2023-03-06 07:07:15 ET
Summary
- Shares of Invisalign maker Align Technology have doubled off their November 2022 low, largely spurred on by a better-than-expected 4Q22 financial report.
- Although earnings and revenue were slightly above consensus, there was nothing in its outlook to suggest that growth will resume to the 22.6% top-line CAGR achieved last decade.
- Trading at over 40X FY23E EPS and a market cap that is approximately equal to the entire malocclusion market, the recent run up in Align’s stock merited a deeper dive.
- A full investment analysis follows in the paragraphs below.
Blessed are they who hold lively conversations with the helplessly mute, for they shall be called dentists . - Ann Landers
Today, we look at a ' best of breed ' medical device maker that has moved up nicely on positive earnings results. An analysis follows below.
Company Overview:
Align Technology, Inc. ( ALGN ) is a Tempe, Arizona based orthodontic device concern focused on the design, manufacture, and marketing of Invisalign clear aligners for the treatment of malocclusions (teeth misalignment), having treated 14.5 million patients since inception. The company also sells intraoral scanners, software, retainers, and teeth whitening products. Align was formed in 1997, received FDA clearance for Invisalign in 1998, and went public in 2001, raising net proceeds of $126.2 million at $13.00 a share. It joined the S&P 500 in 2017 and trades around $335.00 a share now, translating to a market cap of just under $26 billion.
February Company Presentation
Invisalign System
For those unfamiliar, Invisalign is an alternative to traditional metal braces. The process is as follows: a trained orthodontist takes a digital intraoral scan or polyvinyl-siloxane impression of a patient's mouth. From this and other data (e.g., x-rays) Align generates a treatment plan that once approved, results in the manufacture of a series of clear custom polymer removable aligners that are shipped to the orthodontist. The patient places the initial aligner on his or her teeth for a predetermined period - usually a week - and then proceeds to the next one. The number of aligners needed to straighten a patient's teeth is dependent upon the severity of the malocclusion. After the teeth have been properly aligned, the patient receives a clear polymer retainer to maintain teeth position.
February Company Presentation
Over 90% of patients receive an evaluation from an intraoral scanner - typically Align's iTero model - which is sold to the orthodontist (along with attendant software that can present the patient with an 'after' picture of his or her mouth post-treatment) by a sales force ~4,000 strong. The aligners are fabricated in one of three facilities (Mexico, China, or Poland), as are the scanners (China or one of two in Israel). On average, each case of Invisalign clear aligners shipped generates ~$1,150 of revenue for the company.
Malocclusion Market
With crooked teeth affecting approximately two-thirds of the world's population, the opportunity for aligning technology is vast, with ~21 million electing treatment by an orthodontist every year. Interestingly enough, metal braces are still the most popular option, although management estimates that ~19 million cases would be eligible for Invisalign. That said, as the pioneer in clear removable aligners, Align enjoys an ~11%-12% share of the global market, which (according to Data Bridge and Market Research Future) is currently ~$25 billion and is expected to grow at a ~7% CAGR to ~$40 billion by the end of the decade.
February Company Presentation
Operating Segments & Revenue Disaggregation
Management views its performance through two segments: Clear Aligners and Imaging Systems & Services.
Clear Aligners was responsible for FY22 gross profit of $2.23 billion (72.5% margin) on net revenue of $3.07 billion, down 10% and 5% (respectively) from $2.47 billion (76.2%) on net revenue of $3.25 billion in FY21.
Imaging Systems & Services accounted for FY22 gross profit of $405.6 million (61.3%) on net revenue of $662.1 million, down 12% and 6% (respectively) from $461.0 million (65.3%) on net revenue of $705.5 million in FY21.
There were three main culprits for the drop off at the top line. First, there was a 7% decline in Invisalign case shipments to 2.39 million. Second, there was a decrease in scanners sold and average selling price, which was partially offset by an increase in service revenue. Third, with ~45% of Align's revenue coming from outside the U.S., the top and bottom lines were impacted ~5% by currency headwinds. Furthermore, gross margins were hurt by increased manufacturing spend as its Invisalign plant in Poland ramped and by scanner manufacturing inefficiencies.
