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Dental Survey: Domestic Dental Demand Trends

By Jeff D. Johnson, O.D., CFA

Republished. Original Source: Baird Equity Research
March 16, 2020

We surveyed 137 dentists last Thursday afternoon/Friday morning regarding recent domestic dental demand trends and are already seeing moderating patient volumes (with a bigger impact in areas with bigger initial COVID-19 infection rates) and near-term dental equipment purchase expectations. We’re not surprised by any of that and frankly expect these headwinds to grow in coming weeks, with the real value (we hope) being that this survey can act as a baseline by which investors and our industry/channel contacts can monitor domestic dental demand over coming months.

We fielded our quarterly dental survey last Thursday afternoon/Friday morning and received 137 responses, primarily from GP dentists. Not surprisingly, we’re already seeing a fall-off across nearly everything we typically measure in these surveys. While we could slash near-term estimates/price targets across each of our covered dental names today in response to these findings and given what we’re hearing across the industry, there will be plenty of time to do that later (and make no mistake, we’ll have to do that in coming weeks…).

Instead, we hope this survey will simply act as a baseline by which we can better track and compare domestic dental demand over the next few weeks and months, as we started to ask last week for the first time in 15+ years of running these surveys questions about potential office closures, supply constraints, and many other factors we never before thought we’d have to consider.

To that end, several interesting findings from our survey:-Patient volumes – declined 0.4% across all domestic geographies in recent weeks, not too dissimilar from our December survey findings (-0.3%). But West Coast (Pacific region)respondents reported a 3.5% patient volume decline in recent weeks, and we suspect patient volumes across the country will begin to contract more notably in coming days/weeks.

Dentists are starting to see some supply constraints, mainly for masks (to a lesser extent gloves and infection control products), but as of Friday morning, it seemed few of our respondents expected to be closing their offices or even reducing staff hours in the face of the current COVID-19 crisis. To be clear, we believe even that Thursday/Friday feedback is likely already woefully outdated given how much the country started to shutdown over the weekend, but again, that’s why we hope to use these findings as a baseline to track any worsening of these trends over coming weeks.

Dental equipment purchase intent has also recently fallen, as has dentists’ sentiment regarding the 3-6 month outlook for their practices. Again, not a surprise, but something we’ll continue to monitor over coming weeks.

Bottom line, we expect our survey results to further soften and near-term estimates/price targets to fall across our covered dental (and broader medtech) names over coming weeks.For now, however, we believe the bigger value-add we can provide investors is in providing fundamental details like the survey results we review over the following pages.

Executive Overview:  Interesting times to say the least, and while we often stress to investors they should take our quarterly dental survey results with a grain of salt as these results typically come from 150-200 dentists (compared to just over 200,000 dentists actually practicing in the U.S. as of 2019), that’s probably truer today in these uncertain times.   That said, in this month’s survey, which we ran just last Thursday afternoon through Friday morning, we’re already seeing a fall-off in dental demand across most procedures (both low- and high-acuity procedures), as well as falling sentiment from dentists when it comes to the 3-6 month outlook for their businesses and their intentions when it comes to purchasing dental equipment over the balance of 2020.

We believe none of that should come as a surprise to investors today, however, as we’ve anecdotally heard from a number of medtech companies in recent weeks that demand for discretionary healthcare procedures such as dental visits, cataract surgeries, and hip/knee procedures fell in China by as much as 80-90% at the peak of that country’s COVID-19 driven shutdown in February, meaning we’ll need to be on the look-out for similar declines over coming weeks to months in those countries where COVID-19 mitigation strategies are just beginning to ramp.  While it’s admittedly hard for us to fathom such declines for U.S. dental demand over coming months, we also would not have believed just a week ago that our daily lives would have changed as much as they have in recent days.  As such, we’re not ruling out any level of near-term revenue (and earnings) declines for our dental and other covered medtech names and believe investors will have to begin worrying less about such near-term revenue and earnings declines and more about the timing and extent of a potential demand recovery in dental and risks of near/intermediate-term cashflow/debt coverage issues for these companies.

On this former point, we remind investors that during the Great Recession, dental demand fell faster and harder than overall U.S. GDP, with our past analysis suggesting that equal-weighted growth across a number of dental names (ALGN, HSIC, Nobel Biocare, PDCO, Sirona, STMN) slowed from the mid/upper-single-digits in the early to mid-2008 time period to negative mid-single-digits in early 2009.  Both dental and domestic GDP growth bottomed in 2Q-09, however, at which time dental industry growth also rebounded more than GDP growth through early 2010.

