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Hearing Aids Equity Research Sector update, 31 March, 2020 18:36 CET Hearing aids COVID-19 crashes market growth: 2020e decline of 9-27% US market and COVID-19 impact in H2 are key swing factors Demant has the most harmful exposure; down to SELL (Hold) GN protected by GN Audio and limited retail exposure; BUY Three scenarios, all negative Many hearing retail stores in Europe are either fully or partly closed. Senior citizens are being asked to stay home. The US (the largest hearing aid market, accounting for one third of its value) is 2-3 weeks behind Europe and is also closing down. A recent survey from US-based Hearing Review confirms a depressing trend. We have modelled three different scenarios looking at the impact of the COVID-19 outbreak on hearing aid market growth. We lean towards the most likely case being that we have a large negative effect in March-May 2020, improvements during the summer, and then a negative second wave (although smaller) in October-December 2020. We estimate this disruption will lead to a market decline of around 18%, and this is our main input for our revised estimates for GN and Demant. Underlying market fundamentals are, however, still robust and we expect market growth of ~8% in 2021 as the market catches up the backlog. Demant downgraded to SELL as retail exposure slices earnings Hearing instruments account for 77% of Demant’s revenue and are currently seeing poor sales for the reasons outlined above. Only EPOS (CC&O franchise and ~8% of total sales) is expected to reach positive growth (~10% in 2020e). We thus cut 2020e sales by DKK 2.8bn and EBIT by close to DKK 1.9bn as Demant owns almost 3,000 retail stores, which we expect to be affected by closures. We do anticipate a rather swift return to a positive trend in 2021, but from a lower baseline. In total, we slice 2020e-21e EPS by 68% and 17% respectively. We lower our target price to DKK 140 (245) as a result of sector multiple contraction of 25% and our estimates cuts. We downgrade our recommendation to SELL (Hold). The next company-specific trigger will be the Q1 interim update on May 5, when we believe Demant may keep its outlook suspended. GN Audio still expected to grow; minimal retail exposure is a plus GN Hearing (~50% of sales) is also facing the problem of negative organic growth (FY 2020e -17%), however we keep our GN Audio forecast and thus we only lower total sales by 10%. As GN has less than 200 retail stores, we think the net impact on earnings will be smaller than for Demant, and we lower 2020e and 2021e EPS by 29% and 13% respectively. GN, trading at a 2021e P/E of ~19x (on a par with Demant and below Sonova and Amplifon) and with its superior 2019-22e CAGR of 19%, is our favourite in the sector, and we view it as the company suffering the least from the COVID-19 crisis. We therefore reiterate BUY, but lower our target price to DKK 340 (425), reflecting lower sector multiples and trimmed earnings estimates. Annette Lykke, +45 46791295, [email protected] For full disclaimer and definitions, please refer to the end of this report. Sector update, March 31, 2020 Global hearing aid market under pressure from COVID-19 Current visibility on market growth for both H1 and H2 2020 is very low due to the uncertainty caused by the COVID-19 outbreak. We have modelled three different scenarios with various degrees of hearing aid clinic/shop closures, and varying amounts of traffic through those that do remain open. As a result of our modelling, we estimate that the global hearing aid market is at risk of decreasing by 9-27% for FY 2020e. No doubt that for Europe and the US, H1 2020 is already very negatively impacted by the full or partial closure of hearing aid clinics and advice for senior people to stay home to avoid COVID-19 infection. The swing factor in our model is mainly how H2 2020 will turn out. If we have a just as severe close down in H2 as in H1, we think there is a risk that the market could drop by as much as 27% for FY 2020e. Table 1: Three scenarios and 2020e hearing market growth (units) We see potential for Scenario Market growth negative growth in 2020e the global hearing A Severe close down spring 2020 and moderate close down winter 2020 -18% aid market of 9-27% B Severe close down spring 2020 and severe close down winter 2020 as well -27% C Severe close down spring 2020 and normal business winter 2020 -9% for FY 2020e Source: Handelsbanken Capital Markets Hearing aid market and COVID-19 impact We expect market growth to face