2023-03-22 09:51:09 ET
Summary
- ALGN has had significant revenue and profit growth over the last 5 years with low debt and strong cash reserves.
- However, an unstable history of financial growth and concerning forward guidance has caused us to give this stock a SELL rating.
- By using realistic forecasting, we have a wide range for ALGN's future, ranging from a 36% drop to a 60% increase.
Investment Thesis
Align Technology (ALGN) is a global medical device company that specializes in producing and distributing clear aligners as an alternative to traditional braces. Their recent success can be attributed to their commitment to innovation and strong relationships with dentists and orthodontists. Over the past 5 years, their revenue has grown at a CAGR of 13.69%, and their 5-year average EBITDA has been an impressive 23.8%. Despite this, their stock price has plummeted 55% from its all-time high of $729/share in September 2021, currently trading at $326/share. The decline is due to poor earnings and contracting margins, leading to justified investor caution. Management has done little to reassure investors as they have guided for further lower aligner cases and lower margins. As a result, we believe ALGN is a Sell and believe there is substantial potential for further declines.
Business Overview
Align Technology is a global medical device company that specializes in designing, manufacturing, and marketing Invisalign clear aligners, iTero intraoral scanners and services, and exocad computer-aided design and computer-aided manufacturing software for dental practitioners and laboratories. The company focuses on treating malocclusion, which affects 70% of the global population, with the belief that 90% of cases can be treated using their products. Despite this, Align has only treated 10% of this population.
As stated in their 10-K , Align generates revenue by selling their core product, Invisalign, to dentists, and licensing their software for dental laboratories and dentists. The company's two operating segments are Clear Aligners, which accounts for approximately 82% of their revenue, and Imaging Systems and CAD/CAM services, which represents the remaining 18%.
Align's solution provides an alternative to traditional wire braces that are less aesthetically pleasing and more difficult for patients to tolerate. However, to access their proprietary technology, dentists are required to purchase an iTero machine, which has an upfront cost upwards of $50,000 and a monthly leasing fee. In return, they gain access to clear aligner cases that they can sell to patients. With the clear aligner market expected to grow at an explosive 19.7% CAGR from $2.85 billion in 2021 to $10 billion in 2028 , Align Technology aims to maintain control of this future total addressable market ((TAM)).
Invisalign vs Traditional Wire Braces
To gain a better understanding of Align Technology, it is important to compare their core product, Invisalign or Clear Aligner Therapy ((CAT)), to traditional wire braces. CAT offers several advantages over traditional braces, making them a more aesthetically pleasing option due to their virtual invisibility. Additionally, the clear plastic material used in CAT is more comfortable and less likely to cause the pain, sores, and irritation commonly associated with wire braces. Patients can also conveniently remove the appliance for eating, brushing, and flossing, leading to fewer office visits and a decreased risk of cavities , an option not available with traditional braces. The benefits of CAT are numerous and significantly improve patients' quality of life.
Align Technology's Competitive Advantage
Align Technology's competitive advantage lies in its strong commitment to innovation and technological breakthroughs in the CAT industry. The company has invested heavily in R&D, resulting in proprietary materials like SmartTrack and the development of Invisalign clear aligners for younger children and teenagers. Additionally, their proprietary software system, Clincheck , has made treatment plans more accessible to orthodontists and general dentists, enabling them to create custom plans in real-time. This software system also contributes to the automation of the manufacturing process, reducing costs and speeding up production times. Align Technology has also created a strong brand identity, offering training and support programs to ensure its partners are well-equipped to offer Invisalign to their patients. By combining its innovative technology with deep ties to dentists, Align consistently executes reliable, effective, and affordable treatment options, providing a significant competitive advantage in the CAT industry.
Summarized Financial Statements
Compiled from financial information obtained from TIKR.com
Align Technology has shown remarkable revenue growth over the past five years with an impressive 13.69% CAGR. Additionally, the company has maintained an average EBITDA margin of 23.80%, demonstrating strong profitability. The company's low debt and significant cash reserves also reflect a strong financial position. However, when looking at the EV/EBITDA multiple, which is currently 45.87x based on the five-year average, it raises concerns about the company's valuation.
Despite the strong revenue growth and profitability, the company's performance has been unstable, particularly during the COVID-19 pandemic, where revenue growth was nonexistent, and FY22 has been negative. The EBITDA margins have also fluctuated significantly, ranging from 20% to 27%, making it challenging to forecast the company's future performance.
It is essential to consider the most recent earnings report to gain a better understanding of the current state of the company before forecasting their future.
Reviewing their 2022Q4 Earnings
Compiled from financial information obtained from TIKR.com
Align Technology reported its Q4 earnings for the year 2022 on 02/01/2023, and despite reporting disappointing results, the company's stock price rose 15%. However, we believe that this increase was not deserved.
When we analyze the Q4 results, we see a 12.57% YoY decrease in revenue and a shocking -42.5% YoY decline in operating income, with margins contracting by a breathtaking 730 basis points. Even worse was their guidance for the FY23 :
For full year 2023, assuming no additional material disruptions or circumstances beyond our control, we anticipate 2023 GAAP operating margin to be slightly above 16% and expect our 2023 non-GAAP operating margin to be slightly above 20%.
