Cochlear On The Front Foot For Recovery

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

Cochlear is raising equity to preserve liquidity, placing the business on the front foot for a recovery once the deferral of non-essential surgery has passed.

-Net cash position still expected at the end of FY20
-Dividend resumption expected in FY22
-Evidence of delayed elective procedures in Europe and the US
 

By Eva Brocklehurst

The times are indeed extraordinary, as Cochlear Ltd ((COH)), considered one of the more defensive businesses, has decided to raise equity to preserve its liquidity. Earnings and cash flow have been affected by a slowing of cochlear implant surgery, considered a non-essential in the current environment.

Morgan Stanley assesses the capital raising reflects conservative management in respect of the depth and duration of the coronavirus crisis. Rather than cut essential expenditure to offset what may be a transient issue, the company is keeping up R&D and channel development so the recovery phase could be more rapid.

Credit Suisse agrees the liquidity allows the company to support its long-term R&D and capital expenditure amid volatility in the short-term operating environment. Even with a large decline in earnings the broker still expects a net cash position at the end of FY20.

The dividend is suspended until trading conditions improve. Credit Suisse now assumes cochlear implant unit sales decline -47% in the second half and -55% in the first half of FY21. Given the high proportion of senior recipients that are likely to continue viewing surgery as a non-essential the broker does not expect a recovery to the normal level of implant sales until the first half of FY22.

Services revenue declines are expected in the second half of FY20 with a faster recovery in FY21 relative to implants. The broker considers this a quality business with a superior product portfolio and long-term opportunity for growth, particularly in the adult market.

The equity raising includes a fully underwritten $800m institutional placement at $140 a share and a non-underwritten share purchase plan of $50m. As well, the company has obtained approval for an additional $150m bank facility from an existing lender and covenant relief from lenders after June 2021.

UBS was not surprised by the decision, considering the sudden deterioration in the operating environment and the need to pay out around $380m in penalties following the lost patent infringement case.

The outlook for surgery is likely to remain difficult for some time and the broker cuts its dividend forecast to zero in FY21 with pay-out returning from FY22. Based on current forecasts, UBS estimates Cochlear will have a net cash position through FY21.

Beyond the disruption from coronavirus, unit sales growth is expected to return to normal levels and processor upgrade sales improve. Nevertheless, the broker asserts the market is factoring in sustainable cochlear unit sales growth above 10% and penetration of the installed base of over 60% for upgrades, considered unrealistically high.

Conservative

Citi notes Cochlear has an installed base of over 600,000 patients to protect. Hence, if this board felt pressure to de-leverage, it is likely to be a sign that many will follow. At this point, the broker assumes the impact on the business occurs during the fourth quarter and FY21 returns to normal. Nevertheless, Citi acknowledges forecasting is very difficult and this may not be the case.

Macquarie is also positive on the longer-term outlook, expecting a recovery will be supported by market share gains following the recent recall from Advanced Bionics. The capital raising is expected to provide ample liquidity, sufficient to cover 12 months of subdued operating conditions.

The impact of delayed elective procedures has started to become evident in western Europe and the US although there are improved activity levels in China, despite Beijing and Wuhan remaining shut. Normal activity levels are continuing in both South Korea and Japan. Macquarie assumes deferred procedures will be undertaken once elective surgical procedures recommence, underpinned by paediatric recipients.

Morgan Stanley notes, anecdotally, volumes in China are already above 60% of pre-coronavirus volumes, despite the two major cities being shut. Moreover, prior to the crisis, the broker points out the company was in a strong position, having delivered 13% unit growth in the first half of FY20.

FNArena's database has two Buy ratings, three Hold and two Sell. The consensus target is $176.33, suggesting 5.1% upside to the last share price. Targets range from $145 (UBS) to $196 (Macquarie).

See also, Slow Recovery More Likely For Cochlear on March 17, 2020

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