2023-08-04 16:14:39 ET
Summary
- Last week, Align released its earnings. While I have already updated the Overall Quality Score, I still want to analyze the earnings as well.
- The results were better than expected, in all segments and regions, but the prospects of improvement probably caused the big bounce.
- Align keeps innovating and that is necessary for a long-term investment.
- We look at some of the highlights of the conference call and point out some humorous quotes by President and CEO Joe Hogan.
Introduction
Last week, Align Technology ( ALGN ) announced its earnings. As you may have seen, the reaction to the earnings was very positive. When the market opened, the stock was up more than 20%.
Seeking Alpha
Align Technology is not a company that is discussed all that often. I understand that. Despite the name Technology, it's not a tech stock and teeth improvement is not the sexiest industry. When I picked the stock for my subscribers at a much lower price, the reaction was generally tepid. But I think Align is set for long-term results with its Invisalign and iTero products. This is a boring but qualitative compounder. This big market reaction came as a surprise to me.
The Numbers
Revenue was up just 3.1% year-over-year, to $1 billion, but that beats the estimates by $9.2M. On a currency-neutral basis, this would have been 5%. The Q2 Non-GAAP EPS of $2.22 beat by $0.18, which is really good, of course. But there was an impact of $0.15 from foreign currency headwinds.
For Q3, Align sees revenue between $990 million and $1.01 billion, up 12% year-over-year at the midpoint. For the full year 2023, it guides for revenue between $3.97 billion and $3.99 billion, up almost 7% above 2022. The consensus stood at $3.94 billion, so this is a small beat.
Crucial, and probably contributing to the big stock price jump, was the fact that Align's margins were good. For a long time already, since Align's most important patents expired in 2017, the bear case for Align has been that it has no moat and clear aligners would become a commodity product. Up to now, that has not happened at all. All of Align's competitors have struggled to stay afloat. Just look at the troubles at Smile Direct Club ( SDC ), which was seen as Align's most direct competitor for several years.
Revenue from Clear Aligners was up more than the volume. In numbers, Clear Aligner revenues came in at $832.7 million, up 5.4% sequentially and 4.3% year-over-year. The volume of Clear Aligners was 604.4 thousand cases, up 5.0% sequentially and 0.9% year-over-year. This shows Align's pricing power, originating from its market dominance. Gross margins for clear aligners came in at 72.4%, up 0.7% QoQ. That's really high, almost software-like. For systems and services, gross margins were 65.1%, up 3.5% QoQ. The overall gross margin was 71.2%.
The company guided for GAAP operating margins just above 17% and non-GAAP operating margins of 21%, a 1% improvement from the previous guidance.
Align's Moat
Often, consumers will ask for Invisalign braces or something in the same vein, not clear aligners . When a brand is named to indicate a category, that is called a moat, in my opinion. I wouldn't call it the strongest moat there is. Invisalign is not as strong a brand as, let's say, Coca-Cola, but the name Invisalign is an asset.
On top of that, scaling capacity is also important. This is what President and CEO Joe Hogan said about the Palate Expander, but it applies to the whole business:
Remember, with our business, just making it doesn't mean anything, you've got to scale this thing to millions.
I think this is another part of Align's moat. Mass production at a very individualized basis is not that simple but Algin has perfected this, especially by integrating this with iTero, its scanning system.
The Earnings Call
Management talked about the improvements it saw across all segments and regions. The turnaround is still early, but the better guidance reflects the optimism management has about the future.
In my articles when I picked Align as a Potential Multibagger, I pointed out that teens are a big growth opportunity for the company. Up to now, a big part of the growth for Align has come from adult cases. But the teen market is, of course, much bigger and Align is breaking into that market. It's still very early there. The teen market is expected to be as big as that for adults only in 2030 or later. It's one of the reasons why the CAGR of clear aligners in the next several years usually is estimated between 25% and 30%. This is one such projection.
Grand View Research
There are several long-term projections and the lowest I could find was 24%.
That's probably also why Align projects long-term growth of 20% to 30%. Management continues to target teens. President and CEO Hogan:
We continue to focus on gaining share from traditional metal braces through teen-specific sales and marketing programs and product features unique to the Invisalign system.
And:
To increase awareness and educate young adults, parents and teens about the benefits of Invisalign brand, we continue to invest in top media platforms such as TikTok, YouTube, Snapchat, Instagram across all markets as well as key social media influencers and brand ambassadors.
We shouldn't forget that there is also a smaller subscription and services element to Align, primarily with iTero , the company's imaging system.
iTero
(An iTero 3D intraoral device)
Revenue was down 1% year-over-year here but up 10% quarter-over-quarter to $169.5 million. The QoQ results show the real strength of this part of the business, as the YoY numbers are not really comparable. During the last year, Align started with the sales of pre-owned devices, which sell for a lower average price, of course.
The third source of revenue, next to Aligners and iTero, is called non-case revenues by Align. Revenue came in at $80 million, up 6.2% compared to Q1 and 18% year-over-year. Revenue here mainly comes from retainers and aligner-related consumables like cases and whitening and cleaning products.
Also included here is the DSP or Doctor Subscription Program, a subscription-based program doctors can offer for touch-up cases. These are minor tooth alignment cases that usually take just 5 to 10 aligners and less than six months.
This program was rolled out in the US and Canada in 2021. In Q2 2023, it was expanded to Spain and the Nordic countries and it will be launched in France and the UK before the end of the year. In the second quarter, Align shipped over 18,000 DSP cases in North America, up from 15,500 or 16% in Q1 '23 and more than double the case volume in Q2 2022. This makes Align very optimistic about the DSP program and its long-term growth potential.
