	Price target
DCF methodology
WACC (%)	12.0
Term. grwth assumption (%)	3.5
PV of forecast FCFs ($m)	61.5
PV of terminal value ($m)	179.3
Enterprise value ($m)	240.8
Net debt (cash) ($m)	-13.6
Equity value ($m)	254.4
DCF valuation (A$/sh)	4.43
Price target (A$/sh)	4.50

Key assumptions
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17F	FY18F	FY19F	FY20F
Revenue growth (%)	21.3	40.1	33.0	28.0	16.1	46.9	45.2	47.2
EBIT growth (%)	-39.1	35.0	-45.7	90.2	-424.0	-525.4	170.2	81.8
NPAT growth (%)	-9.0	-9.2	-4.8	-72.4	-934.2	-433.7	151.1	78.2
EPS growth (%)	-2.5	75.4	-55.3	-73.3	-877.5	-421.1	151.1	78.2
EBIT/sales (%)	1.8	1.7	0.7	1.0	-2.9	8.3	15.4	19.1
Tax rate (%)	-93.3	3.4	44.8	85.0	-44.5	27.0	27.0	27.0
ROA (%)	2.0	2.3	0.9	1.1	-3.5	12.1	24.0	35.3
ROE (%)	6.3	5.1	2.8	0.5	-4.2	11.4	20.5	29.1
SomnoMed EBITDA ($m)	0.8	1.1	0.9	1.5	3.6	7.5	11.2	14.6
RSS EBITDA ($m)	0.0	0.0	0.0	0.0	-3.7	0.5	8.0	19.6

Profit and loss ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17F	FY18F	FY19F	FY20F
Sales revenue	18.5	25.9	34.4	44.1	51.2	75.2	109.2	160.8
EBITDA	0.8	1.1	0.9	1.5	-0.1	8.0	19.3	34.2
Depn & amort	0.5	0.6	0.6	1.0	1.4	1.7	2.4	3.5
EBIT	0.3	0.4	0.2	0.5	-1.5	6.2	16.9	30.7
Net interest expense	-0.1	0.0	-0.1	0.0	-0.1	0.0	0.0	0.0
Tax	-0.4	0.0	0.2	0.4	0.6	1.7	4.6	8.3
Minorities/pref divs	0.1	-0.2	0.1	0.1	-0.7	0.0	0.8	1.8
Equity accounted NPAT	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Net profit (pre-sig items)	0.7	0.6	0.1	0.0	-1.4	4.6	11.5	20.6
Abns/exts/signif	-0.1	-0.2	0.5	0.2	-0.3	0.0	0.0	0.0
Reported net profit	0.6	0.4	0.6	0.2	-1.6	4.6	11.5	20.6

Interims ($m)
Half-year (AUD)	Dec 15	Jun 16	Dec 16	Jun 17
1HA	2HA	1HE	2HE
Sales revenue	21.3	22.8	23.8	27.4
EBITDA	0.9	0.6	0.4	-0.5
EBIT	0.4	0.0	-0.2	-1.3
Net profit	0.3	-0.2	-0.3	-1.0
Norm EPS	0.8	-0.4	-0.7	-1.8
EBIT/sales (%)	2.1	0.0	-0.7	-4.7
Dividend (c)	0.0	0.0	0.0	0.0
Franking (%)	0.0	0.0	0.0	0.0

Financial stability
Year-end June (AUD)	FY16A	FY17F	FY18F
Net debt	-17.6	-13.6	-13.0
Net debt/equity (%)
Net debt/EV (%)
Current ratio (x)	5.3	4.7	4.4
Interest cover (x)		28.1	�
Adj cash int cover (x)		60.9
Debt/cash flow (x)	0.0	0.0	0.0
Net debt (cash)/share ($)
NTA/share ($)	0.5	0.4	0.5
Book value/share ($)	0.6	0.6	0.6
Payout ratio (%)	0	0	0
Adj payout ratio (%)	0	0	0