There are a number of caveats we believe investors need to keep in mind when it comes to this 2008-2010 analysis and present time, including the faster pace of global shutdown that seems to be happening in our current situation and the fact that consumables pricing was likely growing at close to 3% annually throughout the Great Recession vs. fairly flattish dental industry-wide pricing trends at present.  As such, and as alluded to above, we wouldn’t be surprised to see dental end market growth fall off even faster and to an even greater extent than it did back in the 2009.  Even so, we’d expect dental demand to rebound fairly quickly once these COVID-19 issues pass, but probably back to the low single-digit growth we’ve been experiencing across the industry in recent quarters, with timing of any such rebound also still a big unknown.

As for dental stock performances, we show below that dental stocks also fell off sooner and to a greater extent than both the S&P 500 and the broader medtech space back in 2007-2010, although all three groups of stocks seemed to bottom at nearly the same time (March 2009).  Dental stocks also then bounced off their respective bottom harder and faster than both the S&P 500 and the broader medtech space, at least in the first 12-18 months post the bottoming out process.

In the current environment, going back to just the start of 2020, we see that dental is thus far following a pattern similar to what it did during the Great Recession, falling harder and faster (thus far) than both the S&P 500 and broader Medtech since January 1.  But dental’s underperformance vs. both those groups lasted at least 12-15 months in the Great Recession and we’re not yet seeing any evidence of bottoming for dental stocks or the more diversified market or Medtech peers, making it hard to have high conviction that the group may not have to fall further and begin to show at least some evidence of bottoming before a sustainable bounce can be expected.

As for cash flow and potential debt coverage issues for our dental names, it’s hard for us to get too detailed with this type of analysis at present given a complete lack of visibility when it comes to how much company-specific revenue and earnings might rise (or fall) this year.  If, however, we assume none of our companies generate negative free cash flow this year (for PDCO, that assumes management continues to factor off receivables to support cashflow), then none of our companies look to be at particular risk of any type of cash crunch or liquidity issues in the near term.

To that end, we show below that each of our covered dental names have fairly low net debt to cap ratios, solid current ratios, and strong interest coverage ratios (even when using GAAP EBIT in the analyses below).  ALGN is the clear stand-out in this group, with nearly $900M in cash/equivalents and no debt on its books at the end of 2019, while PDCO is the one dental stock where cash flow and debt coverage metrics aren’t nearly as strong as they are for other dental names.  But with restructuring and other GAAP cash costs for PDCO expected to moderate over coming quarters and with the company’s balance sheet improving in recent quarters (cash/equivalents rose in the company’s last quarter, while long-term debt levels have fallen by more than $300M over the past couple years), we have a hard time believing even PDCO will find itself at risk of any real balance sheet/cash flow issues over the next few quarters.

Finally, when it comes to 2020 estimates and price targets for our dental stocks, we’re going to defer making any changes in these areas for now.  As we get a better feel over the next few weeks for how dental demand across the globe might look over the balance of 2020, we will make updates at that time. What we know for now is that there is likely fairly meaningful downside risk to our 2020 revenue and earnings estimates for each dental stock at present.  What we’re not sure of, however, is if “meaningful downside risk” means our estimates across the group need to move 5% lower, 10% lower, or 25%+ lower in the near term.  More importantly will be what type of recovery we might see across both the broader macro and dental demand in general later this year and into 2021.  At this point, we still feel fairly comfortable believing that dental demand in 2021 should at least rebound to what we originally were expecting in 2020 for most of our covered names, but whether we can build growth in 2021 off normalized 2020 demand or off depressed 2020 demand remains a topic of internal debate for us right now, and barring any conviction in this area, we’re not exactly sure how us taking a fairly blind stab at 2020 and 2021 revenue/earnings estimates for our dental names would be of any help to investors today.

Instead, we are focusing in this note on trying to provide investors a baseline of where domestic dental demand was trending late last week, right before more severe shutdowns across the U.S. began to emerge.  We also are committed to repeating many, if not all, of these survey questions on a more frequent basis (hopefully every two weeks or so) over the next few months to help investors understand how much worse dental demand might get in the near-term, as well as when we might ultimately hit a bottom, if not an emerging recovery, in domestic dental demand later this year.    That’s the real value-add we hope to provide readers in the near-term.

