The healthcare sector has been the best performer of the 10 ASX 200 sector indices, recording a 10% gain whilst the broader S&P / ASX 200 (Index: ^AXJO) (ASX: XJO) has essentially moved sideways.
Although Sirtex Medical Limited managed to double its share price and grab all the headlines with the success of its liver cancer treatments, medical device giants Cochlear Limited (ASX: COH) and ResMed Inc (CHESS) (ASX: RMD) have also performed strongly, recording gains of 22% and 11%, respectively. With the release of their latest products over the past couple of months, I've been pondering which of the two companies makes the better investment.
Below are three reasons why I believe Cochlear is the superior investment.
1. Superior product compared to its competitors: Cochlear's first product is still used in the field and is well supported, with an impressive cumulative survival rate of 92.1% since its release in 1985. However, the survival rate for the first device released in 1996 by its closest rival Advanced Bionics is only 79.38%. Cochlear also has a superior history with product recalls, recording only two through its 33-year history, compared to six from its closest rival. This is a major reason why Cochlear is the undisputed market leader in the industry with 65% market share.
On the other hand ResMed's product is widely deemed to be on par with that of its closest competitor, Philips Respironics, a division of Philips (NYSE: PHG).
2. Higher switching costs: A cochlear implant consists of two components – an internal implant surgically inserted into the head and an external processor to control it. The total cost of getting an implant (including surgery, device, pre- and post-operative visits and therapies) is estimated to range from US$50,000 to $100,000. New external processors are backward-compatible with older generation implants from the same company. The exorbitant cost involved acts as a significant deterrent to switching to an implant from another company, securing Cochlear's current client base.
Sleep therapy devices produced by ResMed are external and much cheaper (ranges between US$700 to $900), so the cost of switching to a competitor is a lot lower.
3. Competitive pricing compared to its competitors: The latest processors from Cochlear are priced similarly to its competitors, whilst being a superior product as mentioned above. ResMed's latest machine is priced at a near 30% premium to Philips Respironics' product. The less competitive pricing coupled with the perception that ResMed's machines are only on par with those from Philips Respironics is the key reason why it has been losing market share over the past few years.
Does this make Cochlear a buy?
The U.S. market is of major importance to the company, comprising nearly 40% of sales. However, sales growth in the medium to long term should come from Asia Pacific, especially China with its growing healthcare needs. The company's position in the country is under question with mixed performance in winning government tenders. More importantly, Chinese competitors such as Nurotron Biotechnology Inc are much cheaper (less than half the price) and have been eating into Cochlear's market share in China.
All is not lost though – Nurotron has had to redesign its device recently after a string of user complaints, and Cochlear posted a 17% growth in Asia Pacific revenues in FY14. However I won't be rushing into the stock until I start to see sustained performance in the Asia Pacific region, but it should be on your watchlist.
