Cochlear (COH) is a world leader in restoring hearing in profoundly hearing-impaired patients and is one of the major stocks listed on the Australian stock market.
The invention of the Cochlear implant was the result of decades of research and development by Professor Graeme Clark, culminating in the first successful cochlear implant surgery in 1978.
The company continually invests heavily in R&D with its new generation product Nucleus Freedom approved in several countries in early 2005.
COH earns most of its income in the US, but reports in Australian dollars.
First-half earnings rose 17% to $57.1 million (from $48.8 million) on the year. Sales revenue climbed 8% to $298 million for the period. As good as the result sounds, it was below stock market analyst expectations of around $63 million.
The disappointment mainly came from a flat second quarter sales growth. COH reaffirmed full year guidance of a 15-20% earnings growth.
The trend toward implants in both ears has been a key driver of volumes as it has several advantages. However, with the current conditions, we see a higher probability of the result falling at the lower end of guidance.
Foreign currency risk
The majority of the company’s recipients are in the USA, Europe and Asia Pacific. 42% of its sales come from the Americas, 43% from Europe and 15% from Asia-Pacific.
With a significant portion of its earnings coming from abroad, COH earns mainly in US Dollars. A stronger Australian dollar against the US dollar is a bad thing for the company since, as we noted earlier, it reduces earnings reported in Australian dollars after conversion.
COH used an average rate of 1 AUD to 0.87 USD, which seems relatively low compared to the current levels the pair is trading. Additionally, many analysts believe the Australian dollar might continue to gain against the US dollar.
The threat of a slowing US economy may also affect sales.
The result reported by the company was not that bad, but, as has become a common theme in our market recently, investors were expecting a better result. With slowing growth in the US and Asia-Pacific, it is likely that COH will struggle to hit the higher end of its earnings targets.
We are also concerned about an impending warning letter from the United States Food and Drug Administration about COH’s Swedish operations following an inspection in May 2007.
Despite recent stock market falls, COH is still trading at a P/E ratio of around 26 times FY08 earnings. This is about double the market average but reflects COH’s dominant position in its industry, its growth prospects and the stock’s defensive nature. COH’s current P/E is also below its average P/E in the mid-30s for much of the last two years.
We feel COH could deliver full-results at the bottom end of its guidance. We rate COH as a Hold at current levels.