With that, we review our early March dental survey over the following pages and wish each of you best of luck and good health over coming weeks….

Spring 2020 General Dental Survey Results

Survey Profile

 Sample Size: 137 survey participants           

 Method:  Survey conducted via online survey tool on from March 12-13.

 Survey Sample Profile – By Practice Focus/Size:

  •   Practice Focus: 89% of respondents consider themselves general dentists and 11% are specialty dentists. In comparison, the ADA estimates roughly 80% of its members are generalists and 20% of its members are specialists, meaning our survey is biased towards general dentists. Given the generally slower growth we’ve been hearing about in general vs. specialty dental offices, we believe this means this bias could cause our survey to understate consolidated end market growth rates.
  • Practice Size: 56% of our respondents work in a single-doctor practice and 44% work in multi-doctor practices. This is generally in line with what the ADA estimates to be just over 60% of dentists operating as sole practitioners.
  • Practice Type/Ownership: ~85% of respondents work in a practice that has 1-3 offices owned by the dentist(s), with only ~5% of respondents working in non-dentist-owned corporate practices.  This ~6% of respondents working in corporate-backed settings is below the 8.8% of U.S. dentists affiliated with DSOs in 2017 per recent ADA reports (and what we assume was likely closer to 10% of U.S. dentists by 2019).  As such, and similar to our comments above regarding practice focus, we believe this bias towards smaller, privately owned vs. corporate-backed dental offices suggests our survey may not be perfectly representative of current dental end-market trends, with the largest potential risk for our survey then being that volume/procedural feedback may modestly underestimate true end market conditions as we know that in recent years (as DSOs have clearly been taking patient volume share away from private dental practices in recent years).

 

Survey Sample Profile – By Geography

  •  Geographic Distribution. Of the 137 dentists who responded to our survey, 42% were from the East Coast, 20% were from the West Coast/Mountain region, and 38% were from the Central states. Compared to BLS data, the most significant deviation was in the Middle Atlantic region, which was underrepresented in our survey

Dental Volumes/Consumables Trends

Q1. How would you characterize patient traffic flow through your office over the last 3-6 months as compared to the same period a year ago?

Results:  On average, respondents to our March survey reported a 0.4% contraction in patient volumes over the past 3-6 months compared to the same 3-6 month period a year ago.  This was 10bp softer vs. our December survey and 70bp softer than in our March survey last year (+0.3%), with this survey also representing the first time in nearly three years that we’ve seen volumes finish in negative territory for three consecutive surveys.

Our take:  On the surface, responses to this first question don’t look overly concerning in light of the COVID-19 concerns currently gripping the world.  As we discussed in the overview section of this report, however, it is apparent patient volumes have been more negatively impacted for east and west coast dentists in recent weeks where COVID19 concentration has been higher (see chart below).  While recent patient volume pressures are also more apparent in several of our survey questions that follow, we suspect patient volume trends in this and our other survey questions will soften further over coming weeks as this survey was fielded last Thursday and Friday morning, before we started to see a barrage of school, bar/restaurant, retail, and other closings across the U.S. announced Friday afternoon and over this past weekend.

Q2. On a scale of 1-10, with 1 being “the worst I’ve ever seen” and 10 being “great, have never been so busy,” how would you rate the patient traffic flow in your office over the last several months?

Results/Our take: The first real evidence in our survey of how different March has already been, at least relative to the past two years.  We’d expect this trendline to worsen over at least the next month or two, and will closely monitor for any type of stabilization, which we believe could be a buying signal for these stocks.  Our gut, however, is that by the time dental office/patient volume trends start to rebound, COVID-19 diagnoses and/or deaths across the globe will be further along on the curve of recovery and the broader market by that point will have already started to rebound.  As such, as much as we will be interested to see how our dental surveys play out over coming weeks and months, we believe even our timely surveys (and the dental visit trends they find) will likely be a lagging indicator of performance for our dental stocks.

Q3. On a scale of 1-10 and specific to coronavirus/COVID-19 and trends in your office over just the last couple weeks, to what extent have you been seeing the following? Please rate with: 1 = not at all and 10 = significantly.

