Cochlear Limited (ASX: COH), a long-time favourite of many investors, is a leading medical technology developer well known for its range of hearing implants. These implants can require quite major surgery and Cochlear remains dominant in this specialised field.
Following a 53% drop in first half 2014 earnings (compared to 2013), Cochlear's management are positive about the outlook for the company. Its arguments are compelling – new product launches gaining traction, contract wins (especially China), predicted growth in gross margins and a line of patent approvals coming through. However Cochlear does face a number of challenges, chief of which are:
Competition risk
Advanced Bionics, William Demant and Med-El are increasingly credible competitors making significant inroads into Cochlear's space. As a result Cochlear's share of the US market has fallen to 60% and indications are this trend will continue. Although management claims impending sales of the flagship Nucleus 6 and other new products will quickly reverse this, investors should be mindful that overall sales have not improved over the past three years.
Patent risks
The medical technology industry is awash with registered patents and Advanced Bionics is a very active participant in this game. Although very much a part of doing business, protecting and defending patent infringements can be costly. Cochlear recently provisioned $22.5m after being found guilty of patent infringement and this particular matter is yet to conclude.
Earnings & financial risks
Taking a pessimistic view, 2014 earnings per share may come in at $1.90, placing Cochlear ($55.05) on a multiple of 29. Although improvement can be expected in 2015, the price earnings multiple will still be above 20 – expensive even taking an optimistic view on growth prospects. It is difficult to see Cochlear doing anything more than holding its present position against rivals.
Of real concern is the high amount of intangibles on the balance sheet and the decisions to borrow funds for dividend payments over the past couple of years. This suggests a capital issue may be required in the short term to bolster the balance sheet.
Foolish takeaway
There's no doubt a logical argument can be made for investing in Cochlear – it is after all the market leader, maintains a good reputation and is well known to surgeons and the medical profession. In addition the share price has fallen by 31% over the past 12 months. However, I think none of these factors make it a worthwhile investment. Basically operating in mature markets and unable to compete effectively in developing markets, Cochlear is increasingly being pinned to the wall.
