Assessment 2 Step 3 – My Key Concept Questions:
My key concepts are underlined, my questions in italics, and my reflections have normal formats.
Inside Cover Page and Page 1
Upon opening the 2018 Annual Report, I could tell straight away that this company is a profitable company. Cochlear certainly communicates this very clearly on page 1, with a graphical financial summary, no doubt intended for prospective and potential investors. The financial summary shows information on the number of product units manufactured, sales revenue, net profit, and dividends per share. They are all growing, especially the sales revenue and dividends. I found this impressive!
The inside cover page told me that Cochlear has a global tax strategy, corporate governance, and a detailed strategy. They have separate documents regarding these things, for investors to look at.
Profit drivers are the elements of a firm that drive up their profit. They can include price, variable costs, fixed costs and sales volume, just to name a few key ones (bizcoach.org, n.d., para. 2).
Knowing that Cochlear is a profitable company makes me excited. I was wondering what is driving and growing its profits, and consequently its dividends. Obviously, I can see that the number of product units manufactured and sales revenue have increased. With more product units to sell, and with success in sales, this must be one of the key factors resulting in a high turnover for the company (Queensland Government, 2016).
What are the elements that are contributing to strong sales revenue results?
What are the elements that are contributing to strong net profits results?
What are the economic and business realities of this firm, contributing to its recent success?
Operating and financial review – Page 7
Cochlear has a market capitalisation of A$10 billion plus. I was thinking that this might mean how much a firm was worth in terms of market value? But I forget what market capitalisation is. If I am to truly understand what I am reading and what is really going with my firm, then I need to ask questions, even if they are rather plain and simple.
What is market capitalisation?
Market capitalisation is the market value of a company’s shares, according to the current market price of one publicly offered share (Investopedia, 2018). According to Investopedia (2018), it is calculated as:
Number of company shares outstanding x Market share price.
Having reminded myself of the definition, I found this concept fascinating, because this definition actually answers one of my original key concept questions for Assessment 2 Step 1 of ACCT11081. These were:
“How does one then account for changes in the value of the equity in the financial accounts, i.e. according to the market value of the equity?
If the current value of a firm and the equity of the firm’s owners is expressed in the financial accounts then are these just changed through the revenue and expense accounts?
After all, these values, that of the firm and that of the equity belonging to the firm’s rightful owners, are changing all the time.” (Spurway, 2019, p. 17)
I now know the answer to the first question!
Cochlear’s investment proposition – Page 8
An investment proposition is a written position developed by management for investors, detailing the benefits of investing into the firm, which will hopefully attract and encourage investors to commit investments to the firm (Business Dictionary, n.d.). It usually contains some of the most relevant and prominent information about a firm, including the firm’s qualities, history, growth potential, business objectives, and prospects for return on investment (Business Dictionary, n.d.). If well-developed, it can be a powerful tool to draw investments (Adviser Business Review, n.d.).
I found this concept exciting because an investment proposition is where one gets to hear the really great things about a firm, including its investment prospects. This is surely a key part of a firm’s pitch to investors and other stakeholders, revealing something about its ability to create value for these parties with a genuine interest in the firm’s activities.
In summary, Cochlear’s investment proposition highlights 5 key points to potential investors:
– Cochlear is a global leader in its industry;
– It has long-term market growth opportunity;
– It has a clear commitment to product innovation;
– It has developed a growing annuity income stream; and
– It has strong free cash flow generation for growth in industry, innovations and dividends.
If an investment proposition is so useful, powerful and yet simple, then why don’t some firms feature one within their annual reports?
Market-leading technology – Page 12
Research and development (R&D) is important to firms because it helps to differentiate them, enhances their sustainability, generates more revenue, can assist in accessing tax incentives, and can give firms a competitive advantage (Ganapathy, 2014). R&D needs to be looked as a potential value creator and driver.
I agree with this concept, because it seems like R&D can be a real game changer for firms if these benefits are realised. In order to survive and thrive, firms should always be looking to be better than what they are, and look for opportunities to create more value. R&D is part of that looking! It is about being sustainable. It is about being a part of a broader strategy to advance.
What are the appropriate strategies for engaging in R&D spending?
