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Market likes what it hears from these 3 stocks

Glenn Freeman  |  22 Aug 2017Text size  Decrease  Increase  |  
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Three Morningstar moat-rated Australian healthcare companies, one a hearing technology innovator, performed strongly in FY17.


Recently upgraded from a narrow to wide moat, Cochlear (ASX: COH) is a global leader in the design and production of hearing implants. It posted a solid FY17 result last week with a $224 million net profit after tax (NPAT) and group sales of $1.24 billion, up 11 per cent and 12 per cent, respectively.

"We see the result as validating our recent move to a wide moat rating, which reflects our view that the company will prove successful in its direct-to-patient engagement initiatives," says Chris Kallos, Morningstar senior equity analyst covering healthcare.

The hearing implant maker also lifted its final dividend and forecast profit growth for FY18. Its core cochlear implant business, which contributes 62 per cent of sales revenue, achieved 5 per cent revenue growth in 2016/17, as the number of implants sold rose 8 per cent to 32.6 million.

Chief executive Chris Smith said Cochlear invested $152 million in 2016/17, or 12 per cent of sales revenue, in research and development, with a pipeline of new products expected to be launched over the coming years.

Cochlear's strong performance extended across all markets and product lines, with an 18 per cent increase in Americas sales revenue (spanning US, Canada, and Latin America) a particular stand-out.

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Kallos believes this result reflects strong uptake of new products, and its successful direct-to-consumer marketing initiatives.

He expects this momentum to continue into fiscal 2018, with other new technology launches due in the US and Europe, including its N7 implant speech processor, which streams sounds from iPhone, iPad, or iPod touch devices.

Kallos increased his fair value for Cochlear by 6 per cent following the result to $145 per share. This stock was among a basket of securities recommended recently by fund manager Bennelong's Julian Beaumont.

Sonic booms

A market leader in pathology services, Sonic Healthcare (ASX: SHL) also posted a positive result last week, reporting $459 million in underlying NPAT on underlying group revenue of $5.3 billion--up 4 per cent and 6 per cent, respectively.

The profit result was slightly below Morningstar's expectations, "but our long-term forecasts are unchanged. At current levels, the shares are trading broadly in line with our intrinsic assessment," Kallos says.

Sales in the US and Germany were again standouts, now representing 22 per cent and 19 per cent of respective group revenue. A spate of acquisitions in Germany support Kallos' positive assessment, having "added significant diagnostic test capabilities and expanded the company's geographic coverage in that country".

"We think this should support synergies with consolidation and centralisation of shared services leading to earnings accretion in the medium term," he says.

Sonic's fair value estimate remains unchanged at $24 per share.

High quality, defensive growth

Major blood plasma company CSL Limited (ASX: CSL), also awarded a narrow moat, reported US$1.3 billion in underlying NPAT and group revenue of US$6.9 billion for FY17, up 24 per cent and 15 per cent year on year, respectively.

Morningstar's fair value estimate has been reduced from $141 to $134 per share but Kallos still believes the company is undervalued.

"We think the market underestimates the positive impact to margins of the Seqirus division over the medium term," he says. Seqirus is CSL's influenza vaccine business, formed in fiscal 2016 after the July 2015 acquisition of Novartis.

"We expect the ageing of the population in most developed markets, and growing expenditure on healthcare in emerging markets, to continue driving industry growth at mid- to high-single-digit rates.

"CSL's revenue and earnings should grow at least in line with industry rates, given its strong market position," Kallos says.

He regards CSL as a "high-quality, defensive growth stock," but which frequently runs into overvalued territory.

"Investors should patiently wait for opportunities that allow entry at a reasonable price," Kallos cautions.

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Glenn Freeman is a senior editor at Morningstar.

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