2023-12-20 16:46:13 ET
Summary
- Henry Schein, Inc.'s valuation multiple of 14 times earnings looks attractive, but its lack of organic growth justifies the non-demanding multiple.
- The company has made several acquisitions to boost its sales, including the recent acquisition of TriMed in the orthopedic market.
- Despite some disappointment in its performance, I remain constructive on the shares but I am waiting for a better entry point in the $60s.
In May, I believed that shares of Henry Schein, Inc. ( HSIC ) started to look appealing again. The company has seen less impressive growth in recent years, as a valuation multiple compression to just 14 times earnings (with leverage being low) looked quite attractive, providing fundamental support combined with the practice of pursuing tuck-in deals.
That multiple looked cheap, but execution in relation to its positioning (of its end markets) has been lagging, perhaps due to self-inflicted tissues or its positioning to distribution channels. It is the lack of organic growth which explained and "justified" the non-demanding multiple. Continued stagnation and a move higher in its net debt load means that I am only willing to commit in the sixties here.
About Henry Schein
Henry Schein is a business which houses a dental distribution business and animal product distribution business under a single roof, accompanied by human physician and alternative care as well.
The company serves many smaller practitioners, in fact over a million of them, and this sheer number creates great diversification, with long-term drivers including growth of the global middle class.
For the year 2022 , the company posted sales of $12.6 billion, meaning a relatively modest 25% revenue growth in about seven years' time, meaning just GDP-like growth, despite the positioning of the business, and practice of bolt-on dealmaking. The dental business was responsible for $7.5 billion in sales, equal to about 60% of total revenues, with medical goods responsible for a third of sales, complemented by the smaller technology and value-added segment.
The company reported adjusted operating profits of $912 million, for margins equal to 7% of sales, with adjusted earnings topping $5 per share, in fact coming in at $5.38 per share. This translated into a 14-times earnings multiple at $75 per share.
This multiple was low, but the 2023 outlook was uninspiring. Full year sales were seen up 1-3%, yet adjusted earnings were seen largely flattish between $5.25 and $5.42 per share, due to profits headwinds from less PPE and Covid-19 units anticipated to be sold. Net debt of $929 million was roughly equal to the reported adjusted EBITDA number, providing significant room for share buybacks and bolt-on dealmaking.
The latter is exactly what the company did. In May, the company acquired Brazilian-based S.I.N. implant system, a dental implants business set to add $61 million in annual revenues, adding about half a percent in total sales. The company furthermore acquired Australian and New Zealand active Regional Health Care Group, in a deal adding $42 million in annual sales.
A 7% earnings yield and long-term positioning towards long-term growth trends (even as the company has not fully lived up to its promise) meant that long-term appeal could be seen, but some better execution would be welcomed.
Stuck Here
Forwarding from May onwards, we have seen shares trade dead flat at $75 per share, although the shares have been trading in a $60-$80 range over the past half a year.
During the year, the company kept on pursuing bolt-on deals. The next one in line was the acquisition of a majority stake in Large Practice Sales early in August, in a deal adding $40 million in annual sales. A day later, the company acquired a majority interest in Shield Healthcare. That deal is set to add $180 million in sales, adding about 1.5% to pro forma sales. No purchase price has been announced, with the deal expected to be neutral to earnings per share.
That month, the company reported a 2% increase in second quarter sales to $3.1 billion, with acquisition being responsible for 3% growth, as adjusted earnings per share improved a penny to $1.31 per share, as the company affirmed the $5.18-$5.35 per share adjusted earnings guidance for the year (after lowering it in the first quarter).
In October, the company announced that it experienced a cybersecurity incident, without offering too many details at that point in time. In November, third quarter sales were reported up 3% to $3.1 billion, entirely driven by dealmaking efforts, with adjusted earnings of $1.32 per share coming in three cents ahead of last year. The company cut the higher end of the adjusted earnings guidance to $5.26 per share, but it did indicate that it expects to suffer a $0.55-$0.75 per share impact from interruptions due to the cybersecurity incident.
By now, net debt has inched up to $1.7 billion as a result of the combination of share buybacks and M&A activity, still quite manageable, but up meaningfully from a number below the billion dollar mark a year before.
In the final days of the year, Henry Schein announced its next deal as it acquired another majority interest in TriMed, in order to enter the upper- and lower-extremities specialty segment of the orthopedic market. Again, no financial details were announced, with the sales contribution pegged at $48 million per annum.
And Now?
Quite frankly, I am a little disappointed with Henry Schein here. Since May, the company has been seeing a modest decline in adjusted earnings per share, even as it geared more money towards buybacks, jacking up leverage ratios in the meantime, although this is still very manageable.
Continued bolt-on dealmaking will help to bolster the top line, but organic growth (certainly in an inflationary environment) is lackluster. Amidst all of this, I still see the value, but fear the impact of the underperformance of the business and execution versus its positioning of the underlying business.
Given all of this, I remain constructive on Henry Schein, Inc. shares, but require a better entry point in the $60s again before considering an allocation.
For further details see:
Henry Schein: Still Not Shining (Rating Downgrade)