All ears at Cochlear's results meeting
Recommendation
The last detailed review of Cochlear (see Cocky Cochlear boosts payout on 21 Oct 11 (Hold – $56.97)) expressed two primary concerns regarding the product recall of the Nucleus 5 implant.
The first was over the device failure rate, which at the time was 1% and growing. By December that rate had grown to 1.9% and it was revealed at the latest results briefing that it now stands at 2.4%. With an installed implant base of 30,000, that means more than 700 people will need to have their devices surgically re-implanted. It’s a trend that, whilst expected, doesn’t look good.
But there’s more to it than that. Two-thirds of the failed devices, which shut down without harm, were manufactured during the first quarter of 2011. That suggests that whilst the number of people affected will continue to increase, the rate of increase might slow.
Key Points
- Result exceeded expectations
- Cochlear is handling the recall well
- Manufacturing ramp-up has been impressive
Replacement strategy
The second concern arose from the replacement strategy; Cochlear intended to boost production of the Freedom implant, which at the time represented only a third of total implant units produced, and give patients that model instead. Ultimately, that required a staggering boost in production from 7,400 units a year to 25,000.
And yet this ramp up hasn’t so far been a problem. By December, weekly production of Freedom implants had exceeded the production levels of Nucleus 5 before it was recalled. Managing director Chris Roberts explained that the overhaul of Cochlear’s manufacturing processes and supply chain over the past five years was critical to delivering this impressive outcome.
Nevertheless, supply constraints over the four-month period since the recall mean implant unit sales of 10,724 were 9% lower than in the previous half, although management expects supply should return to normal in the second half.
2012 | 2011 | Growth (%) | |
---|---|---|---|
Implant sales (units) | 10,724 | 11,765 | -9 |
Revenues ($m) | 387 | 377 | 3 |
Net profit before recall costs ($m) | 80 | 87 | -8 |
Net profit/(loss) ($m) | (20) | 87 | n/a |
EPS (c) | (35.8) | 153.3 | n/a |
DPS (c) | 120 | 105 | 14 |
Franking (%) | 60 | 60 |
So, the return of the Nucleus product might be smoother than anticipated—although it is unlikely to be fast—and the company’s strategy to deal with the shortfall is working well. What was thought to be a potentially huge problem might now be much less so.
Is there anything to worry about? Indeed there is—it wouldn’t be investing if there wasn’t.
The bone anchored division, which accounts for about 10% of company revenue, suffered a 13% drop in sales compared with the previous half. In Shining a light on Cochlear on 12 Aug 11 (Hold – $69.10) we said this area might be a problem and so it has proved. New competition has emerged in the form of Oticon Medical, which makes the ‘Ponto’, a product similar to Cochlear’s Baha device.
Minor effect
The overall effect on the result was minor, though. Total revenue rose 3% to $388m (or 5% in constant currency terms) which, given the lower unit sales, suggests strong upgrade sales of sound processors (the external mechanism unaffected by the recall) over the half.
Excluding recall expenses of $139m, net profit fell 8% to $80m. After recall costs, the company reported a loss of $20m. As forecast at the October annual general meeting, the interim dividend was lifted from 105 cents to 120 cents, 60% franked (ex-date 22 Feb).
With the recall probably less serious than first thought and the fast ramp-up of manufacturing proceeding well, this remains a resilient business. But it’s early days. Regulatory approval for Nucleus 5, as well as the competitive response from Advanced Bionics and Med-El, is uncertain.
Given that, we’d require a larger margin of safety than the share price currently offers to recommend this stock, much as we like this business. With the share price down slightly since our last update on 21 Dec 11 (Hold – $62.72), Cochlear remains a HOLD for up to 5% of a well-diversified portfolio.
The model Growth portfolio owns shares in Cochlear.