##{"id":58832,"date":"2011-09-13T11:59:53","date_gmt":"2011-09-13T01:59:53","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2011\/09\/13\/uncertainty-now-surrounds-cochlear\/"},"modified":"2011-09-13T11:59:53","modified_gmt":"2011-09-13T01:59:53","slug":"uncertainty-now-surrounds-cochlear","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2011\/09\/13\/uncertainty-now-surrounds-cochlear\/","title":{"rendered":"Uncertainty Now Surrounds Cochlear"},"content":{"rendered":"

\n\t– Cochlear recalls Nucleus 5 implant
\n\t– Full financial and reputational<\/span> impact difficult to assess
\n\t– Brokers cut price targets on lowered earnings assumptions
\n\t– Ratings also downgraded<\/strong><\/p>\n

\n\tBy Chris Shaw<\/p>\n

\n\tFollowing a limited number of cases where its Nucleus 5 implant has stopped working due to what are believed to be electronics issues, Cochlear ((COH<\/span>)) has announced a voluntary withdrawal of the product. The previous generation implant will function as an interim alternative for those affected by the withdrawal.<\/p>\n

\n\tThe financial and reputational<\/span> impact on Cochlear of the withdrawal is currently unknown, so brokers at present are guessing with attempts to assess just how badly the company will be affected. As expected, such a situation leads to a wide range of views. BA Merrill Lynch, for one, sees the recall as material, because the CI-5 series represents 65% of all of Cochlear's implants sold as well as 44% of global implant supply.<\/p>\n

\n\tIn terms of the impact to earnings for FY12<\/span>, BA-ML suggests the key is Cochlear's capacity to produce the N24<\/span> alternative implant. Based on an analysis of FY11<\/span> N24<\/span> output and peak output achieved in FY09<\/span>, BA-ML estimates Cochlear can produce around 17,926 implants this year, which would be down 27%.<\/p>\n

\n\tThe other issue is how long it may take to identify and address the fault, BA-ML noting it took competitor Advanced Bionics two months to diagnose their recall cause and a further two months to revise manufacturing procedures.<\/p>\n

\n\tOne plus, according to Goldman Sachs, is the recall doesn't affect external accessories in the Nucleus 5 range, so the alternative can be implanted without any compromise in functionality. Assuming a manufacturing issue given the problem appears to be within the electrical components, BA-ML suggests a 6-12 month period as any manufacturing change requires regulatory approval.<\/p>\n

\n\tIn the view of UBS the recall may end up having a bigger reputational<\/span> impact on Cochlear than an earnings impact. This is because Cochlear was the only participant in the market without a major recall of its product until now.<\/p>\n

\n\tFrom an earnings perspective, UBS suggests with Advanced Bionics not yet approved for a return to the US market and with no mainstream alternative product, surgeons are likely to switch to the old Cochlear implant. This should help limit the financial impact of the recall.<\/p>\n

\n\tIn response to the volumtary<\/span> recall earnings forecasts have been cut, with Goldman Sachs reducing earnings by 30-40% for FY12-FY13<\/span> to reflect lower unit volumes and significant declines in margins. This is more significant than the changes to forecasts made by RBS<\/span> Australia, which suggests a base case scenario implies a cut in FY12<\/span> of around 15%.<\/p>\n

\n\tBear and bull case scenarios for RBS<\/span> suggests earnings per share (EPS) impacts of 37% and 9% respectively. This implies the share price reaction yesterday when the stock lost around 20% was an over-reaction, at least in RBS's<\/span> opinion.<\/p>\n

\n\tCiti<\/span> is not so sure though, suggesting yesterday's sell-off in the stock may not have accounted for all the short and long-term ramifications for Cochlear. This is because along with the more immediate impact on the bottom line, Cochlear may suffer some permanent market share loss.<\/p>\n

\n\tMorgan Stanley agrees, taking the view the share price correction cannot yet imply value in Cochlear as the extent of the earnings impact is difficult to quantify, as is the extent of the reputational<\/span> damage.<\/p>\n

\n\tThe immediate result in terms of broker models is cuts to price targets, which reflect lower earnings assumptions post the recall. The consensus price target according to the FNArena<\/span> database now stands at $59.20, down from $70.72 prior to the recall.<\/p>\n

\n\tThe uncertainty over the impact of the recall has also seen changes in ratings, with both BA-ML and UBS downgrading to Sell recommendations from Hold ratings previously. Goldman Sachs is not in the database but has similarly downgraded Cochlear to Sell from Hold given limited scope for outperformance<\/span> until the recall issues are resolved.<\/p>\n

\n\tThe database shows Cochlear is now rated as Buy once, Hold four times and Sell three times. Morgan Stanley is also not in the database but rates Cochlear as Equal-weight within a Cautious view on the Australian Medical Technology sector.<\/p>\n

\n\tShares in Cochlear today are stronger and as at 11.40am<\/span> the stock was up 84c<\/span> at $58.34. This compares to a trading range over the past year between 52.77 and $85.00. The current share price implies upside of around 1.0% to the consensus price target in the FNArena<\/span> database.<\/p>\n

\n\t <\/p>\n

\n\tFind out why FNArena<\/span> subscribers like the service so much: "Your Feedback (Thank You)<\/a>" – Warning this story contains unashamedly positive feedback on the service provided.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"