Winning Report 2015 2.pdf


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Fig. 1: 1y stock performance vs. SMI index

Global market leader from Switzerland

160

9'500

150

9'000

140

SOON (CHF)

Sonova, with the core of the group originally founded by French-Belgian investors in 1947, offers one of
the broadest service and product ranges within the hearing healthcare industry. The integrated brand
architecture has grown through a series of strategic acquisitions and splits into two segments: hearing
instruments and cochlear implants, with the former comprising of the retail business Connect Hearing. Its
presence in more than 95 countries through a combination of direct subsidiaries (30 countries) and a
network of independent distributors forms the strongest geographic footprint within the industry (Appx.
5). Sonova is listed on the SIX Swiss Exchange and trades close to its all-time high (CHF 153.7) at the
time of writing (Fig. 1).

8'500
130
8'000
120
110

7'500

100

7'000

Highly concentrated competitive environment

Sonova

SMI (RHS)

There are vital and often-cited industry themes in place, which appear to drive future growth of the
segment: a comparison of the number of people benefiting from a hearing instrument and the number of
people suffering from hearing loss reveals a largely underpenetrated market (between 20%-30%
penetration in most countries). In parallel, an increasingly ageing population – not only in developed
countries, but also in emerging societies – plays a key role for industry volume growth, as the average
first-time client is 68 years old.

Source: Google Finance

Fig. 2: Summary: SWOT analysis
Strengths
Established retail business (first mover)

However, our analysis results in a moderation of the short-to-medium term expectations. We are
concerned about a possible overconfidence on the industry’s future. For each of the potential growth
drivers (especially demographics, low penetration rates and binaural fitting potentials) we encounter
adverse mechanisms, which impede confidence in the envisaged path.

Broad product and service portfolio
Weaknesses
Degrading relationship with audiologists

As customers’ appreciation of innovational excellence varies considerably for a variety of reasons, the
industry is now heading towards fierce price competition and novel marketing approaches. Sonova
positions itself as an innovator in this development and plays a decisive role in shaping the competitive
landscape. In our view, the flipside of this aggressive approach is that Sonova steps up a price war and
harms existing relationships with audiologists.

Advance Bionics products recall and damage claims
Opportunities
Avantgarde approach to overcome end-user's stigma
Growth potential in the Cochlear Implant market

As result, we take a rather conservative view on the industry’s growth potential. An expected sales
CAGR of 4.2% for the overall hearing instrument segment and a CAGR of 12.5% for the cochlear
implant market puts us at the lower end of analysts’ expectations.

Threats
Strong negative foreign exchange effects
Downward spiral of prices and volume competition

Sound financial position, but not outperforming peers

Based on the assumptions as further elaborated upon in the valuation section, the DCF results in a 19%
downside compared to the closing price of November 27th. In order to capture the market perspective,
we conduct a multiple valuation of trailing and forward earnings. In our view, the observed premium
(17.5% above peer median) cannot be explained by future EPS outperformance since the consideration
of forecasted earnings results in an even bigger surcharge of 33% (Fig. 3).

60%
50%
40%
30%
Ø
Ø

20%

Ø

10%

2014/15E

2015/16E

Ø

Sonova
WD
GN
Cochlear

Valuation: industry leader trading at an unreasonable premium

Fig. 3: Benchmarking: EPS growth projections

Sonova
WD
GN
Cochlear

Another important factor is the impact of currencies. A substantial part of the cost base is denominated
in CHF (e.g. R&D, SG&A). On the other hand, the percentage of US sales was in the mid-thirties and EU
distribution recently exceeded 40% (CH < 2%). In FY 2013/14, currency movements exercised a
negative impact of 3% on the top line and 5.1% on EBITA. With respect to the ongoing rebalancing of
the sales mix it is difficult to estimate whether exchange rates are likely to have a positive or negative
impact on future margins.

Source: Team assessment
Note: See Appendix 5F for further information

Sonova
WD
GN
Cochlear

The historic figures underscore Sonova’s current healthy financial position. Yet, due to our industry
structure assessment, we currently see no basis for an operational margin expansion beyond the midtwenties EBITA target within a 3y horizon. Potential gains in the retail and cochlear businesses – the
estimated margin contributors – are expected to be balanced against fierce pressure on wholesale
margins on a certain level within the target area. Despite the fact that the underlying growth drivers are
intact, sales growth depends on many variables other than attractive products alone. The fight for market
share fuels competition and ultimately puts average selling prices (ASPs) as well as margins at risk. A
prime example was Sonova’s decision to sell premium products via the US retail chain CostCo.

Sonova
WD
GN
Cochlear

Sonova possesses a strong position in the maturing hearing aids industry. In comparison to other
sectors, customer demand is subject to a confluence of factors such as healthcare policies and access
to treatment. Excellence in research and development does not necessarily translate into market
success. With landmark technology, such as the invisible in-ear solution Lyric, Sonova seeks to reach
the market segment of reluctant hearing impaired, hitherto difficult to penetrate.

SMI

INVESTMENT SUMMARY

2016/17E

2017/18E

0%

Sonova as industry leader might attract investors for alternative reasons (e.g. sustainability scores – see
other headings), which might explain a certain premium. Nevertheless, we do not perceive these
arguments as being sufficient to explain such a markup. Under the assumption that our price target is
realized, Sonova reaches a forward P/E of 21.4x – still high, but intrinsically justified.

Source: Team assessment, Thomson Reuters EIkon

Our final price recommendation for Sonova combines both DCF and multiple valuation. The fair price of
CHF 122 lies in-between the results of the valuation techniques (Fig. 4).

Sonova – like other players of the medtech industry – faces the risk of product failure or malfunctions,
which directly impact the health of patients. The threat of liabilities related to product recalls and damage
claims became reality when the company was called to account for an Advanced Bionics cochlear
implant issue that arose in 2006 – before the acquisition of the California-based company.
Competitors experienced comparable liabilities, e.g. Australian Cochlear Ltd. in 2012. Furthermore, the
innovation capacity is one of management’s biggest concerns and is a problem inherent to the sector.
The industry seems to reach a shifting point and turns to fierce price competition. The aggressive market
approach pursued by the group burdens its partnerships with retailers and audiologists. This second
class of risk potentials appears to be more specifically related to Sonova. Some risks, further elaborated
upon in the risk section are inter-connected and bear the potential to generate a domino effect. A
confluence of factors may negatively affect Sonova’s position and consequently lead to adverse
valuation results.

Fig. 4: Fair price calculation
130
125
125
120

CHF

Risks: many factors are common to the industry, some are consciously entered

115

122
119

110
105
100
DCF

Fair price

P/E

Source: Team assessment

2