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It's hard to please investors these days. While many of its
corporate peers have to make excuses for declining profits,
Sydney-based bionic ear device maker Cochlear
delivered an interim result with earnings up an impressive 32
per cent.
Yet its shares still fell sharply. On February 19, the day
of the result, the stock dropped 3.24 per cent in a single
session and then languished for several days.
Sales in North America, where a key rival had badly
stumbled during the period, surged 51 per cent. But outside
that territory, the results were much softer, in the high
single digits.
The company is priced for a long-term growth rate of at
least 20 per cent and any signs, however nebulous, that this
may be in jeopardy can cause share price falls.
In its defence, Cochlear
management pointed to the seasonal nature of sales in Europe,
where the purchasing of devices is generally done under
contracts tied to government budgets. These are not
established until mid-year and flow through to the second
half.
Cochlear chief
financial officer Neville Mitchell also lauded the
"portfolio effect" of having a truly global
business, whereby if one leg weakens, the other compensates.
But skittish investors ignored his argument, especially as
the company's net profit of $27 million only met analysts'
expectations, rather than surprising on the upside, as Cochlear
so often does when it posts earnings.
In a sharemarket where any bad news is seized upon, sell
orders came fast. It mirrored the analysts' downgrades, with
Deutsche Bank and JB Were demoting the stock from
"buy" to "hold".
Many observers were nervous that, given the growth rate in
the US would be hard to sustain, if Europe did not step up a
notch, the forecast full-year profit expectations might be too
high.
Cochlear is, in
essence, a simple business model with a conservative and
transparent approach to financial reporting. Its full-year
guidance of $57 million puts the stock on a 2003
price-earnings multiple of about 30 times.
Yet management believes that there is still plenty of fuel
left in the tank. While Cochlear
is a single product company, it still has a long way to go in
terms of addressing the potential of its market.
A Deutsche Bank analysis identifies a low level of implant
adoption among the profoundly and severely deaf. Across nine
developed nations, the number of profoundly deaf people was
pegged at 910,000 and severely deaf at 2.1 million.
A proportion of the potential recipients would not benefit
from an implant because they have been deaf for too long or
there are other health issues. "A further subsegment
refuses implantation on the basis that they [or their
children] would prefer to remain deaf," said Deutsche
Bank analyst David Low.
He conservatively estimates this to be about 40 per cent,
so the potential market is about 1.8 million people. How many
devices of Cochlear and
its competitors have been installed to date? Only 61,000.
That implies that cumulative penetration is a paltry 3.4
per cent. And that, as Low points out, takes no account of
developing nations like China, in which 35,000 children are
born each year who would benefit from a Cochlear
implant.
Selling a greater number of implants in developing nations
will depend on government reimbursements being introduced.
There are only two real competitors to Cochlear:
US-based Advanced Bionics Corp and Med El in Austria. Advanced
Bionics had to withdraw its Clarion device for six weeks last
year after US regulators linked its implants with the
incidence of meningitis among recipients.
It allowed Cochlear
to capture more ground, rising to a total global market share
of 65 to 70 per cent. Managing director Jack O'Mahoney is
confident that this level can be sustained, in part through
defending its technological edge over its competitors.
However, as Mitchell and O'Mahoney have been reminded, the
burden of high expectations weighs heavy.
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