Cochlear (ASX:COH) is a long term growth story you should listen to

Cochlear is one of few stocks that has created immense shareholder value and has also greatly improved the lives of its users. Yes, this can be said with respect to many ASX health stocks, but this one can hang its hat on its societal impacts more than most other companies. The stock has seen a 28% gain over the past year and the momentum has continued into CY24 so far on the back of strong earnings growth.

 

Who is Cochlear?

Cochlear (ASX:COH) is an Australian hearing device maker. Its mission is to “Help people hear and be heard, empower people to connect with others and live a full life and help transform the way people understand and treat hearing loss” achieved through innovation and bringing to market a range of implantable hearing solutions that deliver a lifetime of hearing outcomes.

Graeme Clark, the original inventor of Cochlear devices, was a practicing ear, nose and throat surgeon in Australia and the UK. His interest was first prompted because his father was hearing impaired. By 1970, Scots College-educated Clark had started research on research related to the hearing nerves in the human cochlea, or inner ear, and the possibility of electronically stimulating those nerve ends to help deaf people hear. He bought to market a device considering these principles…and the rest is history.

 

More than simple hearing aids

Cochlear is now a company with a market capitalisation of over $20bn and nearly $2bn in annual sales. Its sales were made across 180 countries, resulted in a a 60% global market share and a ~$300m net profit. The company has issued guidance of a $385-400m net profit in FY24, which was an 8% upgrade from the initial $355-375m initially advised in August last year.

It is crucial to note that Cochlear implants are not conventional hearing aids. All hearing aids do is amplify sounds so they can be detected by damaged ears, but this company’s implants bypass damaged portions altogether an directly stimulate the auditory nerve.

 

FY23 and 1HY24 Earnings

Cochlear has 3 main business segments that contribute to its revenue. In FY23, 58% came from Cochlear implant systems, 30% from processor upgrades and accessories and 12% from Acoustics Bone conduction systems and sound processor upgrades.

The latest results (FY23 and 1HY23) saw solid top line growth – 16% and 20% respectively. The bottom line growth (that is to say profit growth) was more modest in FY23, you’d take any profit growth amidst high inflation. Its FY23 profit was only up 7% but surpassed $300m. And in 1HY24, its profit grew 21% to $191.4m. The stock is up nearly 80% in 5 years.

These results were driven by market growth, improved clinical capacity, market share gains and COVID catch-up surgeries. But arguably most important was the successful launch of new products.

 

 

Is there growth left?

We believe that there remains further opportunity for Cochlear to continue its so far successful growth strategy expanding into underpenetrated markets and the launch of its new acoustic implants that is supported by a growing market.

The company has been able to achieve 80% market penetration to its customer base of children in developed markets (130,000 people) leaving little room for growth. However, across adults and senior customers in developed markets the estimated addressable market is over 6million customers which is currently only 3% penetrated.

 

New products and new markets

Additional growth opportunities for children in emerging markets with an addressable market of over 1.3m that is currently under 10% penetration. Emerging markets business has been growing readily as awareness of cochlear implants increased and wealth grows across many emerging economies.

We also note that the company’s new products and upgrades to existing ones can help too, including the Osia 2 System, Baha 6 Max Sound Processor and Nucleus 8 Sound Processor – all of which have been upgraded. The new 3 Tesla MRI compatible Osia 2 System was just launched in the US and is expected to be launched across the rest of the world as regulatory approvals are obtained.

 

Finally getting its hands on Oticon

A final important tailwind will be the acquisition competitor Oticon Medical, a deal first announced just under 2 years ago for A$170m but only approved by the ACCC earlier this month after Cochlear addressed preliminary concerns that it could impact competition. It is important that the UK regulator, the CMA, still needs to approve the deal, but having previously rejected it and outlined terms on which it could be approval, we think likelihood is better second time around.

Oticon Medical was a subsidiary of Danish company Demant that opted to get out of hearing implants, even though it had 75,000 recipients. At the time of the acquisition, Cochlear promised it would get A$75-80m in revenue and that it could eventually reach a net profit margin of 18% in the longer-term.

 

Conclusion

We believe that while the indication that the stock is fairly valued that there remain long term positive growth outlooks in underpenetrated large addressable markets. The delay in getting approval to close to Oticon Medical has been regrettable, but it is not Cochlear’s fault, and we believe the wait could be worth it.

 

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