Cochlear’s (ASX: COH) fiscal 2025 underlying net profit after tax grew just 1% to $392 million, with revenue up 3% and margins contracting due to a sales mix shift to lower-margin emerging markets. Fiscal 2026 underlying NPAT guidance implies 8% growth at the midpoint.

Why it matters: Earnings and guidance broadly met our expectations. Earnings growth is normalizing, and our forecast five-year EPS compound annual growth rate of 12% is intact. Services revenue fell 10% as we think cost-of-living pressures and satisfaction with older sound processors are delaying patients from upgrading.

  • Unit sales growth in core developed markets slowed to 6% on small market share losses and the declining children’s market following recent above-average growth. We forecast unit growth to spike to 11% this year with the recent launch of the Nucleus Nexa implant before moderating again.
  • We expect growing emerging-market revenue to limit the midcycle NPAT margin to 19%, versus 17% now. We estimate emerging-market volumes grew roughly 25% but average selling prices fell 9% with more units sold in lower-tier tender markets in the Middle East, China. and Asia-Pacific.

The bottom line: We raise our fair value estimate for wide-moat Cochlear by 2% with the time value of money. Shares are overvalued as the market extrapolates high cochlear unit sales. Our forecast five-year CAGR (compound annual growth rate) for cochlear unit growth is 8% compared with the trailing three-year CAGR of 12%.

  • We expect revenue growth to moderate as Cochlear implant sales to children slow down and average selling prices decline, given a mix shift to lower-priced emerging markets. We forecast a five-year group revenue CAGR of 9% compared with the trailing three-year group revenue CAGR of 12%.
  • Cochlear’s success mostly depends on adult referral rates. However, this requires more marketing to improve awareness and uptake. Older patients often prefer hearing aids, and a shorter expected lifespan limits longer-term, high-margin services revenue.

The company earns an increasing proportion of its revenue from sound processor upgrades and accessories used in the growing global installed base of over 600,000 implants, most of which are cochlear implants. We forecast this annuitylike revenue stream to contribute 37% of group revenue by fiscal 2030 from 29% in fiscal 2020.

Importantly, non-Cochlear sound processors and accessories are not compatible with Cochlear’s implants. In addition, once a patient receives a Cochlear implant, switching costs such as the inconvenience, risk, time, and money of further invasive surgery is likely to prevent the patient switching to an alternative device for their entire lifespan. This is further strengthened by external sound processor upgrades being available that improve with technological advancement over time. Thus, we see the services segment being largely unaffected for over 20 years.

Bulls say

  • There are signs Cochlear is looking to expand beyond the hearing market with the investment in Nyxoah, a company focused on development of a hypoglossal nerve stimulation therapy for the treatment of obstructive sleep apnea.
  • The annuitylike revenue stream from sound processor upgrades and accessories is an increasingly important component of the revenue stream.
  • Cochlear earns ROICs well ahead of the cost of capital even in our bear-case scenario, which is testament to the high quality of the company.

Bears say

  • Growth in the cochlear implant market is becoming more costly to achieve, limiting the potential upside to earnings.
  • The arrival of low-cost competitor Nurotron could disrupt markets other than China should it seek to expand and this could trigger price deflation.
  • A quick recovery in emerging markets such as India and Latin America is largely dependent on a smooth vaccination rollout, which might prove challenging.

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.