An interactive model allowing clients to use the “Trading Games” framework, looking at three key variables (Revenue, EBITDA, EV-EBITDA multiples) across multiple recession and recovery periods to provide perspective and a historical sanity check on estimates and valuation.
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Given the rapid shifts in the operating backdrop, and diverging valuations, we revise our models and PTs across Tools & Dental coverage; changing 6 ratings and 10 PTs. We also roll out a new stock selection framework, which will allow you to forecast returns using comparative cycles as far back as '01/'03 to benchmark Tools & Dental company revenue, margins, multiples, and ultimately, valuation.
ALGN is down -32% since 1/23, compared to the S&P 500 at -26%. We adopt a new modeling approach (see page 2) that implies ’09 volumes, depressed by near term practices closures, ‘20/’21 revenues fall 17%/16% below our prior estimates to 12% below consensus for ’20 and 14% below for ’21. Our model now implicitly assumes protracted practice closures and a deep recession. Within that backdrop, we anticipate 39% upside to our price target by E’20, on a multiple that assumes a premium relative to the S&P 500 that is based on a median of the ’14-’16 timeframe.
With NVST shares down 58% since 1/23 and 53% YTD vs our coverage down 32%/28%, the stock embeds fears over leverage covenants and confusion on how US/EU dental will evolve this year relative to China. Device investors note Zimmer Biomet (ZBH, not covered) at a recent conference indicated an 85%-90% decline in elective procedures through February in China and commentary from XRAY that APAC revenues are expected to be down 70% in 1Q; neither dynamic is translatable to US/EU Dental for 2Q unless you assume COVID dynamics last into late May and you assume Dental care is tied to hospital care, which is only true broadly (~70%) in China. Outside of China dental care is almost entirely performed in dental offices, we estimate roughly half the impact per-week seen in China.
Dental video brief 3.25.2020.
While consensus is stale, this is true broadly, Dentals on consensus are at 15+year lows vs the S&P and Healthcare. The moves have also flipped the historic premia that the manufacturers trade at to become discounts, with fears over NVST leverage elevated and XRAY calling for >50% declines in APAC in 1Q that some are extrapolating to Western markets for 2Q. These dynamics likely fade this year, the China/APAC experience is unlikely to repeat in the West, and our preference for the manufacturers is more acute. In the slides available at the link below, we walk through takeaways from our latest calls with dentists and corporates in the space, as all parties consider the implications of practice shutdowns (slides below have details at the country level) and the potential for an increase in unemployment.
Aside from Agilent, where expectations were set for the April quarter to see ~-9% pressure on APAC sales from COVID-19 (Agilent is the only co in the group with a Jan-April quarter), there is limited commentary on the impact anticipated for Tools co’s. In Dental, XRAY guided for ~-70% pressure on APAC. This report aims to synthesize updates from a range of other healthcare/testing co’s, to approach a base expectation for 1Q; our discussions with Tools co’s find a view that sales likely see 2-5% pressure relative to expects, and for equipment-heavy players, these numbers would be larger.
In the near-term, exposures to the following are concerning for non-therapeutic Healthco’s: discretionary healthcare (exposed to hospital resource reallocation), applied/industrial (see: cyclical end markets) APAC, and instruments. We attempt, with admittedly limited visibility and an appreciation that we are perhaps nearer to the beginning than the ending of a challenging period, to quantify exposures on these metrics and consider which companies’ consensus figures have adjusted to contemplate these exposures. Our effort is admittedly tactical in nature, and the extent to which structural changes emerge from the current COVID-19 challenges persist is an unknown.
One of the bigger challenges that ALGN faces is the comparatively slow shift of general dentistry to digitization, if you agree that the key next leg of growth in the US is low-friction aesthetic cases. While ~20% of US clinicians are digital via CADCAM/3D, this proportion moves slowly. Owning exocad gives ALGN a closer tie to clinicians that are in the intermediate digitization phase, leveraging software ties to labs for outsourced production. ALGN has a clear aligner solution for these clinicians, but marketing it should move faster with software ties that exocad should enable. This is a smart deal with returns measured in relationships that will take 2-3 years to become evident. While near-term ALGN share performance is COVID-19 dependent, this deal is a long-term positive.
With PDCO’s January quarter result confirming robust PrimeScan uptake and DSWorld timing supporting 4Q, the top line consensus beat driven by Tech/Equipment was expected. The result beat consensus by 2% and WRe by 1% top line, and contributed $0.01/$0.02 more to the bottom line vs. forecasts. More importantly, the underlying trend (Exhibit 3) from our bridge analysis shows a modest uptick in underlying performance at the total company level in 4Q on a CAGR basis, suggesting the trend is to 1-2% underlying into ’20, excluding the tailwinds from PrimeScan/Mill and SureSmile. All-in, we remain comfortable with the ’20 expectation (and now official in guidance) for 3-4% organic and >100bps of EBIT margin expansion.
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