Australia | Jun 04 2013
-Share price now more realistic
-Some brokers see time to buy
-Overall, caution still prevails
By Eva Brocklehurst
As feared by many brokers, Cochlear ((COH)) has announced a revision to FY13 earnings estimates. It's downward. The company is used to being the market leader in speech processors and cochlear implants but competition has crept up steadily. Tie that to a softening of developed markets, particularly in the US, and you have the scenario most broking houses are painting. The stock, in the lead up to the announcement, was deluged with Sell ratings. The share price was too high. Competition is threatening the company's number one standing. There were legacy issues with the Nucleus 5 processor. Now, the radical views are being softened. Bell Potter thinks it's time to buy Cochlear.
The broker's rule of thumb is to buy Cochlear on product recalls and major new product launches. The company believes its Nucleus 6 sound processor will be game changing. Bell Potter notes the product has overcome the issues that have beset the company with Nucleus 5. That's one obstacle out of the way. Only Canada and Korea have approval for the N6 so far and approvals in other major markets should come over the next six months, so for other brokers the benefits of the product launch are some time away.
The N6 processor launch will help upgrade sales but this will have little benefit to new sales in BA-Merrill Lynch's opinion. The new processor will add to upgrade revenue from September 2014. The history of patient processor upgrades indicates that 35-50% are likely to upgrade as they become entitled to reimbursement, which Merrills notes is generally every five years. This broker believes pivotal new products are likely to be 2-3 years away.
Merrills also suspects emerging market tenders will benefit in the volume stakes but have little effect on Cochlear's margin because of lower prices. In a way, the slowing of the developed market is exacerbating the price squeeze in emerging markets and in tenders. Slow sales leading up to a product launch are not something unusual, anywhere. Macquarie notes Cochlear's top line has historically been under pressure in the year preceding a product launch. So much of the weakness can be attributed to a cyclical factor. Nevertheless, there are other issues underpinning the pressures on the bottom line. Merrills notes a greater mix of adult patients, who have greater demand elasticity and increasing awareness of what's on offer.
Bell Potter thinks the stock has simply reacted to the downgrade in the earnings outlook and traders have ignored the new product news. This broker has moved to a Buy rating from a Sell rating and has a target price of $78. Bells believes Cochlear is set up for the long haul and has been investing heavily in manufacturing, reaping benefits of lower costs and margin improvement. FY15 is seen as the year the company returns to market dominance. Morgan Stanley is not at all confident that's the case and has a contrary view. The changing demographics and focus on older patients is seen as benefiting Cochlear's competitors, which offer a broad spectrum of hearing solutions. Hence, Morgan Stanley finds the dominant market share is vulnerable and consensus expectations for the stock are too high.
Now the risk of a near-term downgrade to earnings has passed Macquarie is also more positive on the stock. Currency headwinds are also fading as the Australian dollar eases, meaning the catalysts for the stock are more balanced. Macquarie emphasises the model is not broken and while FY14 will be challenging growth should still be happening, around the percentage mid teens. This should support the price of the stock well in excess of current levels. Goldman Sachs also takes the view that the company's scale efficiencies in both manufacturing and marketing will stand it in good stead to make healthy returns and has removed Cochlear from the Sell list.
Unit sales and margin forecasts, as well as earnings estimates have all been adjusted after the company's downgrade. Earnings forecasts out to FY15 are adjusted down by up to 23% across most brokers covering the stock on the FNArena database. The share price was hit in the wake of the announcement and brokers have adjusted price targets accordingly. Now the stock is viewed as trading at a more realistic price. The consensus target price has dropped to $54.30, suggesting 2.0% downside to the last share price. This compares with a consensus target of $62.87 on May 29. The other positive aspect is the dividend yield, not to be lightly regarded in the current environment. Based on FY13 consensus earnings forecast it is 4.5% and for FY14 it is 4.4%.
BA-Merrill Lynch downgraded the rating to Underperform just prior to the company's announcement. The broker sees fit to retain that recommendation. Others, such as Macquarie and JP Morgan, have decided that the price is a better point of entry now and have upgraded the rating to Neutral from Underperform or Underweight. While there is some relief the earnings downgrade is out of the way, most are not sure that the way ahead is that easy and caution prevails. In total there are now six Sell ratings and two Hold on the database, compared with seven Sell and one Hold when we last reviewed the stock.
See also, Cochlear Feeling The Pinch on May 23 2013.
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