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Cochlear outlook positive but market 'overstating' profit lift

Glenn Freeman  |  20 Feb 2019Text size  Decrease  Increase  |  
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The early negative market reaction to Cochlear's half-yearly result is overdone and ignores solid growth in hearing implant upgrades, says Morningstar.

The hearing implant company yesterday posted a 16 per cent profit increase to $128.6 million, but its share price dropped around 8 per cent to $178 by market close, on news of slowing sales in the US and Europe.

Sales revenue was also up 11 per cent to $711.9 million, or 6 per cent after allowing for a stronger US currency in the back-end of calendar 2018.

"On the surface it was OK, but the result was flattered by the US currency effect and the lower US tax rate," says Morningstar senior equity analyst Mat Hodge.

Hodge says there have historically been periods of share price weakness for Cochlear (ASX: COH), which have provided investors with good buying opportunities.

"We don’t think that's the case yet, with the shares near our fair value estimate. But further weakness may see market valuations cut and provide investors a rare opportunity to purchase this high-quality stock at a discount" he says.

Hodge has maintained his $180 fair value estimate for Cochlear, which sits at a modest premium to today's opening price of $176.58.

"Its implants business was soft, which is around half of revenue. Unit sales were up 5 per cent, but revenue was flat, meaning unit prices have come under a bit of pressure."

Cochlear managment said it was experiencing strong growth in Japan but lower growth in the US and Europe, particularly German, after a competitor launched its product.

Sales revenue grew just 3 per cent across the Americas and 8 per cent in both its Asia Pacific and Europe, Middle East and Africa regions.

"Investors didn't like the market share loss," Hodge says, but points to strength in its services and upgrades, which deliver around one-third of group revenue.

"Those upgrades look really strong, and this is a part of the business I really like, and I think the market has overlooked that a bit."

Sales revenue from this segment was up 21 per cent for the half compared to the previous corresponding period.

Hodge says the outlook remains positive for Cochlear. "They're still the market leader, and I'm confident they'll do what's required."

"Management is working on its sales and marketing efforts, including direct-to-consumer and within the aged care space, and is still spending on research and development."

Research and development spend of $88.2 million, 12 per cent of sales revenue, was up 8 per cent on the same period 2018.

New products launched during the half include a Nucleus-branded sound processor and accompanying mobile application, and Baha bone induction system.

US legal dispute largely immaterial

Cochlear management also provided an update on its US patent battle with Alfred E. Mann Foundation for Scientific Research and Advanced Bionics.

A US federal court in November awarded them $US268 million ($375m) against Cochlear in a long-running patent dispute, but the Sydney-based company is appealing.

"They've made a provision of $20 million and they think they can win, but even if they lost the whole amount, it only contributes around 3 per cent of our fair value estimate," Hodge says, highlighting the final result is largely immaterial to his assessment.

is senior editor for Morningstar Australia

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