2023-05-10 10:00:29 ET
Summary
- Henry Schein has seen less impressive growth in recent years, as valuation multiples have compressed in response to this slower growth.
- Valuations have come down to about 14 times earnings, while leverage is low, which looks compelling.
- Tuck-in deals and the fundamental support should drive the investment thesis here.
It has been a long time since I last covered Henry Schein ( HSIC ) , in fact it was 2015 when I concluded that growth and margins came at a steep price. In the years that followed, the company has seen modest revenue growth, but as the company has been disciplined with share buybacks, reasonable growth on a per-share basis has been achieved.
A Recap
Back in 2015 Henry Schein was a diversified business which housed a dental distributor and distributor of animal products under a single roof, all while the company was active in human physician and alternate care as well.
The company serviced over a million practitioners, as this huge number and diversification across industries made the business extremely well diversified, set to benefit from the growth of the middle class across the globe.
The company generated about $10 billion in sales at the time, being quite diversified in terms of geographical regions. Dental was responsible for about half of sales, with animal health and medical segment combined making up the other sales, and animal health being slightly larger.
Shares of the company traded at $142 at the time, granting equity of the company a $12 billion valuation at the time. This valuation came down to about $55 in today's prices following a 2-for-1 stock split performed in 2017 and another partial split trading place in 2019 (1275-for-1000)
With net debt of $832 million being largely equal to reported EBITDA, valuations were not cheap. The company guided for earnings as high as $6 per share back in the day, meaning that shares traded at 23-24 times forward earnings, a steep multiple given the valuations at large at the time.
That said, the company has seen solid performance before, on the back of organic growth and bolt-on dealmaking, which has resulted in steady growth over time, something to be applauded. Nonetheless, I concluded that the premium valuation made me a bit cautious at the time.
A Bit Stuck
Trading at roughly $55, adjusted stock prices shares rose to just a $70 pre-pandemic. With exception to a quick move lower during the pandemic, shares have traded in a $65-$90 range ever since, now trading at $75. This marks nearly 40% capital gains, but this is over a period of some 8 years, working down to a compounded annual growth rate just around 4%.
Forwarding to the 2022 results it is obvious why returns are limited. Full year sales, which hovered around $10 billion in 2015, have risen to $12.6 billion, marking modest growth. The $7.5 billion dental business is now responsible for about 60% of sales, with medical goods responsible for about a third, now complemented by a smaller technology and value-added segment, responsible for about 5% of sales.
Adjusted operating profits rose to $912 million, for margins of around 7%, with adjusted earnings having improved to more than $5 per share. This shows that a cumulative 25% revenue growth over 8 years is not that impressive, but with shares stuck around $75 and earnings having improved to $5.38 per share on an adjusted basis (roughly corresponding to $12-$13 earnings per share pre splits) valuation multiples have compressed to 14 times earnings.
For the year 2023, the company sees flattish adjusted earnings per share between $5.25 and $5.42 per share on the back of 1-3% sales growth. This does not look too convincing, but note that the company expects real sales and profit headwinds from lower PPE and Covid-19 kits, with underlying growth seen at a solid pace.
Taking advantage of these relative modest valuations, the board announced a $400 million share buyback program in February, sufficient to reduce the share base by nearly 4% at prevailing share prices. There is enough room to do that as net debt of $929 million by the end of 2022 was largely equal to reported EBITDA. The 136 million shares value equity at $10.2 billion at $75 per share, for an $11.1 billion enterprise valuation. This is actually lower than 2015, mostly the result of continued buybacks which have reduced the float over time.
An Update
The company announced two bolt-on deals early in May. The first is the acquisition of Brazilian-based S.I.N. implant system, a manufacturer of dental implants. No purchase price has been announced, but the $61 million revenue contribution adds about half a percent to total sales of Henry Schein.
A few days later the company announced the purchase of Regional Health Care Group, a medical products distribution company with activities in Australia and New Zealand. This deal adds about $42 million in revenues, as again no further financial details have been announced, with both deals set to increase total sales by about a percent.
At this moment of writing shares are down 6% in response to the first quarter results, as released on the 9th of May. The company reported a 4% fall in first quarter sales, but this is due to lower PPE and Covid-19 test kits, with sales otherwise up 6% on the year before. This made that adjusted earnings fell twenty-three cents to $1.21 per share.
The company cut the full year guidance to $5.18-$5.35 per share, not due to the softer quarter (which was widely anticipated amidst tough Covid-19 comparables) as dilution of $0.05-$0.10 per share is seen from the Biotech Dental deal. Net debt was pretty stable around $950 million, of course ahead of the two bolt-on deals discussed briefly above, on which no purchase price has been announced.
Given these trends, I am cautiously upbeat here, mostly on the back of a 7% earnings yield. The long term positioning is good and current growth with exception to pandemic related revenue streams looks solid, but the reality is that Henry Schein has not really lived up to its positioning and expectations in recent years. That said, modest leverage, bolt-on dealmaking and the current earnings yield should drive long-term appeal here.
For further details see:
Henry Schein: Starting To Look Appealing Again