 

Results/Our take: This question, and the next two, are new to our dental survey, so we don’t have historical context to which we can compare.  As such, we believe that while responses to this question suggest there’s already at least some level of heightened appointment cancellations and reduced willingness to purchase dental consumables/equipment, the real value (hopefully) in this question will be to see how these ratings and rankings change from this baseline survey vs. our next few surveys.   

Q4. On a scale of 1-10, what is the likelihood that you do any of the following over the next couple/few weeks due to coronavirus/COVID-19 concerns? Please rate with: 1 being very low likelihood and 10 being very high likelihood.

Results/Our take: Again, this and the question just prior and just after are new to our dental survey, so we don’t have historical context to which we can compare.  As such, we believe that while responses to this question suggest there’s already at least some likelihood dentists reduce their office hours or even close their offices over coming days/weeks in response to COVID-19 issues, the real value (hopefully) in this question will be to see how these ratings and rankings change from this baseline survey vs. our next few surveys.   

Q5. Have you been notified of any shortage of product availability in regard to infection control/hygiene products in recent weeks? If so, what kind of products?

Results/Our take: Again, this question and the prior two are new to our dental survey, so we don’t have historical context to which we can compare.  As such, we believe that while responses to this question suggest a number of dentists are already experiencing a shortfall across several important products (namely masks in this question that was open-ended), we believe it will be even more interesting to track how these product shortfalls might change from this baseline survey vs. our next few surveys.   

Q6. Over the PAST MONTH how would you characterize each of the following? Please rate with: 1 = Has become significantly worse, 4 = Has stayed about the same, 7 = Has become significantly better.

Results: We started asking these procedural-specific questions in 2010, so do not have results from the Great Recession era to which we can compare.  That said, it’s clear demand across nearly all types of dental procedures, both high- and low-acuity, has moderated quite a bit thus far in March, and as discussed earlier, we would expect these results to worsen over coming surveys as this survey was fielded last Thursday and Friday morning, before mass closings across the country were announced.

 

Q7. Considering both the current state of your business (patient volumes and practice revenues) and your expectations for the next 3-6 months (again, focusing on both patient volumes and practice revenues), please rate your sentiment for each. Please rate with 1 = awful, 10 = great, never been better.

Results/Baird Take:  Sentiment in this survey decreased significantly from the past survey and declined well below the average of our prior five surveys dating back over the past 12-18 months and also the 10 survey averages dating back over the last couple/few years. While we only have data for this question dating back to late 2012, we find it interesting that dentists are recognizing that demand in their “current environment” has softened relative to the past 1218 months but is still better than it was a in the early- to mid-2010s.  These same respondents, however, are also quite concerned about the 3-6 month outlook for their businesses, something we ultimately believe will likely prove well placed.

Dental Consumables – AMZN & General Purchasing Preferences

 

Q8. In the past 1-2 years, what percentage of your dental consumables/supplies did you purchase from each of the following sources? (columns should sum to 100%)?

 Q9. In the past month, what percentage of your dental consumables/supplies do you purchase from each of the following sources? (columns should sum to 100%)?

 Q10. In the next 1-2 years, what percentage of your dental consumables/supplies do you expect to purchase from each of the following sources? (columns should sum to 100%)?

Results/Our Take: While we’re more focused at present on COVID-19 issues and the broad fall-off in dental demand we expect in the U.S. and globally over coming weeks to months, we believe investors also need to continue monitoring some of the broader secular pressures currently facing the domestic dental market, including growing traction we’ve been seeing for discount and other alternate dental product dealers in recent quarters.  Once again in this survey, respondents seem to suggest that over the next 1-2 years, they expect to increasingly purchase more of their dental consumables products through alternate dealers, including not only AMZN (where our checks suggest traction remains fairly limited), but also others such as TDSC, SourceOne, Net32, etc. (where our checks suggest traction has been more consistently growing over the past 12-18 months).

Given these pressures, we believe it will be interesting to see how dental stocks recover over the next 6-12 months, or whenever the market ultimately finds a bottom and begins to rebound.  While it will obviously depend on how far and to what valuation levels each of these stocks fall, our sense is dental manufacturers such as ALGN, NVST, and even XRAY will likely offer greater multiple reflation opportunities than the dental dealers over time as secular pressures in dental, while not de minimis for dental manufacturers, is lower for these manufacturers relative to the value-add dealers.

