Cochlear: Result 2013

Cochlear has announced a full-year net profit of $132.6m, bang in the middle of the $130-135m range given in its profit warning at the beginning of June and 16% lower than last year (excluding last year’s product recall costs).

In terms of business performance, the main problem, as expected, was a $24m fall in sales of processor upgrades ahead of the launch of the Nucleus 6 processor – $17m of this fall was in the US market where the N6 isn’t expected to be available until the end of this year.

On the plus side, implant sales grew 16% to a record 26,674 units giving the company a claimed market share of around 65%. This market share figure is boosted by a Chinese Government contract for 2800 low-priced units mostly in the first half, and it has probably fallen to below this level currently, but it’s still a fair way higher than the 60% that had been feared.

The relatively mature, but high margin US market saw total sales fall 5% in constant currency terms, while Europe grew 3% and the lower margin Asia Pacific region grew 20%, helped by the Chinese contract win.

Research and development spending grew 5% to $124.7m, representing 17% of total revenue. This is putting a big dent in profits at the moment, but it’s also been the source of the company’s competitive advantage, so we’re pleased to see no slowdown here.

A full-year dividend of $1.27 was declared (30% franked, ex date 23 Aug), giving $2.52 for the year, an increase of 3%. The company ended the year with net debt of $117.8m compared to net cash of $2.9m in 2012, due in part to a sharp increase in working capital. Trade receivables rose about $43m to $188m, about $15m of which related to the Chinese Government contract. Inventories rose about $30m to $132m, presumably due to the release of the Nucleus 6. We'll be keeping an eye on this in coming results.

Hedging losses to come

Hedging gains added about $26m to the after-tax result, compared to about $52m last year. Excluding this, the net profit would have been close to flat. But that is scant consolation since 2012 included the recall of the Nucleus 5 implant.

It’s also somewhat ominous because, at current rates, the hedging gains will turn into hedging losses for the next few years. There are $233.8m worth of A$/US$ hedges in place for the next three years at an average rate of 0.97, and A$/euro hedges of $188.3m at an average rate of 0.72. At current rates of 0.90 and 0.67, that will mean total losses of about $25m over the next three years, with about half arriving in 2014.

Of course the flipside is that the lower rate should mean higher A$ revenues, as is the purpose of hedging. And as the hedging contracts roll off, you’re ultimately left with the underlying position – which will benefit considerably from a lower A$. We’d rather they didn’t bother with all this confusion and just allowed their profits to ebb and flow with the exchange rate. If they really wanted to cut currency risk they should move more of their cost base to the US.

The stock is down slightly since Cochlear cops an earbashing on 25 Jun 13 (Hold – $59.70), putting it on a multiple of about 22 times forecast 2014 earnings of $2.77. That’s a fair price given the prospects for growth. HOLD.

Disclosure: Our model Growth Portfolio owns shares in Cochlear.