What is the return on investment and cost of capital benchmarks regarding this?
How might R&D spending be sustained within a firm?
What is the right way to plan a R&D spend?
For FY2017-18, Cochlear spent A$168 million on R&D (Cochlear Ltd, 2018, p. 12). They continue to spend more and more on R&D because they are committed to retaining industry leadership through market-leading technology (Cochlear Ltd, 2018, p. 6). They are also able to access the Australian Government’s tax incentives for significant R&D work (Cochlear Ltd, 2018, p. 3).
Growing revenue across all business units – Page 18
A sales revenue analysis allows a firm to make decisions regarding their business strategy, showing it how products are performing, and helping it to decide on where further investments or discontinuations are needed (Chron, n.d.).
Cochlear has produced a sales revenue analysis within its annual report, showing a breakdown of its products’ sale revenues. Figure 1 shows the graphic used.
Figure 1. Cochlear’s sales revenue analysis for the last 4 years. From 2018 Cochlear Limited Annual Report, by Cochlear Ltd, 2018 (https://www.cochlear.com/shared-library/downloads/global-downloads/about-cochlear/annual-report-fy-2018).
I believe this is a good concept and tool to use, because it can show what products are driving sales revenues and what ones are lagging. Also, a sales revenue analysis will help a firm in deciding upon which areas to engage in for R&D, for future product upgrades or replacements.
How common are sales revenue analyses? Where are they used most?
What other analyses will be useful in strategic product and R&D decisions?
Cash flow – Page 22
Free cash flow (FCF) is a measure of profitability that is the calculation of residual cash available after accounting for the necessary maintenance spending on operations and the capital assets (Investopedia, 2019). Being a pure cash measure, it excludes non-cash items.
Operating cash flow (OCF) is another measure of profitability that is the calculation of the cash generation from a firm’s normal business operating activities (Investopedia, 2019). Being a pure cash measure, it involves using the earnings before interest and taxes (EBIT) and then making changes with non-cash items, in order to arrive at the OCF (Investopedia, 2019).
I agree with these key concepts, because they are very different concepts, being arrived at in different ways. Nevertheless, they are similar also, being both cash measures. They can both be measures of success for a firm! In ACCT11059, I had some confusion in thinking they were both the same thing. Yet while reading the ACCT11059 Study Guide, ‘cash’ was actually often meaning FCF. But I did not know what FCF was before ACCT11059. I only knew what OCF was. However, they are both different. FCF is always a certain bottom line total, OCF is not.
Cochlear has obviously put together much financial analysis for potential investors. This is very organised. The figures of the FCF and OCF in particular, will be useful and of great interest for any sophisticated investors.
For FY2017-18, Cochlear’s figures are strong: OCF = A$258.1 million, FCF = A$202.7 million (Cochlear Ltd, 2018, p. 22).
In my view, this is a great way to attract more investors. That is, to do a lot of the financial analysis work for them.
Why don’t more firms put out their FCF for potential investors?
Is it because of a lack of human capital or time taken to prepare the annual report?
What do the ‘sophisticated investors’ look for in an annual report? What is important to them?
Capital employed – Page 23
Capital Employed represents the amount of capital being used up for a firm’s capital assets and projects, in order to generate value (Investopedia, 2019). According to Investopedia (2019), it is calculated as:
Total Assets – Current Liabilities
Total Equity + Non-Current Liabilities.
I found this concept interesting, and potentially helpful for a firm, because it allows one to see the value of the capital being used in the firm, and where it is being used, for value creation (Investopedia, 2019). This figure is useful to calculate the return on capital employed (ROCE), which is EBIT divided by capital employed (Investopedia, 2019).
What might ‘capital employed’ be able to tell us about the economic and business realities of a firm beyond what has just been said?
For FY2017-18, Cochlear has A$697.0 million worth of capital employed, being an increase of A$24 million mostly by way of working capital increases (Cochlear Ltd, 2018, p. 23).
Net debt – Page 23
Net Debt represents the amount of cash that would be left if the firm’s debts were paid immediately in the short-term (Investopedia, 2019). It only compares the liquid cash assets to the payment of the debts, regardless of other current assets of value (Investopedia, 2019). According to Investopedia (2019), it is calculated as:
( Short-Term Debts + Long-Term Debts ) – ( Cash + Cash Equivalents ).