 

Q11. What percent of your dental consumables purchases included/will include product from each of the following manufacturers? 

 

Results/Our Take:  Historically, we’ve assumed dental consumables market shares are fairly sticky and a few bp share shift that might be predicted one way or another by our surveys wouldn’t impact how we think about our various companies under coverage.  But with XRAY recently introducing its One DS consumables loyalty program in an effort to drive increased market share, we first added this question to our quarterly survey last December to get a baseline by which we can monitor future changes in survey answers.

While we therefore believe tracking these share shift expectations over the next 12-24 months will be more insightful than just looking at the results we found in our last two surveys, we find it interesting that over each of these two past surveys, respondents have not expected XRAY to gain consumables market share over the next two years, while NVST has been expected to gain consumables market share over the next couple years in each of our past two surveys, with NVST’s expected share gains expected to come largely at the expense of 3M.  If our survey is right on that, we’d consider that an incremental positive for NVST once COVID-19 related concerns across the industry and the broader market begin to moderate.

For XRAY, the lack of expected 1-2 year out share gains we’ve seen the first two times we’ve now asked this question in a survey isn’t necessarily a bad thing for the company, but these findings do feed into our concern that it could be hard for this stock to outperform the broader market over time if its consumables growth remains near flattish levels once the overall market rebound back to pre-COVID-19 levels over coming quarters (we estimate broader dental consumables market growth on a pre-COVID-19 basis was likely trending in the flat to +2% range).

Dental Equipment Spending Outlook

Q12. On a scale of 1-10 and given recent patient volume and practice revenue trends, what best describes your expectations for dental equipment spending over the next 6-12 months? Relative to the past 6-12 months, I expect equipment spending to be…

 

Q13. Regarding dental equipment, how much did you spend over the past 12 months and how much do you expect to spend over the next 12 months on dental equipment purchases? 

Results:  Question No. 12 above asks qualitatively about dental equipment spending plans over the next 6-12 months (“on a scale of 1-10, will you be spending more or less over the coming year”), while Question No. 13 is more quantitative in nature (“how much did you spend over the past year and how much do you plan on spending over the coming year?”).  On both fronts, but especially from a qualitative perspective, dental equipment spending expectations in this survey declined notably relative to recent surveys, most likely due to growing COVID-19 uncertainty.  As noted earlier, however, we believe it will be even more interesting to see where these spending expectations move over coming weeks to months as dental demand likely slows further due to COVID-19, with our gut being that both high-end and basic dental equipment demand falls off fairly significantly in coming weeks/months as new office expansion efforts slow (new office expansion is a key driver of basic equipment demand) and willingness to buy new technology for current offices also takes a hit as dentists look to preserve cash flow our limit financial outflows during a period of slower patient demand.

For perspective, we show below that over a five quarter period from calendar Q4-08 through Q4-09, HSIC reported an average y/y decline in North American dental equipment growth of ~9%, while PDCO’s North American dental equipment revenue fell an average 3.5% y/y during that same period.  As intimated throughout this survey, we believe the global shutdown due to COVID-19 is happening much faster than what we saw back in the Great Recession, meaning we wouldn’t be surprised if PDCO, HSIC and the dental equipment manufacturers ultimately report an even greater y/y decline in equipment-related revenue in the near-term.  The bigger question that we have, and are nowhere near prescient (or arrogant) enough to believe we can answer at this point, is how severe of a recession might the U.S. and/or world fall into due to these COVID-19 issues.  Knowing that the Great Recession produced roughly a five quarter period of mid- to upper-single-digit declines in North American dental equipment revenue for the dental dealers might be helpful context once we move beyond the immediacy of the current COVID-19 issues, but for now we’re not sure how helpful even that data point is.

Dental Equipment – Product-Specific Purchase Intent

Q14. For each of the following technologies, please indicate your likelihood of purchase over the next 12 months. Please Rate with: 1 = “Highly unlikely I purchase”; 10 = “Highly likely I purchase.”

 Q15. For each of the following technologies, please indicate your likelihood of purchase over the next 1-3 years. Please Rate with: 1 = “Highly unlikely I purchase”; 10 = “Highly likely I purchase.”

