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Decent quarter but short-term challenges ahead

  • 01 Dec 16

GN Store Nord reported a healthy quarter with revenue rising 13% to DKK2.1bn, driven predominantly by M&A (c.5ppt mainly Audigy) and forex tailwinds (c.2ppt), while organically the growth receded (6% vs. 9% both in Q2 16 and Q3 15). GN Hearing’s 5% growth (organic, excluding Otometrics), reflected a slowdown sequentially (Q1 16: 11% and Q2 16: 10%) but GN Audio sustained its strong momentum (+9% organically) supported by the sturdy uptake (24%) in Contact Centre & Offices (CC&O) offsetting a sharp decline of 21% in its mobile business. Additionally, it has divested Otometrics (the diagnostic equipment business reported under the GN Hearing segment) to Natus Medical for $145m, and acquired VXi, a US-based headset manufacturer, for $35m, intended to strengthen the GN Audio’s North American presence. With FY 15 sales of DKK649m (c.8% of the group turnover), the GN Otometrics deal translates into 1.5x EV/Sales vs 1.9x as per our NAV. Factoring in these recent transactions, management now guides for an EBITA of c.DKK1,100m for GN Hearing (previously c.DKK1,200m) excluding transaction costs. Also, management expects a much lower effective tax rate of c.22% from the earlier 25-26% for FY 16. The rest of the guidance remains unchanged – GN Hearing: c.6% organic growth; GN Audio: c.7-10% organic growth & c.DKK590m EBITA. Separately, at its Capital Markets Day (CMD) held in September 2016, GN shared its new medium-term targets for 2017-19: a) GN Hearing: annual organic revenue growth of 6-8% and EBITA margin of 20-22%; b) GN Audio – annual organic revenue growth of 6-9% and EBITA margin of 17-19%; and c) effective tax rate of c.22%, in line with the lowered Danish taxes. The key focus in the hearing business will be on increasing its share in the open market (comprising independent dispensers, ENTs and buying groups), while further fortifying its relationship with large retailers (Costco, Veteran Affairs and Amplifon) and the successful launch of its fifth generation 2.4GHz-based product in 2017. The company is also looking to further secure its position in North America, particularly the US (aiming to be number 1), through sales-force expansion, leveraging Audigy’s network and strengthening the Beltone network in the US. On the other hand, GN Audio’s focus will be on improving its presence in the call-centric space, gaining further ground in the Unified Communications (UC) domain and repositioning itself in the mobile segment (geared more towards integrated voice and music solutions).

Initiating coverage on GN Store Nord

  • 23 Aug 16

Recommendation and upside We are initiating coverage on GN Store Nord (market cap. of DKK21.9bn/ €2.9bn and a float of 100%) with an Add recommendation and a target price of DKK165 (c.17% upside). Our upside is driven by the company’s traditional technological superiority over peers, strong control on costs (through low-cost manufacturing centres such as China and Malaysia), a healthy balance sheet and attractive shareholder reward programmes (through significant share buy-backs and dividends). The stock had come under pressure recently following concerning read-across from its Netcom/ Audio business, weaker profitability and increasing threats from recent product/ platform launches by hearing-aids peers, but has since recovered to come close to its 52-week high. While we acknowledge the upside potential, we restrict our recommendation to an ‘add’, as we continue to see the company facing headwinds in its Netcom business and expect it to under-deliver on its FY 16 profitability guidance, given tougher comps in H2 16 (we see H2 margin expectations as demanding given the H1 run-rate), a changing product mix (from premium towards medium and lower cost products) and limited visibility on a new platform launch this year (given competitors’ recent launches and the US Veteran Affairs contract up for renewal in November, GN may end of conceding some of its market share gains in the past few months – GN currently accounts for a c.20% share of the VA market). Business and trends GN Store Nord operates two separate businesses under its corporate umbrella – GN Resound (hearing) and GN Netcom (audio). The former includes manufacture and marketing of hearing aids and is the core business for the company (accounting for 62% and 66% of FY 15 revenue and underlying operating profit, respectively). The other segment constitutes the company’s hand-free communications equipment (office and mobile headsets). With a volume share of c.17% at the end of 2015, GN is the fourth largest player in the c. $4bn oligopolistic global (wholesale) hearing instruments market. Characterised by the constant need for innovation and technology upgrades (the products’ lifecycle has declined to 1-1.5 years from the earlier 2-3 years) and by virtue of being highly regulated, the industry offers natural barriers to entry (the top six players – Sonova, William Demant, Sivantos, GN Store Nord, Starkey and Widex – account for c.95% of the market). However, competition amongst the six players remains intense, with market share gains/ volumes gaining critical importance, particularly in the wake of the intense pricing pressure being faced by the industry – average selling prices (ASPs have been declining 1-2% p.a.). Courtesy of its technology focus, GN has been steadily gaining market share since 2010, following the launch of its path-breaking 2.4GHz technology platform (four generations of the platform have been launched to date) and the first of its kind, made-for-iPhone wireless hearing aids. However, both Sonova and William Demant are currently in the process of launching their own 2.4GHz platforms (and promising additional features), threatening GN’s competitive advantage. Moreover, unlike its peers which have increasingly been tapping the diversification route (venturing into the retail and hearing implants space) to beat market overhangs, GN has remained steadfast in its strategy to focus only on the core wholesale side of the business. While this strategy does have merit (increased focus, greater earnings visibility and better terms with independent audiologists), it would require the company to stay ahead of the curve in terms of technological prowess and delivery. Performance delivery in the hearing devices segment takes on an even more critical role, given the headwinds faced by GN’s audio business. While the duopolistic Contact Center and Office business (CC&O) has been taking off, courtesy the strong uptake of the ‘Unified Communication’ devices (Plantronics and GN are the only two key players), it is being offset by the structural changes in the mobile headset market, leading to double-digit decline for the sub-segment. We expect the segment to remain soft in the near term. Need to know While operating under the GN Store Nord umbrella, the company’s two segments, Resound and Netcom, operate as completely unique entities, each headed up by a different CEO, with no synergies or overlaps in operations or end consumers. Back in 2007, GN had tried to divest its hearing aids business, Resound, to Sonova for $2.6bn but the deal was shot down by the German competition authorities which contested that the deal would create an oligopoly in Germany (the German courts dismissed GN’s 2013 petition for €1.1bn damages against the German authorities in 2014). The segment has since gone on to become the core earnings contributor for the company. Divestment/ sale of the business looks highly unlikely in the near term. The hearing aids industry, in recent times, has also been plagued by the noise around ‘commoditisation’ with a multitude of technology companies showing interest in entering the hearing aids space (particularly Samsung). Of note, however, is that other players such as 3M, Motorola and Panasonic have previously tried and subsequently failed to make inroads into the industry. We maintain that the current breeds of ‘pretenders’, the Personalised Sound Amplification Products (PSAPs), while much more pocket-friendly (costing a tenth of traditional hearing aids) and increasingly ramping up in sophistication (adding features such as noise cancellation), are still not programmed to correct hearing loss. However, the recent agreement by the FDA to have another look at its position on the regulation of hearing aids may become a threat if it does decide to soften its stance. Upcoming triggers We expect the next triggers for the company to be its Capital Markets Day, scheduled for 26 September 2016 (where the company is expected to discuss its medium-term guidance for 2017-19), the EUHA conference in October 2016 (possible announcement of the new platform) and the launch of the 5th generation 2.4GHz platform later this year/ early 2017.