Is it time to buy Cochlear?

On 21 January 2013, Cochlear (ASX:COH) shares were trading at a near five-year high of $82.87. Having released underwhelming half-yearly results in early February and a profit downgrade in early June, the shares have tumbled to a one-year low of $52.71 on 3 June. While Foolish investors will know that past performance does not guarantee future results, only three times in the past five years have the shares dipped below $50 — and each time they have recovered swiftly.

The half yearly results were weaker than expectations primarily due to the effect of the strong Australian and the recovery from a high profile product recall in 2012. The results noted strong sales of cochlear implants (up 27%), though the increase was distorted somewhat by replacements issued due to the recall. Actual growth was estimated at 10%. Revenue increased 1 percent over the previous corresponding period.

A recent trading update reduced net profit after tax (NPAT) guidance to between $130 and $135 million, from the market expectation of $150-155 million. The reduction was said to be caused by slowing sales due to the imminent release of an updated model and the effect of the high Australian dollar.

The reasoning behind the poor result appears logical, with companies such as Apple noting in previous years that demand for current generation devices reduces markedly in the lead up to the announcement of an updated version. Similarly, the high Australian dollar reduces the competitiveness of the Cochlear implants versus rival American-made devices. Cochlear generates around 40% of revenue from the US and a sustained increase in the strength of the US Dollar will favourably impact Cochlear’s profit margins.

A promising sign for investors was the confirmation in the trading update that the final dividend will be at least $1.25 per share, indicating a 4.4% yield based on the current price of around $57. Franking is expected to be in the vicinity of 40%. The FY13 dividend payout represents around 110% of earnings, reaffirming management’s confidence in the recovery.

A significant risk for the company is the potential for lost market share due to the delay of the latest model and the 2012 product recall. Cochlear reported that it had not lost ‘material’ market share, however competitors Advanced Bionics reported that FY13 sales increased by 47% which may indicate otherwise.

Foolish takeaway

The recent fall in the price of Cochlear presents an opportunity for investors to purchase a quality company at a reasonable price. Management believes the new product release in the second half of 2013 will produce a sharp rise in earnings and regain any lost market share during the past 12 months.

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Motley Fool contributor Andrew Mudie owns shares of Cochlear.

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