 Q16. For each of the following technologies, please indicate your likelihood of purchase over the next 3-5 years. Please Rate with: 1 = “Highly unlikely I purchase”; 10 = “Highly likely I purchase.”

Results:  We reworked our high-tech dental equipment questions recently and are now asking respondents to simply rate how likely it is they will purchase a certain piece of high tech equipment over three different time periods (next 12 months, next 1-3 years, and next 3-5 years).  With dentists likely only in the market to purchase a sizable piece of equipment once every few years (at best) and likely owning a specific piece of equipment for at least 6-8 years once purchased, we wouldn’t expect a high level of purchase intent across any of these technologies or time periods.  As such, we believe the relative rankings of each technology across the various timelines is more important than the absolute result of where each technology falls on the 1-10 scale we provided.

With that in mind, we’re not overly surprised that digital impression scanners represent the technology dentists seem most likely to purchase over the next year, the next 1-3 years, and the next 3-5 years, a recent trend we’ve seen in our surveys since we began asking this question.  At the same time, we’re also not surprised to see that purchase intent even for DI scanners over the next 12 months moderated vs. our last few surveys, something we believe likely reflects early impacts from COVID-19 demand slowing and something we wouldn’t be surprised to see soften further in future surveys.  What we believe will be more interesting to see over our next few surveys, however, will be if 1-3 and 3-5 year purchase intent for DI systems moderates.  We don’t suspect that it will unless the domestic economy moves into a protracted period of significant decline, but time will tell.  

 Q17. Regardless of whether or not you might purchase the technology anytime soon, please indicate below what DI system you’d be most likely to purchase in the future if you were in the market for such technology?

 

Results:  Up until the last year or two, we would have assumed that because our survey skews heavily to general practitioners (89% of the respondent base for this survey) and small practice docs (85%+ of respondents for this month’s survey work in smaller 1-3 office settings owned by a dentist), DI systems from XRAY and even 3Shape would likely outperform ALGN in this question as GP dentists have historically been more focused on restorative procedures such as crown and bridge work for which XRAY’s Omnicam and now Primescan, and 3Shape’s TRIOS, scanners are well known.  But we believe the higher interest for ALGN’s iTero DI scanner in each of the five surveys in which we asked this question points to the growing interest GP dentists also have in fitting clear aligners, most notably Invisalign.

We also believe ALGN’s recent announcement of its planned acquisition of exocad (restorative treatment planning software for both office- and lab-based work) and the pending domestic approval of the company’s Element 5D scanner (expected sometime in 1H-20) could drive even greater GP purchase intent for iTero scanners over coming quarters.

We also found it interesting that in this month’s survey the uptick in interest/purchase intent we saw for XRAY’s Primescan in our December survey moderated and actually fell to a five-survey low.  We’ll watch where that interest goes over time but have been discussing with investors that our checks and channel work suggest Primescan interest in the U.S. may have peaked in late 2019 with the Primescan upgrade programs HSIC and PDCO were offering into calendar year-end.  This survey result may be even further evidence supporting that point, but again we’ll want to see where this purchase intent moves over coming months if/when end-market demand begins to normalize in a postCOVID-19 world.

 Q18. Regardless of whether or not you might purchase the technology anytime soon, please indicate below what in-office CAD/CAM system you’d be most likely to purchase in the future if you were in the market for such technology?

Results:  While our survey work suggests somewhat limited interest over coming years in purchasing a full in-office CAD/CAM system, we’re not surprised to see that CEREC remains the most preferred system by a wide amount, with CEREC far and away enjoying the most dominant position within any of the technologies we asked specifically about in this survey (56% of respondents likely to purchase CEREC vs. a competing technology if they were to purchase CAD/CAM technology in the future).

Q19. Regardless of whether or not you might purchase the technology anytime soon, please indicate below what digital intraoral imaging system you’d be most likely to purchase in the future if you were in the market for such technology?

Q20. For digital impression scanners, please rank the importance of each of the following when considering the purchase of one system relative to another. Please rate with: 1 = Very Unimportant and 10 = Very Important.