I thought that this concept was useful, but somewhat confusing, being among so many other debt metrics out there. Some of the other debt metrics that exist are: Debt-to-Equity Ratio, Cash Conversion Rate, and the Net Liquidity Ratio (Investopedia, 2019). Each other metric has its own way of analysing and looking at the debt situation of a firm. I would love to know the difference and significance of each.
What are the other debt metrics? What are their differences?
When should each type of debt metric be used? How can they be used together?
What is the best way to make a sound judgement about a company’s solvency?
What is the best way to make a sound judgement about a company’s debt situation?
Should ‘net debt’ best be used in conjunction with other debt metrics, to get a better picture?
Cochlear has obviously given prominence to the ‘net debt’ concept and calculation. Just how often is it used in companies?
Areas I Found Difficult to Understand:
I found some of the terminology used difficult to understand. In particular, ‘indications’ on page 5 and ‘tender activity’ on page 20.
In the health care sector, indications are the latest innovations relating to existing treatments that are already available (Investopedia, 2018).
Tender activity, in the context of the cause of growing sales revenues, refers to Cochlear’s winning of contracts, in order to go ahead with the supply of their products (Investopedia, 2019).
Areas That Were Most Important to Me:
The following areas were of most importance to me:
The recent Financial History, the Chairman’s Report, the CEO & President’s Report, the Investment Proposition, the Growth Drivers, the Company Strategy, the Results of Operations, the Financial Review, the Business Risks, the Financial Statements, and the Shareholder Information.
These areas were important to me, because I really want to engage with and connect to the economic and business realities of this firm. In other words, I want to find out what is really going on, and what makes this firm tick. What makes it successful. What drives its value creation. Therefore, these areas were important to me so I could learn about and discover Cochlear’s economic and business realities.
About the Key Challenges:
Cochlear is doing extremely well. Therefore, their key challenges look more like opportunities than difficulties.
One of Cochlear’s main key challenges is to raise awareness among, and treat, the 95% of people who could benefit from a quality implantable hearing solution and who are currently missing out (Cochlear Ltd, 2018, p. 9). This presents a great opportunity to Cochlear (Cochlear Ltd, 2018, p. 2). Figure 2 highlights the situation. This is expected to drive Cochlear’s growth and that of its industry (Cochlear Ltd, 2018, p. 9).
Figure 2. The hearing loss market. From 2018 Cochlear Limited Annual Report, by Cochlear Ltd, 2018 (https://www.cochlear.com/shared-library/downloads/global-downloads/about-cochlear/annual-report-fy-2018).
Another challenge for Cochlear is to maintain innovation and R&D investments. The reason for this is to retain market leadership and remain competitive and sustainable (Cochlear Ltd, 2018, p. 25). As new products and services become replicated by their competitors, the price of these will fall, and consequently the revenues (Cochlear Ltd, 2018, p. 25).
An additional challenge is to deliver on their plans for continued growth and a dividend payout of 70% of net profit (Cochlear Ltd, 2018, p. 18). Cochlear has made ambitious plans. However, recent business and market conditions would suggest that they will probably deliver. Nevertheless, they are forecasting a weighted average AU/US exchange rate of 75 cents for the 2018-2019 financial year (Cochlear Ltd, 2018, p. 6). On recent exchange rate figures, for the year so far, I’m not sure they will hit this target. They may end up falling under it.
How it is meeting the Key Challenges now:
Cochlear is building collaborative partnerships to achieve research and treatment access for those affected by hearing loss (Cochlear Ltd, 2018, p. 3). Initiatives include:
– committing US$10 million over 10 years to the Johns Hopkins Bloomberg School of Public Health in the United States, in order to address hearing loss as a global health priority;
– setting up the Cochlear Chair in Hearing and Healthy Ageing at Macquarie University in Australia, to bring about collaborative research; and
– partnering with the Chinese government and universities to establish an international hearing research centre (Cochlear Ltd, 2018, p. 3).
