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Is now the time to buy Cochlear?

Hearing implant manufacturer Cochlear Limited (ASX: COH) has seen its share price fall 3% today to $66.03, despite no news to explain the fall. Shareholders may have become a little more than exasperated by the recent share price action, including a 4% rise last week, a 9% fall on Feb 5 2012, a 4% fall the day after, and a 3% fall on February 21.

The big fall of around 13% at the start of February appears mainly due to the company narrowly missing analyst estimates of an $80 million half year profit. To recap, Cochlear reported a net profit of $77.7 million for the six months to December 2012, recovering from a $20 million loss the year prior, on the back of a recall of its flagship CI500 series hearing implant in September 2011.

Cochlear was forced to re-start manufacturing of its previous model implant, which from all reports is still superior to many of its competitor’s products. Cochlear has yet to confirm when its flagship CI500 implant will be reintroduced, although it’s possible that the company will instead release a newer, improved model to replace both the CI500 and its temporary replacement models.

In the meantime, a number of low cost competitors have sprung up, seeking to take advantage of Cochlear’s high prices it charges for its implants. Yesterday, the China Digital Times reported that Hangzhou Nurotron Biotechnology, has received approval to sell its implant in mainland China at around less than half the costs of its major competitors products, including Cochlear, and expects to eventually seek US Food and Drug Administration approval for its devices.

In India, government-backed researchers are starting clinical trials of a locally developed device, with expectations that if the two year trials go according to plan, a made-in-India implant could cost as little as US$2,500.

So along with its existing competitors, Sonoma and Advanced Bionics, Cochlear also faces up and coming competition from companies that have comparatively very low costs of production. On face value that might be enough for shareholders to abandon Cochlear. But Cochlear has the advantage of refining its products over many years, and has built up a strong competitive advantage, leading to its virtual monopoly in cochlear implants. That competitive advantage should not be underestimated.

Its junior competitors in China and India don’t have that history and arguably their products may not be as well designed as Cochlear’s implants and accessories. As Cochlear’s competitor Sonoma found, one small issue is enough to see a product recalled, which ruins the company’s reputation and makes it incredibly hard for customers to trust it again.

There’s also another factor that will likely work in Cochlear’s favour as well as its competitors. China has an estimated 28 million deaf people, while 30,000 Chinese babies are born without hearing each year. That is a huge virtually untapped market, and the rise in the awareness of cochlear treatments could see a rise in the sale of cochlear implants for all providers as the market expands.

Foolish takeaway

With a virtually unblemished record for many years, apart from the 2011 recall, investors should not rule out Cochlear maintaining its dominance of the market, as well as benefiting from the increased awareness of cochlear implants in the world’s largest populated countries. Should the price drop much from here, I’ll be looking to top up my holding.

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More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in Cochlear.

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