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Top broker downgrades Cochlear shares

The Cochlear Limited (ASX: COH) share price will be one watch on Tuesday after the hearing solutions company was the subject of a broker note out of Goldman Sachs this morning.

What did Goldman Sachs say?

According to a note out of the investment bank, its analysts have downgraded Cochlear’s shares from a buy rating to a neutral rating with an improved price target of $212.00.

Goldman made the move largely on valuation grounds after a strong share price gain left it trading within just 1% of its price target.

The broker explained: “Since mid-April, the shares are up 18% vs. ASX 200’s 4% and the stock now trades at 29.0x NTM EV/EBITDA, +3 standard deviations above its 5-year average. Whilst we remain generally constructive on market fundamentals and COH’s positioning, we believe there are a number of risks which should be more carefully considered at current valuations.”

What are the risks?

One risk is near-term funding challenges. The broker notes that “through 1H the outperformance of competitors appeared to fall materially short of COH’s underperformance, suggesting FY19 market growth is tracking below recent averages.”

Goldman believes that funding caps in the EU markets could be hindering market growth for now. Though it acknowledges that these should be cyclical and can potentially be mitigated by processor upgrades in the short-term.

Another risk that Goldman has suggested investors should consider is that the adult market is tougher than the paediatrics market.

It said: “As the growth opportunity has increasingly shifted towards the adult segment over the last ten years, volume upside is significantly larger, the hurdles to adoption are more pronounced and difficult to overcome, not least: the lack of a specific catalyst in a progressive condition; cost; fear of surgery; stigma and barriers on both the payor and physician side.”

And a final risk to consider is its balance sheet. Whilst the broker sees no immediate cause for concern, it notes that the loss of the patent dispute with AB could put pressure on its balance sheet.

The US District Court has awarded damages against Cochlear of ~US$268 million and while the company is appealing it, there is no provision in the balance sheet at present.

Goldman warned: “If it is unsuccessful in overturning the verdict then we estimate net debt/EBITDA moves from 0.2x to 1.1x.”

What does Goldman rate as a buy?

Goldman has retained its buy rating and lifted its price target on JB Hi-Fi Limited (ASX: JBH) shares to $32.40 following its full year result. It also reiterated its buy rating and $2.35 price target on Nine Entertainment Co Holdings Ltd (ASX: NEC) shares following its takeover approach of Macquarie Media Ltd (ASX: MRN).

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James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Cochlear Ltd. The Motley Fool Australia has recommended Cochlear Ltd. 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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