We recently carried out a theme review of the hearing aid sector. With the global population ageing, and the fact that the hearing loss prevalence rate increases dramatically from 40% for people aged 60-69 to almost 90% for people aged 80 or above, hearing aids naturally fall into our investment universe within our health theme.[I]
On the surface, hearing aids appear to be an attractive sector for investment given secular demand growth and an oligopolistic market dominated by 6 major hearing aid manufacturers,[ii] each of which generates a healthy return on invested capital. However, on further analysis deeper, we believe the sector faces various challenges.
People with hearing impairment are often sceptical about the benefits of hearing aids, even though the technology has advanced so much in recent years. We now have better algorithms to filter background noise. We have technologies that stream stereo sound directly to hearing aids from smart phones, tablets and TVs. However, we do not pay as much attention to hearing aid product launches as we do to iPhone’s, and people still stigmatise hearing aids as being clunky, unsightly and expensive. No wonder the penetration rate in developed markets has remained stuck at around 20% for the past 10 years![ii]
In this oligopolistic market, the manufacturers are surprisingly aggressive in competing against each other and continually seek to gain market share through launching new products. As a result, the product cycle has shortened from 3 years in the late 90s’ to less than 1 year in 2014.[ii] Last year, the market leader Sonova decided to sell its high-end products at Costco, which offers lower prices than independent audiologists can. Such intense competition has led to continuous pricing pressure, causing 1-2% price decline per annum over last few years.[iii]
As the manufacturers scramble to grow their businesses in a consolidated market, they are expanding into retail distribution, which generally has lower profitability and returns relative to their traditional manufacturing business. We are also seeing a shift in sales channels from independent retailers to retail chains and big-box stores, which have stronger bargaining power. This change in distribution not only leads to further pricing pressure on manufacturers, but also potentially puts the manufacturers’ retail assets at risk.
We currently have no exposure to the hearing aid market. The highly competitive nature of this market is beneficial to people with hearing loss, as manufacturers keep launching products with increasingly advanced features at competitive prices. However, from an investment point of view, we believe the industry dynamic is difficult for manufacturers and we do not find current share price valuations attractive relative to the challenges highlighted above.
[i] World Health Organisation
[ii] Jefferies’ report titled “Medical Supplier & Devices – Hearing Aids: Disruptive Retail Trends to Turn Up the Volumes as Prices Plunge”, 13 April 2015
[iii] Citi’ report titled “Global Hearing Industry – Prefer Wholesalers to Retailers and Implant Manufacturers”, 16 December 2014