Hogan also emphasized the continued innovation at Invisalign. Over the last year, there were several launches and he named a few.
ClinCheck live update for 3D controls, which allows doctors to generate modified Invisalign patient treatment plans in real-time. Two minutes of modifications versus two weeks, that's a huge improvement.
Invisalign Personal Plan, or IPP helps with workflows and treatment plans.
Invisalign Smile Architect helps general dentists integrate clear aligners into their general treatment plans, by combining tooth alignment and restorative planning in one platform.
Invisalign Virtual Care is a remote monitoring solution with artificial intelligence.
Cone Beam Computed Tomography or CBCT shows doctors the patient's roots as part of the digital treatment planning process.
Invisalign Outcome Simulator Pro is an improvement of Align's existing Invisalign Outcome Simulator, which shows patients the outcome of their treatment in 3D. Patients see their new smile much better.
Invisalign also launched its Palate Expander in Canada and promised more news on the Investor Day.
And these were just a few of the innovations. I wanted to highlight these, as Align must keep improving to remain the first choice for professionals and customers.
Hogan explained how the tougher economic times have a double impact. First, obviously, some consumers are tighter with their budgets. That creates the second effect. As orthodontists have fewer customers, they don't see the need to speed up their process. In other words, they don't digitize, also because the machines and software cost money. So they stick with the traditional braces. Clear aligners cost about 3.5 times as much when it comes to the original cost.
For orthodontists, Invisalign is interesting as they can have much more patients and make more money after all. But right now, because of the tougher times, these investments are sometimes delayed.
But I think in these kind of challenging economic times, it's just more difficult to move the orthodontic community over to the clear aligner piece because they're just used to the workflow of what we have with versus wires and brackets.
As a side note, I found this quote from Joe Hogan hilarious. On why the company now gave full-year guidance:
We just felt like... I mean we're going to give it to you... You're going to make it up. So we might give the best guess we have.
By the way, I think Hogan is wonderful. Just look at his answer to this question.
Could you just what goes into the thought process that now is the right time to have the Analyst Day. As you say markets are still pretty uncertain. There's still some volatility, visibility is not fully back. So kind of what goes into that decision?
Hogan:
We usually do this about every two years, Michael. It is a really sophisticated algorithm we use to figure that out, but it's about every two years. And we think it's just about time for that,
Dry humor, I like that a lot!
Investor Day
The company will have its Investor Day in September and that is an event I look forward to, as at the Investor Day event, the company will give insight into its long-term growth prospects.
Up to now, the company has always said it aims for 20% to 30% revenue growth. 2022 was a tough year, because of the comparables to 2021, in which revenue skyrocketed because so many people saw their smiles on Zoom screens for so many hours. The first half of this year was also tough because of a weaker economy, but it looks like the rebound will start in Q3.
Is this enough for management to confirm the long-term goals of 20% to 30% revenue growth? If they reconfirm, I can see the stock staying at these levels or maybe even experience another jump. If they lower that long-term guidance, the stock may be punished. I guess we'll have to see.
Valuation
Valuation will always remain a topic for discussion. With the changed macro circumstances, though, especially higher interest rates, valuations are much more critical now than in the last few years.
Of course, there are as many types of valuation as you want. I will select the ones that make the most sense to me for the stock and the growth phase the company is in.
Let's first look at some traditional metrics, the forward PE ratio, the price to free cash flow and the enterprise value to EBITDA.
As you can see, the stock has become more expensive this year, except when it comes to price to free cash flow. Free cash flow can be quite volatile, though. Investments, a cash acquisition, new headquarters and much more can cause lumpiness. And that's the case here.
The reason for the drop in FCF is the macroeconomic headwinds. Align will always be susceptible to those. But the previous quarter and this one as well showed signs of improvement already.
You also have to look at what sector the company is in. In this case, it's categorized under medical devices. If you look at the sector, you see that the premium companies in this sector also trade at a premium price. You can see that Align moved from last or next-to-last, to the most expensive stock.
The reason for the overall higher valuation of stocks in this sector is that investors know that medical devices can grow at above-market rates for a very long time, much longer than most other companies. Even if their patents expire, it's hard to get into the market. Again, I refer to SmileDirectClub in this context.
The long runway of the medical devices category also makes a DCF, a discounted cash flow model, not suitable. A DCF takes five or usually 10 years of higher growth and then a terminal rate comparable to the general economy. But for this category, 10 years is not enough. 15 or 20 years would often be closer to the truth, but it's impossible to forecast free cash flow in 2035 with any degree of certainty. So, it's just better not to do it at all, in my opinion.
Clear aligners are still in their early phase as well. They are expected to grow at a CAGR of anything between 22% to 31% for the next 6-9 years, depending on the source. Align has about 75% of this market. Even if it loses a bit of market share, the revenue growth will still be substantial. Management has also reiterated several times that it sees 20% to 30% long-term revenue growth and 20%+ operating margins. And as the company is very profitable, free cash flow and net income should follow.
Overall, any valuation method will show that Align is priced at a premium right now. That's also the main reason I didn't add to my position at this price. At the same time, I'm not a market timer, but a long-term investor. That's why I didn't sell my shares.
Conclusion
The big stock price jump was surprising but I think many investors recognized that Align had a turnaround quarter and the raised guidance only fortified that feeling.
At the current price, I'm not willing to add, as I already explained in my previous article, but I'm happy to hold my position.
Made by the author
In the meantime, keep growing!
For further details see:
Align Technology: The Bounce And Some Dry Humor From The CEO