Price Target Justification and Risks

ALGN. Our $325 price target continues to represent a 35x EBITDA multiple applied to our $890M EBITDA projection for 2021, discounting this number back by 25% to account for an expected return on this stock next year, and giving ALGN credit for ~ $15 in cash per share we expect them to have on the balance sheet one year from now. We’re building our valuation off 2021 instead of 2020 EBITDA as we believe 2021 EBITDA will be normalized vs. the depressed EBITDA expectations we have for ALGN in 2020 due to COVID-19 issues that are clearly impacting in China so far this year. Note we are also adding back stock comp into our 2021 EBITDA estimates when valuing this company even though management has decided to begin providing non-GAAP margin and earnings results beginning in 2020 that will exclude both non-recurring items and stock-based comp. We’re doing that, at least for now, as we’ve long valued this company including stock comp and believe our valuation shouldn’t be artificially inflated today simply as management is now choosing to exclude stock comp in how it communicates margins and earnings to the Street. As for the 35x EBITDA multiple we’re using to value this name, we believe such a multiple is warranted by the 25-30% EBITDA growth we expect for ALGN over the next few years, with this 35x EBITDA multiple largely in line with the average multiple at which this stock has traded in recent years. Risks to our Outperform rating on ALGN include: (1) highly competitive industry, (2) growing new market entrants in the comprehensive part of the market following treatment planning IP for ALGN that expired in late 2017, (3) risk of shifting consumer purchasing behavior for clear aligners as DTC providers such as SDC, Candid, and others continue to spend aggressively, (4) risk that shifting mix to lower acuity cases in DSOs and other offices and/or growing doctor retention costs continue to pressure ASPs and drive revenue/earnings growth below case shipment growth over the longer term, and (5) general macroeconomic risk, especially in the near-term from China, which is ALGN’s second largest market after the U.S. and where GDP growth has recently slowed to multi-year lows, and (6) risk that the coronavirus headwinds that are expected to impact ALGN significantly in 2020 may not resolve as quickly as we currently expect heading into 2021.

HSIC. Our $68 price target applies a multiple of just under 17.5x to our forward year NTM (2021) EPS projection of $3.92. While uncertainties around HSIC’s NA dental business and overall margin performance remain, medtech multiples also continue to rise, meaning that the 17.5x multiple we continue to use when valuing this name is now a slightly bigger 4-6 point discount (~20-25%) to the 22-24x valuation range at which HSIC’s broader medtech peers currently trade. With the greater secular uncertainties we believe HSIC is currently facing and the more limited margin expansion and EPS growth we expect from HSIC in the near/intermediate-term vs. medtech peers, we believe this discount vs. peers we’re using to value this stock remains warranted. Risks to our Neutral rating on HSIC include potential that dental end-market growth rebounds back toward historical 4-6% levels over time, HSIC’s medical business continues to grow well above the mid-single digits (closer to the upper-single-/low-double-digit range it did in 2015-2017), potential that planned restructuring efforts over coming quarters drive more than 5-10bp per year of annual OM% expansion, and potential that management considers a more aggressive recapitalization of its balance sheet with net debt-to-ebitda levels currently ~1x following the spin-off of the company’s animal health distribution business in early 2019.

NVST. Our $33 price target applies an 18x multiple to our 2021 EPS projection of $1.81. From an EBITDA perspective, this $33 price target assumes ~16.5x our 2020 EBITDA projection of $421M. Relative to smid-cap medtech peers that we estimate are currently trading at median NTM P/E and EV/ttm EBITDA multiples of ~26x and 19x, respectively, these 18x forward year NTM P/E and 16.5x NTM EBITDA multiples we’re using to value NVST represent discounts of ~15-30%. We believe such discounts for NVST vs. peers are currently appropriate given the ongoing secular growth challenges facing the broader dental market overall, as well as NVST’s own company-specific growth challenges near term. If, however, NVST is able to deliver the sequentially improving revenue and earnings growth we currently project into late 2020 and 2021, we believe the valuation gap at which NVST currently trades relative to these peers could narrow, while the size of the valuation discount we’re currently using to value NVST over the coming year could also moderate, suggesting potential upside for this stock even beyond our current $33 price target over the coming year. Risks to our Outperform rating include: 1) a slower macro environment in the U.S. or globally translates to weaker-thanexpected dental patient volumes, 2) increased secular headwinds from factors such as DSOs and payer reimbursement, 3) highly competitive markets, particularly in the clear aligner and dental implant categories that NVST is launching new products near term, 4) financial and integration risk associated with potential future M&A activity, and 5) any change in relationships with dental dealers as 50% of company-wide revenue is tied to products sold through dental distributors.