Cash flow ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17F	FY18F	FY19F	FY20F
EBITDA	0.8	1.1	0.9	1.5	-0.1	8.0	19.3	34.2
Interest & tax	0.0	-0.5	0.1	-0.2	-0.1	-1.7	-4.6	-8.3
Working cap/other	-0.3	-1.3	-1.2	0.9	-0.1	-3.3	-4.7	-7.9
Operating cash flow	0.6	-0.8	-0.2	2.1	-0.3	3.0	10.0	18.1
Maintenance capex	-0.2	0.3	-1.2	-1.9	-3.5	-3.6	-3.7	-3.9
Free cash flow	0.4	-0.5	-1.4	0.2	-3.8	-0.5	6.3	14.1
Dividends paid	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Growth capex	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Invest/disposals	-0.5	-0.3	-0.2	-1.3	-0.3	0.0	0.0	0.0
Other inv flows	-0.1	-0.4	-0.3	-0.4	0.0	0.0	0.0	0.0
Cash flow pre-financing	-0.2	-1.2	-1.9	-1.5	-4.0	-0.5	6.3	14.1
Funded by equity	0.5	0.0	7.3	10.7	0.0	0.0	0.0	0.0
Funded by debt	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Funded by cash	-0.3	1.2	-5.3	-9.2	4.0	0.5	-6.3	-14.1

EPS reconciliation ($m)

FY16A Rep Norm	FY17F Rep Norm
Sales revenue	44 44	51 51

Balance sheet summary ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17F	FY18F	FY19F	FY20F
Cash	4.2	2.9	8.3	17.6	13.6	13.0	19.3	33.5
Current receivables	4.4	5.5	7.2	7.8	8.3	12.3	18.0	26.9
Current inventories	0.9	1.0	1.3	1.7	2.2	3.3	4.8	7.2
Net PPE	1.2	1.3	2.1	3.6	5.0	6.4	7.1	6.9
Investments	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Intangibles/capitalised	5.3	8.5	8.9	9.7	10.5	11.1	11.7	12.4
Other	0.2	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Total assets	16.1	19.1	27.8	40.4	39.6	46.1	61.0	86.8
Current payables	3.5	3.3	3.9	6.1	6.8	8.6	10.9	14.0
Total debt	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other liabilities	1.0	3.2	2.4	1.7	1.8	2.1	2.3	2.6
Total liabilities	4.5	6.6	6.2	7.7	8.7	10.6	13.2	16.6
Minorities/convertibles	0.6	0.2	0.2	-0.4	-0.4	-0.4	-0.4	-0.4
Shareholder equity	11.6	12.6	21.5	32.7	30.9	35.5	47.8	70.2
Total funds employed	11.6	12.6	21.5	32.7	30.9	35.5	47.8	70.2

EBIT 0.6 0.5 -1.7 -1.5

Net profit	0.2	0.2	-1.6	-1.4
Notional earn	0.0	0.0	0.0	0.0
Pref/conv div	0.0	0.0	0.0	0.0
Profit for EPS	0.2	0.2	-1.6	-1.4
Diluted shrs (m)	48	52	55	55
Diluted EPS (c)	0.3	0.3	-2.9	-2.5

Returns
FY16A	FY17F	FY18F	FY19F
ROE (%)	1	-4	14	28
ROIC (%)	2	-6	22	46
Incremental ROE	-4	-33	426	82
Incremental ROIC	6	-65	146	134

SomnoMed Limited - 1H17 results

Summary

We maintain a BUY rating and 12-month price target of $4.50 per share. SomnoMed has reported its 1H17 earnings and reiterated its FY17 guidance. Investors will need to keep an eye on the RSS roll-out in America, which did provoke some modest push-back from "direct" customers in the 1H, who perceived a competitive threat. We don't expect this phenomenon to have a materially adverse impact on SomnoMed's US device business, believing that the core offering (price, quality, reimbursement access and turnaround times) will underpin US business performance through this marketplace transition. RSS is up and running, and is going to become a permanent fixture in the US sleep market from here.

