The floodgates are opening for dentistry to resume in earnest, but the market may already be clued in
Although many dental practices and individual businesses in this area have struggled during the pandemic, this company has remained resilient throughout 2020.
After a dental office hiatus for many people, the industry is due for a boom as patients make up for lost time. Uniform Accounting helps reveal that this may already be priced into this company’s stock.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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Over the past year, people have taken advantage of a few benefits of social distancing. For example, we are sure many were not too sad to have an excuse not to go to the dentist’s office.
For many, the idea of having someone dig around in your mouth in the middle of a pandemic caused by an airborne virus isn’t appealing.
Following this assumption, it would make sense to believe any business directly exposed to dental practices would suffer.
One company suffering from this constricted demand is Align Technology (ALGN). The company is well known as the manufacturer of Invisalign and other innovative dental products.
Contrary to most predictions, the stock is up from around $300 before the pandemic to over $600 today.
However, this story would look quite confusing to investors who are viewing this company based on its as-reported metrics.
With only these metrics, returns dip amidst pandemic-related headwinds.
Specifically, as-reported return of assets (ROA) declined from 14% levels in 2019 to 7% in 2020. This translates to approximately a 50% decline in returns, putting the company below corporate averages.
However, when viewing the company through the lens of Uniform Accounting, investors can realize the true resiliency in profitability.
Even though Uniform ROA levels slightly faded from 35% in 2019 to 26% in 2020, these levels are still well above corporate averages during challenging times and 4x greater than as-reported metrics.
To understand what the market is expecting coming out of the pandemic, we can use our Embedded Expectations Framework.
Most investors determine stock valuations using a discounted cash flow (DCF) model, which takes assumptions about the future and produces the “intrinsic value” of the stock.
At Valens, we know models with garbage-in assumptions only come out as garbage. Therefore, we’ve turned the DCF model on its head with our Embedded Expectations Framework. Here, we use the current stock price to determine what returns the market expects.
In the chart below, the dark blue bars represent Align Technology’s historical corporate performance levels in terms of ROA. The light blue bars are Wall Street analysts’ expectations for the next two years. Finally, the white bars are the market’s expectations for how the company’s ROA will shift in the next five years.
Wall Street analysts are expecting Align Technology’s Uniform ROA to improve to 36% levels by 2022. They understand the firm’s resiliency through pressures in the dental industry.
With this forecasted growth, the market is pricing in Uniform ROA to make a huge leap up to 60% by 2025.
With current market expectations after the recent rally so high, it looks like the market may have gotten ahead of itself.
As a result, even if there is a surge of demand which translates into revenue as people return to the dentist office after the hiatus, investors may be banking a little too much on this trend.
SUMMARY and Align Technology’s Tearsheet
As the Uniform Accounting tearsheet for Align Technology, Inc. (ALGN:USA) highlights, the Uniform P/E trades at 68.0x, which is above the global corporate average of 25.2x and its own historical average of 52.5x.
High P/Es require high EPS growth to sustain them. That said, in the case of Align Technology, the company has recently shown a 14% Uniform EPS shrinkage.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Align Technology’s Wall Street analyst-driven forecast is a 57% and 26% EPS growth in 2021 and 2022, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Align Technology’s $606 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 38% annually over the next three years. What Wall Street analysts expect for Align Technology’s earnings growth is above what the current stock market valuation requires in 2021, but below its requirement in 2022.
Furthermore, the company’s earning power is 4x the long-run corporate average. Also, intrinsic credit risk is 40bps above the risk-free rate and cash flows and cash on hand are 4x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low dividend and credit risk.
To conclude, Align Technology’s Uniform earnings growth is above its peer averages, and is also trading above average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research