a material negative impact as a result of the global COVID-19 health crisis. Senior citizens (the average first-time user of a hearing aid is ~72 years old) are part of the high-risk group for COVID-19 and are advised to stay at home to protect their health. In some markets, hearing aid clinics/shops are partly or completely closed. In a simplified illustration, the situation (which greatly varies from region to region) can be divided into four different phases: Phase one: high caution regions; no complete lock down (shops, restaurants and schools partly open), social distance recommended, e.g. markets such as Sweden, Australia and New Zealand where audiology shops are still open (or have the option to be open). In these markets there is a moderate negative impact. Phase two: partly shut down, but still possible to have hearing aids adjusted and, in some regions, new fittings can be performed. A country in this mode is, for example, Germany, although guidance and government actions change quickly. Phase three: complete shutdown mode (no audiology shops opened), including countries like Italy, Spain, Denmark, France and others. This mean that the selling/fitting of new hearing aids is close to zero. Phase four: the recovery phase, coming from low activity and gradually ramping up. This is currently the situation in China. According to Demant and GN, there is some free capacity in the systems, thus when recovery takes place activities can be higher than index 100 and it should be possible to capture some of the backlog from the spring, although not all of it. In conclusion, we have created three scenarios and believe that the overall FY 2020e hearing aid market growth (in value) will most like be in the range -9% to -27%. It is important to stress that the COVID-19 situation is very fluid and overall visibility remains rather low. Scenario A: Most likely and our base case In scenario A (2020e market growth of -18%) we assume a second transmission wave late in 2020, most likely from October (based on current information and given that there is currently no vaccine). We assume store/clinic close downs will be less 2 Sector update, March 31, 2020 dramatic than in spring 2020, but still material. When we dare to add less dramatic close downs for H2 2020, it is based on the assumption that part of various countries’ populations are immunised (by transmission) and that governments have gained experience from the first COVID-19 peak, now know what works best, and therefore can hopefully be more effective in their actions. Figure 1: Scenario A, market growth (most likely) Global hearing aid market, scenario A (FY2020 growth -18%) USDm Scenario A: some 600 20% negative impact in 10% 10% 500 H2 2020… 0% -10% 400 -20% …we add negative 300 -30% market growth of -40% around 18% to our 200 -50% forecasts for GN and 100 -60% Demant, impacting -70% 0 -80% hearing aid sales Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec growth 2019 2020e 2021e Growth M-o-M 2020e Source: Handelsbanken Capital Markets Scenario B: Bearish case In our most bearish scenario (B) we assume the close down for hearing aid clinics will be almost as severe as it is currently. We also assume there is no vaccine available, governments continue to tell senior people to stay home and that several shops are either completely or partly closed during October to December 2020. Clearly in this scenario we will also see a negative effect in 2021, although we expect part of this to be compensated for during the remainder of 2021, as the fundamental clinical need for hearing aids is unchanged (see discussion page 11). Figure 2: Scenario B, market growth (bearish) Global hearing aid market, scenario B (FY2020 growth -27%) USDm 600 20% Scenario B: COVID-19 10% 10% transmission wave and 500 0% general close down 400 -10% will be just as severe in -20% 300 -30% H2 as in H1… -40% 200 -50% …FY 2020e market 100 -60% growth could be as -70% low as -27% 0 -80% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2019 2020e 2021e Growth M-o-M 2020e Source: Handelsbanken Capital Markets Scenario C: Optimistic case Our third and more optimistic scenario C assumes that the impact from the second COVID-19 transmission wave in autumn/winter 2020 will be fairly small as we assume a vaccine will be in place. In this scenario we see an annual decrease in market growth of 9%, which could be even lower if the backlog of patients, who had postponed having a new hearing aid fitted, reschedule during H2 2020.
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