Stock Price Performance
With key domestic patent protection into 2017 (ex-U.S. 2018) and a sizable opportunity to exploit, Align's net revenue grew at a 22.6% CAGR from 2009 to 2019 to $2.41 billion. The market took notice, rallying the stock 1,466% from $17.82 at YE2009 to $279.09 at YE19 with a pre-pandemic high of $398.88 (2,138%) set in 2018. Understandably, that revenue growth spurt stunted to 2.7% in 2020 with the advent of the pandemic. However, with people returning to the dentist in 2021, the pent-up demand was substantial, and Align saw its top line surge 60% to $3.95 billion in FY21. After bottoming at $127.88 during the March 2020 pandemic selloff, shares of ALGN rocketed 475% to an all-time high of $735.17 in September 2021 - at which point they were trading at 65.5 times FY21 non-GAAP EPS of $11.22. Priced for perfection against a deteriorating macro backdrop that spawned serious forex headwinds, Align's stock cratered 77% to $172.05 a share on November 3, 2022, approximately a week after whiffing on 3Q22 earnings ($1.36 a share (non-GAAP) vs. expectations of $2.18; net revenue $890.3 million versus consensus of $952.6 million), guaranteeing that for the first time since 2006, its top line would move in reverse.
4Q22 Earnings & Outlook:
However, since that time, shares of ALGN have nearly doubled, buoyed by a better-than-expected 4Q22 financial report, released on February 1, 2023. The company posted non-GAAP earnings of $1.73 a share on net revenue of $901.5 million versus $2.83 a share (non-GAAP) on net revenue of $1.03 billion in 4Q21. Although, these metrics represented declines of 39% and 13% year-over-year (respectively), they solidly bested Street estimates of $1.53 a share on revenue $881.9 million. These results were against a backdrop where currency translations negatively impacted Align by $67.6 million year-over-year.
February Company Presentation
Furthermore, the company projected FY23 non-GAAP operating margin of 20%+ after registering 21.5% in FY22 (27.9% in FY21), suggesting that the 18.3% posted in 4Q22 was a bottom for that metric. That said, management indicated that 1Q23 would look similar to 4Q22 with slightly lower aligner volumes offset by price increases.
The market really liked the news, rallying shares of ALGN 27% to $359.88 in the subsequent trading session. The stock has given back a small part of that gain since.
Balance Sheet & Analyst Commentary:
Also bullish was Align's board authorizing another $1 billion share repurchase program when the current one, which bought $475 million of stock in FY22, runs out - likely in 2Q23. The company's balance sheet is in pristine condition, reflecting cash and marketable securities of $1 billion and no debt. Align does not pay a dividend.
Although leaning largely positive with two buy and six outperform ratings against one hold, the Street seemed to be caught a bit flat-footed by the 4Q22 report with four analysts raising price objectives to between $335 and $375, which does not represent significant upside from its current price. The one hold was a post-earnings upgrade from a sell by Nathan Rich at Goldman Sachs. On average, they expect Align to earn $8.01 a share (non-GAAP) on net revenue of $3.81 billion in FY23, followed by $9.74 a share (non-GAAP) on net revenue of $4.31 billion in FY24. To provide some context, the company earned $7.76 a share (non-GAAP) on net revenue of $3.73 billion in FY22 after producing $11.22 a share on net revenue of $3.95 billion in FY21.
Verdict:
If Street analysts are correct on their consensus FY24 view, with all the falling back and catching up through the pandemic, Align's top-line CAGR will have dropped from 22.6% (2009 to 2019) to 12.4% (2019 to 2024). That's solid growth but the question becomes: is it worthy of a market capitalization approximately equal to entire market opportunity? At the end of the day, it's the bottom line that matters and the company is trading at over 40 times FY23E EPS and just under 35 times FY24E EPS - not quite the 65.5 PE commanded at its all-time high, but back then it was growing much faster and interest rates were next to zero. As such, the recommendation is to avoid until valuations become more compelling (e.g., a 25 forward PE with no changes to the current outlook).
The truth is not always beautiful, nor beautiful words the truth . - Lao Tzu
For further details see:
Align Technology: Valuation Not 'Aligned' To Current Growth Prospects