Competition Fears Hound Cochlear

This story features COCHLEAR LIMITED. For more info SHARE ANALYSIS: COH

-Is Cochlear too expensive?
-Implant unit growth subdued
-Upside from leveraging installed base
 

By Eva Brocklehurst

Cochlear ((COH)) is being trounced by competitor Sonova, in the view of some brokers. Market share concerns prevail for both Citi and Morgan Stanley as Sonova reported cochlear implant sales grew 23.0% in US dollar terms terms in its first half. This growth  occurred despite an interruption from a hardware launch and the absence of Chinese tender sales.

Morgan Stanley estimates implant unit growth for Cochlear in the second half of FY14 was a disappointing 3.2%, ex tenders. The broker suspects the company is losing market share, as Sonova reported 50.2% revenue growth for its cochlear implant division, Advanced Bionics, in its first half. The broker does not believe the premium at which Cochlear is trading against FY15 estimates is justified. Morgan Stanley estimates the earnings per share compound growth rate since the company's pre-N5 recall in 2010 is just 2.0%, while the rate for units over the same period is 5.0%.

Citi concludes that AB is gaining market share at the expensive of Cochlear, the industry's largest player. The broker assumes a significant speech processor upgrade cycle through FY15 and implant unit sales growth of 7% in the US in 2015, but this requires a slight reversal of recent market share losses upon the release of the Nuclear Profile implant, supported by the full features of the N6 speech processor. Given Sonova's results, Citi suspects there is increased downside risk to this scenario. The broker also considers Cochlear expensive in both absolute and relative terms. If market share losses continue and/or market growth remains modest, downside risks are heightened. Regulatory intervention and reimbursement changes in the US add a further uncertainty to the mix.

US Medicare issued a final ruling earlier this month, deciding not to broaden the hearing aid exclusion for auditory implants such as BAHA devices. Credit Suisse welcomed this decision on Cochlear's behalf and noted new products and upgrades were driving sales but implant unit growth was subdued. The broker concedes processor upgrades are likely to be a significant contributor to growth in what appears to be an earlier-than-expected upgrade cycle. Still, Credit Suisse's key fear is loss of market share, suspecting this was the cause of the company's slowdown in the second half of FY14.

Macquarie is less inclined to worry about market share, believing upgrades sales will provide the positive surprise in FY15. The size of Cochlear's installed base has continued to grow over the past four years and this means management's historical guide for upgrade sales to be 10-15% of group sales has become less relevant. Macquarie, therefore, analyses upgrades as a function of this installed base. The recently approved N6 drives an upgrade cycle that is around 37% higher than the previous cycle in FY12, in the broker's calculations. Moreover, high margin sound processors can create further upside. While new patient sales have been largely flat over the past three years Macquarie considers a solution lies the development of a more effective adult distribution channel.

As upgrades and BAHA are contributing 35% of earnings, the broker is more confident that Cochlear can deliver strong growth in the absence of a rebound in implant units. Macquarie concedes the stock is not cheap but finds the investment attractive and retains an Outperform rating. This represents the only Buy rating on the FNArena database. There are one Hold (Deutsche Bank) and six Sell. The consensus target is $58.84, suggesting 17.4% downside to the last share price. Targets range from $53.21 (Citi) to $72.00 (Macquarie).
 

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