Table 1: SomnoMed's 1H17 results vs pcp and Wilsons' estimates

($ in mn) 1H16a	1H17a	%chg Forecast %chg Var (abs$) %var
USA 9.5 Europe 9.9 APAC 2.0	10.4 11.4 2.1	9% 10.915% (0.6)-5% 15% 10.911% 0.44% 6% 1.9-2% 0.28%
Net revenue 21.3	23.8	11% 23.812% (0.0)0%
COGS 9.1	10.1	11% 9.88% 0.33%
Gross profit 12.3	13.7	12% 14.014% (0.3)-2%
SG&A 9.8 Corporate 1.6	11.3 2.0	16% 11.518% (0.2)-1% 23% 2.132% (0.1)-6%
EBITDA 0.9	0.4	-56% 0.4-54% (0.0)0%
SomnoMed 0.9 RSS -	1.4 (1.0)	54% 1.343% 0.18% n/a (0.9)n/a (0.1)0%
Interest, other 0.0 Tax 0.1 Minorities 0.0 Adjustments (0.2)	(0.1) 0.4 (0.2) (0.3)	nm - 0% (0.1)0% nm 0.2nm 0.2nm nm (0.2)nm (0.0)15% nm -nm (0.3)0%
NPAT 0.2 Adjusted NPAT 0.3 Adjusted EPS (cps) 0.8	(0.6) (0.3) (0.7)	nm (0.3)nm (0.3)96% nm (0.3)nm (0.0)14% nm (0.6)nm (0.1)17%
Diluted shares 51.5	53.1	3% 54.05%
Operating cash flow 0.9	(0.9)	nm (1.0)nm 0.16%
% of net revenue Dec-15a	Dec-16a	Wilsons
Gross profit 57.5% MAS gross profit 68.0% SG&A 45.8% Corporate, R&D 7.5% Operating income 4.3% Pre-tax profit 2.2% Net income 0.8%	57.6% 69.1% 47.7% 8.3% 1.7% -0.5% -2.5%	58.9% 69.1% 48.3% 8.8% 1.8% -1.2% -1.3%

FY17 Guidance	SomnoMed	Wilsons	RSS	Wilsons
Units	70,000+	68,889	1,000+	800
Revenue	$54m+	49.3	$2m+	2.1
EBITDA	$4m	3.6	-$4m	-3.7

Source: SomnoMed, Wilsons' estimates

Results notes

INCOME STATEMENT Core medical device unit sales were 33,309 in the 1H (up 14.9% on pcp) which was broadly in line with our forecasts but ~5% below the run-rate implied by full-year guidance (70,000+). Revenue of $23.8m grew 11.5% on pcp noting ~4% pcp currency headwinds on both EUR and USD sales. SomnoMed's global medical device business reported underlying EBITDA of $1.4m (Wilsons: $1.3m) driven by Europe, primarily, which was up again by 18% in volume terms. SomnoMed's full-year EBITDA guidance for its global medical device business remains $4.0m (Wilsons: $3.6m). The new RSS business recorded a 1H EBITDA loss of $1.0m which compared well with our forecast: USA. Unit sales of 18,128 devices was up 15.5% on pcp with a softening in direct sales. Segments of the US direct customer base are cautious about SomnoMed setting up in competition to them with RSS clinics. This needs to be carefully monitored over the next few periods. SomnoMed describes positive experiences from customers adjacent to the S3 clinics in Texas, who report volume increases following local advertising campaigns. SomnoMed's product quality, pricing and turnaround times will remain an attractive feature for the majority of sleep dentist/physician customers. Revenue in the US increased 9% to $10.4m. Europe. Unit volume growth 18.1% across 16 active countries. Revenue in Europe was Asia Pacific. Revenue increased by 6% to $2.1m with flattish earnings. Australian sales were better in Q2 with dental customers returning to SomnoDent after trying out a new entrant to the domestic market in Q1 - the O2Vent device by Oventus (ASX:OVN, not covered by Wilsons). RSS. As reported at the Q2 update, SomnoMed has opened its RSS campaign, with treatment centres now accepting sleep apnoea patients in Oklahoma City and Tulsa. Start-up losses of $1.0m were a little lower than we had forecast. $11.4m (up 15%) and earnings were up 20% to $1.3m. The outlook in Europe is supported by recent reimbursement changes in France and Belgium, both of which have recently put market access for oral appliances on par with CPAP therapy. NPAT. The reported net loss of $600K was lower than our forecast of $300K principally on account of higher tax. SomnoMed pre-paid tax relating to the US business but this will normalise full year.

Figure 1: Quarterly device unit sales FY08-18e 20,000 15,000 10,000 5,000 - USA ROW Europe Source: SomnoMed, Wilsons