EUR 850.00 For Business Accounts Only

Morningstar | Launching Coverage of GN Store Nord With Narrow Moat, Negative Trend Ratings; Shares Expensive

We are initiating coverage of GN Store Nord, a Danish company offering hearing instruments and audio solutions, with a narrow moat and a negative trend rating. We believe the shares are currently trading at lofty levels, more than 30% above our DKK 250 per share fair value estimate, which implies 2018 adjusted P/E and EBITDA multiples of 25 times and 16 times, respectively.

We believe the hearing segment is a narrow-moat business, given the sticky audiologist/manufacturer relationship and technological sophistication of the hearing device. The hearing aid industry is an oligopoly controlled by five major players, but a competitive one, with the innovation pace rapid and the refresh cycle often only a few years. While GN has a portfolio of products somewhat comparable to its biggest rivals (Sonova and William Demant), the company lacks their brand recognition within the premium segment, along with their scale and end-market reach. The latest industry trends (for example, independents squeezed by larger retailers, more transparent pricing, and wholesalers' expansion into retail) don't favour GN's largely wholesale model, and thus we expect its competitive positioning will likely weaken over time, resulting in a negative moat trend for the firm.

On the positive side, the firm is committed to maintaining its title as the leader in the connectivity space. GN's audio business, while in our view a no-moat segment, has also been delivering strong results, mostly due to the proliferation of unified communication. However, we do not believe there are any real barriers keeping other UC players from entering GN's audio business.

We forecast GN Group to increase revenue at 7%-9% annually over the next five years, with GN Audio as the main near-term growth driver. We forecast a slight increase in the EBIT margin, as higher margins gained through more premium products in both businesses will be offset by countries with lower gross margin profiles like China and India.

A wholesale-focused model within the hearing business affords GN little room for error and exposes the company to the "stuck-in-the-middle" risk. This strategy is advantageous for gaining market share in the independents channel, the largest and the most price-insensitive distribution channel. However, we believe this market segment is in structural (albeit very gradual) decline, as specialised retailers such as Amplifon and big-box retailers like Costco continue to grow rapidly, often through aggressive pricing strategies. GN's larger peers (Sonova and William Demant) have adopted vertically integrated models, which also represent a threat to the independents' current dominance, particularly in Europe.

GN Audio is the group's main growth driver, but over the long term we doubt the current robust growth, fueled by the early UC adoption, is sustainable. UC penetration levels are still rather moderate, especially in small to midsize enterprises, which will afford the firm a few years of profitable growth. However, unlike in its hearing business, barriers to entry in UC are quite low. UC technology lacks the proprietary know-how of hearing aids and offers limited switching costs. Clients can easily switch between brands when purchasing headsets, and the field is exposed to new competition from larger hardware/software providers.