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Cochlear On The Mend But Recovery Unclear

Australia | Oct 21 2020

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

Implant volumes in Cochlear's major markets appear to be on the mend, which is supportive of revenue, but concerns are emerging regarding another bout of elective surgery restrictions.

-First quarter rebound largely stemming from a backlog
-New candidate pipeline filling but is it enough?
-Little clarity on timing of recovery in emerging markets


By Eva Brocklehurst

Growth in developed markets has returned for Cochlear ((COH)) in the first quarter of FY21, amid both rescheduled and new surgeries. Implant volumes are stemming from the major market recovery as activity in emerging markets is at a standstill.

While health systems across the globe are preoccupied with the pandemic, non-paediatric surgery has to give way to more pressing procedures. Moreover, several brokers note the resurgent coronavirus cases, particularly Europe, could result in another downturn in elective surgery.

Despite implant volumes falling -14% in the September quarter the company reported just a -6% drop in revenue, reflecting the strong growth in higher-price developed markets, specifically the US, Germany and Korea.

Macquarie is positive about the stock, given this shift in mix towards more expensive markets. While surgery in China is growing, other emerging countries are substantially down on volumes. The broker's investment view is based on the scope for above-industry unit sales and market share gains as a surgical procedures resume.

Credit Suisse now assumes implant unit sales decline -10% in the first half while services & acoustics revenue is on a positive trajectory and should return to pre-pandemic levels by the first half of FY22.

Pace Of Recovery

There is little clarity regarding the expected pace of recovery in emerging markets, where volumes declined -40% in the quarter, UBS points out. Despite robust operating assumptions going forward, including sustained implant sales growth of 7% and processor upgrade penetration reaching 60%, the broker continues to derive a price target well below the share price, at $175.

The new candidate pipeline is filling and Goldman Sachs is encouraged but with the company not in a position to provide guidance and the recovery appearing to lag many other stocks in the sector, considers this a less-assured road to recovery.

The broker's concerns stem from the disproportionate reliance on the adult/senior cohort and a larger negative correlation to further outbreaks of coronavirus and/or restrictions on surgery.

Furthermore, a backlog was built up through March to May and this has been largely delivered. Hence, a lack of late-stage pipeline candidates now exposes Cochlear to risk centred entirely on new demand. Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Sell rating and $165 target.

Ord Minnett suggests fears the early uplift in implant numbers would purely reflect catch-up have not been realised, as the company has reported most recent surgery in key markets came from newly-identified patients and lead generation remains solid.

The broker lifts forecast to reflect a more rapid recovery in revenue, with a significant increase in expected earnings in FY21, but with the stock trading close to its historical high maintains a Lighten rating.

Yet Wilsons, also not one of the seven, assesses the glass is half empty when it comes to implant numbers, observing the increase in the first quarter volumes was more about clearing the backlog.

The broker finds no evidence organic demand has recovered, particularly within the adult/seniors cohort in the developed world, and a primary determinant of earnings and valuation over the next year or so is the propensity of these cohorts to seek treatment.

Wilsons maintains a Market Weight rating with a target of $228.95 and believes the next major processor launch, Nucleus 8, could be the catalyst to become more positive about the stock, valuation permitting.

Credit Suisse remains cautious about the rate of recovery particularly because of the rise in coronavirus infections in the northern hemisphere and the likelihood further restrictions will be reimposed in coming weeks. The broker considers it unlikely a strong rebound in sales will occur in FY21 and it will take time for the market to clear the backlog in demand.

Meanwhile, the company will reinvest any additional benefits from the government's R&D tax incentive into growing its business in FY21. The main areas of investment will be the pipeline of products & services, referral channels in developed markets, direct-to-consumer marketing and expansion in emerging markets.

FNArena's database has two Buy ratings, two Hold and three Sell. The consensus target is $206.05, signalling -7.3% downside to the last share price. Targets range from $175 (UBS) to $241 (Macquarie).

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