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Why I’m waiting to buy Cochlear Limited (ASX:COH) shares

The share price of hearing implant manufacturer Cochlear Limited (ASX: COH) has risen 29% over the last 12 months, significantly outperforming the broader market’s gain of 6%. The company’s share price managed to hit a record high of $204.56 during last Friday’s trading session, before retreating to currently trade at $197.08.

Is it time for investors to buy shares in the company? 

A stronger second half

Cochlear announced a reasonably solid set of numbers in February for the six months ended 31 December 2017. The company saw sales revenue increase 6% (up 7% in constant currency) to $639.6 million despite the number of implant units sold falling 2% to 15,972 for the period.

Services revenue was the standout performer after climbing 12% to $161.6 million following the release of the Nucleus 7 Sound Processor and the first contribution from Sycle, the audio practice management software business that was acquired in May 2017.

Despite the growth in revenue, Cochlear’s reported net profit fell 1% to $110.8 million (up 1% at constant currency). This was largely due to a $5.5 million non-cash impact from the revaluation of deferred tax assets following the reduction of US corporate tax rates that lowered net profit growth by 5%.

Management expects FY18 reported net profit for Cochlear to be in the range of $240 million to $250 million, which represents a 7%-12% increase on FY17. This infers a stronger second half performance of around $129-$139 million in profit. The forecast is also based on a weighted average AUD/USD exchange range of around 79 cents. The recent weakness in the Australian dollar may also provide a tailwind to the company’s full year numbers.  

Foolish takeaway

Cochlear is an exceptional business alongside other healthcare market darlings CSL Limited (ASX: CSL) and ResMed Inc. CHESS (ASX: RMD)

Their track record of outstanding performance and projected growth in future earnings justifies a valuation premium to the general market. These types of companies rarely trade at conventionally cheap valuations, so the real issue for investors is determining the level of valuation premium they are willing to pay to acquire shares in these sorts of businesses. 

Cochlear is currently trading for around 46 times FY18’s estimated earnings and 40 times FY19’s estimated earnings. Even for such a high quality company, the current valuation appears to be a little stretched. 

The market seems to be pricing in a significant beat of the company’s FY18 result that is scheduled for release in August. Should Cochlear not live up to the market’s expectations, a better buying opportunity with a more attractive valuation could present itself for patient investors.

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Motley Fool contributor Tim Katavic owns shares of CSL Limited. The Motley Fool Australia has recommended Cochlear Ltd. and ResMed Inc. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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