With this backdrop, for Q1 2023, we anticipate clear aligner volumes to be down sequentially primarily due to weakness in China from COVID, partially offset by some stability from our Americas and EMEA regions. We anticipate clear aligner ASPs to be up from Q4’22 primarily due to higher pricing and favorable foreign exchange rates. We anticipate iTero scanner and services revenue to be down sequentially as the business follows a more typical capital equipment cycle.
Management itself is predicting a decline in clear aligner volumes and iTero scanner and services revenue in the coming quarters, which is a cause for concern.
Risks and Catalysts
Despite being a sizable $25 billion company, Align Technology still has significant potential catalysts that could drive its growth. The most obvious one is expansion into new markets. While Align has achieved significant penetration in key markets, there are still many regions of the world where clear aligners are not widely available, providing an opportunity for the company to expand its geographic reach.
Another potential catalyst is the increasing demand for orthodontic treatment among adults and children. While Align's products are already popular among teenagers, there is still room for growth in the adult and children's markets. If Align can successfully tap into these markets, it could benefit from a significant increase in demand for its products.
Align can also continue to partner with dental professionals to drive adoption of its product. As the company builds stronger relationships with dentists and orthodontists, it could see an increase in referrals and recommendations, which would directly benefit its top-line growth. This growth could also help raise consumer awareness, leading to increased demand for Align's product through dental professionals or word-of-mouth recommendations from happy patients.
However, there are significant risks that could hinder ALGN's growth trajectory. Increased competition from existing competitors such as Byte, SmileDirectClub (NASDAQ: SDC ), and Henry Schein (NASDAQ: HSIC ) , as well as potential new entrants, could pose a challenge to ALGN's dominant market position, leading to slower growth or market share loss. Additionally, ALGN's growth is heavily dependent on the overall health of the economy. In the event of an economic downturn, consumers may be less willing to spend money on elective dental procedures such as orthodontics, which could have a significant impact on the company's top and bottom line.
Furthermore, ALGN is heavily reliant on their technological innovation, and any potential disruptions in their technological advances could have a negative impact on their growth. Finally, should Align's relationships with dental professionals deteriorate or become damaged, their growth could be negatively impacted. As we consider these risks and potential catalysts, coupled with their financial statements, we can create a bear, base, and bull case scenario for the company.
Base Case
Compiled from financial information obtained from TIKR.com
In our base case scenario, we can assume that Align Technology's revenue growth will continue to be healthy, with a CAGR of 10% over the next five years. However, we can also assume that the company's EBITDA margins may weaken slightly to 19%. This forecast assumes that the clear aligner market will continue to grow, and that Align Technology will be able to maintain its market position and capitalize on this growth. However, it also takes into account potential factors that could impact demand, such as economic downturns or increased competition.
Based on these assumptions, we may expect to see a slightly negative IRR of -0.31% over the next five years, which suggests that Align Technology may not be a buy at its current valuation.
Bear Case
Compiled from financial information obtained from TIKR.com
For our bear case scenario, we can assume that Align Technology's revenue growth will slow down significantly, with a CAGR of 7% over the next five years. Additionally, we can assume that the company's EBITDA margins may contract significantly, with an average of 17% over the same period. As a result, we may assume a lower EV/EBITDA multiple of 17x in this bearish scenario as investors will be unimpressed with this anemic growth.
Bull Case
Compiled from financial information obtained from TIKR.com
For our bull case scenario, we can assume that Align Technology will maintain its strong revenue growth, growing at a CAGR of 13% over the next five years. Additionally, we can assume that the company will maintain its robust EBITDA margins of 23%. With such strong financials, it would be reasonable to value Align Technology at a higher EV/EBITDA multiple of 25x. This forecast assumes that the clear aligner market will continue to grow at a strong rate, and that Align Technology will be able to capitalize on this growth effectively.
If these assumptions hold true, investors could expect to see significant upside at the current valuation, with potential returns of 60% and an attractive IRR of 9.90% over the next five years. However, it's important to note that such a bull case scenario is dependent on several factors, including market growth and Align Technology's ability to maintain its competitive position.
The Bottom Line
Align Technology is a company that has experienced impressive revenue growth and EBITDA growth over the past 5 years, and has maintained a healthy balance sheet with low debt and strong cash reserves. However, despite these positive financial indicators, the company's stock price has declined 55% from its all-time high and is currently trading at $326/share. This is due to bleak growth prospects and thinning margins, which have understandably made investors cautious.
While Align Technology has a significant competitive advantage, with a strong brand identity and deep ties to dentists, the company's performance has been unstable, to put it lightly. The most recent earnings announcement indicates that there will be a significant decline in revenues and EBITDA going forward. While there is potential for the company to surprise to the upside and reveal strong revenue growth and EBITDA, the risks of competitors creating pressure and potential economic downturn are causes for concern.
When considering all of these factors, we recommend a Sell rating for ALGN and advise investors to exercise caution prior to investing in Align Technology.
What are your thoughts on Align Technology? Where do you see this company going?
For further details see:
Align Technology: A Clear Risk For Investors