Elective Surgery Deferrals and Legal Case Loss Reduce Cochlear Fair Value, Reduce FVE 5% to AUD 129

Wide-moat Cochlear withdrew fiscal 2020 profit guidance on the back of expected major declines in elective surgeries worldwide as hospital space gets prioritised to deal with COVID-19 patients. Given that cochlear implants are the standard of care for severe hearing impaired children, we expect the delayed surgeries to resume later in the calendar year. We estimate that 60% of implant units sold in fiscal 2019 relate to children across developed and emerging markets. However, in adults, cochlear implant treatment is discretionary and we expect the company may lose 20% of the potential implant opportunities over the next nine months. Once elective surgeries resume, we expect operating theatre capacity and government funding constraints in many markets will limit the pace of the rebound and children will receive priority over adults. The rate at which deferred surgeries resume is a key unknown and currently we assume that around 70% of normalised volumes are achieved in fiscal 2021, with the backlog taking a further two years to catch up. The near-term loss of sales combined with management’s intention to maintain staffing levels leads to reduced profits in fiscal 2020 and 2021. Furthermore, Cochlear’s unsuccessful appeal on a long outstanding patent infringement case sees the company now liable to pay the USD 268 million penalty. We had already included a 50% likelihood of this outcome in our fair value estimate, however, we now expect the near term dividends to be reduced due to cash flow pressure. We reduce our fair value estimate to AUD 129 from AUD 135.