Schadenfreude For Cochlear

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

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

One of Cochlear's ((COH)) major competitors in the hearing implant market is Advanced Bionics, which has announced the third global recall of its cochlear implant in the past 10 years.

According to BA-Merrill Lynch, the last two global recalls suggest this third recall is unlikely to last more than several months, but there will be a market share impact for Advanced Bionics as a result. Add in the fact any new generation implant from Advanced Bionics is two or more years away and BA-ML sees Cochlear as a market share beneficiary from the recall.

On the broker's numbers Cochlear could see its cochlear implant market share increase from around 70% now to around 75% over the next couple of years. There is scope for an even better outcome for Cochlear according to UBS, which suggests given a current dominant market position Cochlear should be able to take the majority of the 15% or so of the market share that has opened up on the back of the Advanced Bionics product recall.

Assuming Cochlear does increase its market share, brokers have been quick to lift earnings forecasts for the company for both FY11 and FY12. The increases in forecasts range from around 5% for both years for BA-ML to 11-12% for Citi.

Citi points out there is potential for the earnings boost to be even larger, as it estimates if Cochlear could gain 70% of the market share made available by the Advanced Bionics recall and the recall lasts for 12 months there is as much as 20% upside to Cochlear's earnings in FY12.

Revised consensus earnings per share (EPS) forecasts for Cochlear according to the FNArena database now stand at 318c in FY11 and 344.4c in FY12. Citi's changes mean it is well above consensus with forecasts of 340.1c this year and 356.5c in FY12, while Credit Suisse is below consensus with respective EPS forecasts of 308.1c and 309.9c.

With increases to earnings forecasts have come increases to price targets, the FNArena database showing a consensus price target for Cochlear now of $74.16. This is up from an average of $72.63 previously.

On the back of the earnings and price target increases both BA-ML and UBS have upgraded their ratings for Cochlear to Buy from Hold previously. While BA-ML accepts Cochlear is trading on an elevated 12-month forward earnings multiple of around 24 times, this premium is warranted given the expectation of earnings growth of around 15% in both FY11 and FY12.

UBS's upgrade is on a similar basis, as it sees earnings risk for Cochlear as to the upside given the problems at Advanced Bionics and the fact that company is around two years away from bringing any new implant to the market.

Overall the FNArena database shows Cochlear shares are rated Buy twice, Hold five times and Underperform once. The latter comes courtesy of Credit Suisse, as while it sees potential for Cochlear's earnings to be boosted by as much as 8% from the issues at Advanced Bionics there is uncertainty as to how long Advanced Bionics will be out of the market just how much Cochlear will thus benefit. CS had previously set an Underperform rating on a valuation basis.

The Hold ratings reflect views Cochlear is trading around full value at current levels, as even allowing for higher earnings from an increase in market share Citi estimates the stock remains on an elevated earnings multiple that fully factors in the potential upside to earnings.

Morgan Stanley continues to rate Cochlear as Equal-weight within a Cautious view on the Australian Medical Technology sector. This reflects the broker's view the likely share price reaction to the news will be greater than the likely market share benefit Cochlear achieves from the Advanced Bionics product recall.

Shares in Cochlear today are higher and as at 10.40am the stock was up $2.49 or 3.3% at $77.37. This compares to a range over the past year of $60.69 to $79.11 and implies downside of around 1.0% to the consensus price target in the FNArena database.

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