Cochlear is continuing to spread awareness about hearing loss and their solutions, through their products, programs and services (Cochlear Ltd, 2018, p. 5). Initiatives include:
– strengthening Cochlear’s servicing capability to provide world-class products, programs and services;
– investing in sales and marketing activities, including direct-to-consumer marketing activities and marketing through the hearing aid channel; and
– reinvesting efficiency gains into more market growth activities (Cochlear Ltd, 2018, pp. 5-6).
Cochlear is going to keep on investing significantly in innovation and R&D (Cochlear Ltd, 2018, p. 6). Initiatives include:
– monitoring the world for new technologies that may advance Cochlear innovations;
– making small early-stage innovation investments with other organisations, like Otoconsult working on technology to have a superior cochlear implant fitting, Sensorion looking into therapeutic approaches with cochlear implants, and Epi-Minder developing a monitoring device for epileptic seizures; and
– investing in product developments to grow sales revenues (Cochlear Ltd, 2018, p. 3).
Cochlear is striving to maintain its growth. They seek to work toward delivering excellent customer outcomes, and returns for investors. Initiatives include:
– continuing product developments;
– promoting market growth activities;
– reinvesting operating cash flows for building awareness and market access;
– upholding disciplined investment;
– reinvesting any efficiency, currency or tax gains into market growth activities; and
– progressing large long-term investment projects, like the construction of a new Chinese manufacturing facility and stronger IT platforms to advance health, digital and cyber security capabilities (Cochlear Ltd, 2018, p. 6).
“Cochlear invests more than $160 million each year in R&D and currently participates in over 100 collaborative research programs worldwide.” (Cochlear Ltd, 2018, p. 7).
About the Company Strategy:
Figure 3 sums up Cochlear’s chief business and mission is, i.e. what they set out to do.
Figure 3. Cochlear’s chief business. From 2018 Cochlear Limited Annual Report, by Cochlear Ltd, 2018 (https://www.cochlear.com/shared-library/downloads/global-downloads/about-cochlear/annual-report-fy-2018).
Cochlear wants to be the standard of care for people when it comes to hearing loss (Cochlear Ltd, 2018, p. 11).
Their strategy centres on:
– activities to build awareness of hearing loss and their products,
– efforts to improve access to hearing solutions,
– strengthening servicing capability to provide products, programs and services for patients, and
– being the industry technology leader by investing in R&D to improve hearing solutions (Cochlear Ltd, 2018, p. 11).
Figure 4 sets out what Cochlear are trying to do to fulfil and accomplish their mission.
Figure 4. What Cochlear is doing in terms of strategy to accomplish their mission. From E. M. Spurway, 2019.
Figure 5 shows what Cochlear’s strategic priorities are.
Figure 5. Cochlear’s strategic priorities. From 2018 Cochlear Limited Annual Report, by Cochlear Ltd, 2018 (https://www.cochlear.com/shared-library/downloads/global-downloads/about-cochlear/annual-report-fy-2018).
Retain market leadership
Cochlear is delivering market-leading products, generating strong sales revenues (Cochlear Ltd, 2018, pp. 12, 19). They recently delivered A$1,351.4 million overall, up by 9% in FY2017-18, including:
– 62% from cochlear implants;
– 26% from services, including sound processor upgrades and accessories; and
– 12% from acoustics, including bone conduction and acoustic implants (Cochlear Ltd, 2018, p. 19).
They are also striving for a world-class experience for customers, through reliable products and consistent customer engagement efforts (Cochlear Ltd, 2018, p. 14).
Grow the hearing implant market
Cochlear seeks to build market awareness, access, and hearing solutions based on clinical evidence (Cochlear Ltd, 2018, pp. 15-17). Figure 6 shows their target market segments.
Figure 6. Cochlear’s chosen market segments and targets. From 2018 Cochlear Limited Annual Report, by Cochlear Ltd, 2018 (https://www.cochlear.com/shared-library/downloads/global-downloads/about-cochlear/annual-report-fy-2018).
Deliver consistent revenue and earnings growth
Cochlear seeks to invest significantly in sales, marketing and R&D activities; reap and reinvest savings from operational efficiencies through their scale; and maintain a strong Balance Sheet and FCF with the aim of returning substantial dividends to investors (Cochlear Ltd, 2018, p. 18).
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