Competition Batters Cochlear

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

-Chinese competitors ramp up
-Questions over growth remain
-Concern over high dividend pay-out
 

By Eva Brocklehurst

The competition is hacking away at Cochlear ((COH)) remorselessly. The pre-eminent pioneer and provider of cochlear implants to the deaf no longer has the market corralled. Moreover, the competitor armies are advancing quickly, much more quickly than many had believed. 

Recent information from Med-EL shows that competitor has garnered substantial share in Europe and is becoming a major threat, in Morgan Stanley's observations. Meanwhile, Sonova/Advanced Bionics is benefitting from vertical integration, with aggressive strategies in place and taking share as Sonova hearing aid users are converted to cochlear implant users. Morgan Stanley sees a similar risk with William Demant's acquisition of the small French manufacturer, Neurelec, which has a 2-3% global cochlear implant share. William Demant's share of the bone anchored hearing aid (BAHA) market has grown from zero three years ago to 30% now, and that's been wholly at Cochlear's expense.

Morgan Stanley believes that the changing demographics for cochlear implants, with a focus on older patients, is likely to benefit competitors which offer a broad spectrum of hearing solutions. Then there's China. Cochlear missed out on the remaining tender contracts for this year and Morgan Stanley believes it has to do with the company not being willing to sell at the price of US$7,000, the winning tender. UBS also thinks Cochlear declined to take a hair cut, because dropping under US$10,000 reduces earnings and brand reputation. The cash market remains at a premium around US$20,000 and that's where Cochlear is positioned.

Morgan Stanley has crunched the numbers. Cochlear's FY13 unit sales grew 15.5% to 26,674. Within this number was a Chinese tender order for 2,800 units.Therefore, ex-China sales were 23,874. With no sales expected to be forthcoming from China in FY14 and assuming underlying growth of 10%, that adds up to 26,261 units, a 1.5% contraction year on year.

UBS has pointed to the emergence of Chinese manufacturer Listent, which has now joined its compatriot Nurotron to sell implants into the adult market. Listent also aims to have paediatrics approval in three years time. Both are expected to scale up to manufacturing capacity of 5,000 units each and around a price point of US$10,000. This is likely to entrench Cochlear at the top of the cash market. Moreover, UBS believes volume growth in China is in the mass market – government contracts and tier 2 hospitals – where health care access is expanding via upgrades to tier 2 hospitals which service a population of around 800 million. The cash market is likely to be a subdued component.

In the US, following the roll out of the Naida processor by Sonova/AB, which has been well received, Cochlear appeared to be forced into releasing a partially-approved N6 in an attempt to stop the loss of market share. Will the full launch of the processor alleviate the weak outlook? Morgan Stanley does not think so. Given the recent N5 upgrade cycle and related time limits for insurance purposes the broker is not convinced the N6 upgrade cycle will be as immediately successful as the N5.

Other brokers have questioned the company's ability to grow profits amid the erosion of market share. Citi is concerned about plans to maintain a high dividend  and thinks this could, in the longer term, harm shareholder relations. A strategy of paying out large dividends by increasing borrowings to reward shareholders might be alright if the challenges are short term. If not, and the competitive landscape changes, a strong balance sheet that could have provided significant advantage is wasted. Citi thinks this may do shareholders more harm than good over the long term.

All brokers are worried about the risk to guidance if Cochlear does not turn market share losses round or find new areas of market growth, particularly in the US if the uptake for N6 speech processor upgrades is delayed. Deutsche Bank does not see the lift in market growth occurring, despite Cochlear's spending on growth initiatives. The FY14 results will be heavily biased to the second half and the dividends are being paid above the earnings rate for the second year running. The broker expects a fall in profit of 3% in FY14, in comparison to the company's expectations for a flat result.

The stock retains seven Sell ratings and one Hold on the FNArena database. The consensus price target is $53.30, suggesting 6.4% downside to the last share price. The dividend yield is 4.5% on FY14 forecasts and 4.6% on FY15.

 See also, Cochlear Confidence Falls On Deaf Ears on October 16 2013 
 

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