SDC - SmileDirectClub: Maintaining Sell Rating

Summary

• Despite the recent cost-cutting plans, long-term business prospects remain weak.
• The company's financial metrics continue to deteriorate in an uncertain economic environment.
• Liquidity and solvency risks remain elevated.

Maintaining Rating

We initiated coverage of SmileDirectClub ( SDC ) on October 20, 2022, with a "Strong Sell" rating . We justified this rating based on poor financial results, economic headwinds, and financial risk. Our sentiment was accurate, as the stock has declined 60% since the time of the initial coverage. The stock has gained recent interest and momentum after the company reported cost-cutting plans . And as seen in the chart below, the company has gained 62.4% YTD and has seen recent price appreciation in recent weeks. Despite the recent news and change in momentum, we maintain our "Strong Sell" rating on the stock.

Cost-Cutting Plans

The company reported cost-cutting plans which the company estimates will save $120 to $140 million in 2023. The management aims to achieve this synergy through reductions in SG&A costs along with marketing expenses. Management already forecasts that in 2023, the company's CapEx will be in the range of $35 million to $45 million, which is roughly 25% lower than the CapEx range of 2022, which ranged from $50 million to $53 million. This initiative is similar to the company's move last year to "increase profitability" which included the suspension of operations in various locales (i.e., New Zealand, Netherlands, Austria, and Hong Kong) along with reduction in the workforce.

Bearish News

Though the market reacted positively to the news, in our view, the announcement of another cost-cutting plan by a once-growing company is another troubling sign for investors. From the press release in early 2022, the company confirmed 2021 FY revenue in the range of $630 million to $650 million. In this recent cost-cutting announcement, the company now forecasts a range of $470 million to $472 million for 2022 FY revenue guidance. Such contrast demonstrates that these cost-cutting efforts are a natural response to the fact that their top line has deteriorated remarkably in the past couple of years, and that is not a good news for investors. Overall, we are not optimistic with the company's turnaround story given the declining top line and measures to cut costs, which appear to be in a negative cycle.

Continued Cash Burn

Our thesis in October 2022 revolved around the company's troubling cash burn and the deterioration of the balance sheet. For FY 2022, the company preliminary forecasted a net loss between -$278 million to -$286 million with an Adjusted EBITDA range of -$135 million to -$137 million. For a company with a market capitalization around $200 million after the recent stock market bounce, the net loss is truly a large comparative to the size of the company. What's more, trouble is that the YE cash balance is between $118 million to $119 million. We are worried about potential liquidity risks due to the low cash balance and the comparatively illiquid economic circumstances as a result of higher interest rates and poor sentiment. As seen in the chart below, the company's cash balance continues to decline at a rapid pace, with no signs of slowing down. As economic conditions affect consumers even more, it is likely that SDC will see more financial difficulties.

Upside Risks

Upside risks continue to remain as the company has a high short float and could be a potential acquisition target. Compared to the last time of our writing, the short float has actually declined from 23.30% to now under 20%. In addition, we believe the likelihood of potential acquisition has declined since the last time of writing. Though it is impossible to predict M&A activity, we believe the current interest rate environment and expected slowdown in the economy negatively impact the chance of another company acquiring SmileDirectClub. However, we caution investors that there may be major upside risks unrelated to the fundamentals given the aforementioned situations.

Conclusion

We are maintaining our previous rating of "Strong Sell" for SmileDirectClub. Though the recent market bounce back and the news of cost-cutting measures have propelled the stock forward in the recent weeks, we see too many financial risks associated with the company. We will keep a watchful eye on next quarter's earnings and update readers based on the results and any signal from the management of other strategic movements and decisions.

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