PDCO. Our $28 price target applies a 15.5x multiple to our forward-year NTM earnings projection. We believe this multiple is warranted given the company’s improved operating performance in recent quarters (three consecutive quarters of OM % expansion, narrowing of dental consumables market share losses) and increased confidence we have in management’s ability to execute to its near-term financial targets. Relative to PDCO’s historical trading range, this 15.5x multiple is below the 16.4x average NTM P/E multiple at which these shares have traded over the past five years, a discount that we believe is warranted by secular end market pressures in both of PDCO’s dental and animal health segments, as well as profitability metrics that remain below five-year average levels. This 15.5x multiple is also below the 17.5 multiple we’re currently using to value PDCO’s closest dental peer HSIC, although we remind investors that on an apples-to-apples basis, we’re really only using a multiple closer to 15.5x to value HSIC on a cash EPS basis (after adjusting for deal-related amortization that HSIC does not exclude when calculating its EPS the way PDCO and many other company’s current do). While we’ve historically argued for a multiple premium for HSIC vs. PDCO given HSIC’s stronger execution history and the faster growth HSIC has historically delivered relative to PDCO for much of the past decade, we believe PDCO is likely positioned to grow its dental business faster than HSIC over coming quarters given the PDS win for PDCO/loss for HSIC and as Primescan (and possibly Primemill) upgrade tailwinds should ultimately prove more impactful for PDCO vs. HSIC over coming quarters given PDCO’s bigger installed base of CEREC users and smaller overall dental equipment revenue base. Risks to our Neutral rating on PDCO include: (1) risk that company-specific dental and/or vet execution begins to improve sooner or to a greater extent than we currently expect, (2) risk that dental end markets strengthen and begin to grow faster than the 2-4% we’re currently assuming in our dental models over the next couple years, (3) risk that PDCO’s new management team can move the company into adjacencies or other areas of dental or vet that might carry greater growth and/or margin expansion opportunities over time, and (4) risk that PDCO’s struggles and recently depressed valuation attract either activist, strategic, or financial interest from outsiders.

XRAY. Our $57 price target applies a 19x multiple to our forward-year NTM EPS projection of $3.00. We believe this multiple is warranted as the median multiple at which XRAY’s midcap medtech peers currently trade has fallen recently to 21x vs. 23x a few weeks ago, and we continue to believe XRAY deserves a couple point discount to these peers given continued uncertainties regarding both the broader dental market’s secular outlook and XRAY’s competitive positioning across a number of product lines (implants, orthodontics, digital imaging, etc.). Risk to our Neutral rating on XRAY include potential that dental end market growth rebounds back toward historical 4-6% levels over time, that new products drive revenue growth above mid-single-digits near term, recent restructuring and headcount reduction efforts drive the company’s operating margin back into the upper teens/low 20% (vs. ~15.5% in 2018) sooner than we currently anticipate, and potential that management considers a more aggressive use of its balance sheet for share buybacks and/or acquisitions once restructuring-related expenditures fall away beyond 2019.

Appendix - Important Disclosures and Analyst Certification

Approved on 16 March 2020 20:44EDT/ Published on 17 March 2020 01:05EDT.

Covered Companies Mentioned
All stock prices below are the 3/16/2020 closing price.

Align Technology, Inc. (ALGN – $161.72 – Outperform)
DENTSPLY Sirona, Inc. (XRAY – $35.18 – Neutral)
Envista Holdings Corporation (NVST – $17.04 – Outperform)
Henry Schein, Inc. (HSIC – $51.65 – Neutral)
Patterson Companies, Inc. (PDCO – $18.84 – Neutral)
(See recent research reports for more information )

1 Robert W. Baird & Co. Incorporated makes a market in the securities of ALGN, HSIC, NVST, PDCO and XRAY.
10 Robert W. Baird & Co. Incorporated and/or its affiliates have been compensated by Henry Schein, Inc. and DENTSPLY Sirona, Inc. fornon-investment banking-securities related services in the past 12 months.
2 Robert W. Baird & Co. Incorporated and/or its affiliates managed or co-managed a public offering of securities of Envista Holdings Corporation in the past 12 months.
3 Robert W. Baird & Co. Incorporated and/or its affiliates have received investment banking compensation from Envista Holdings Corporation in the past 12 months.

Appendix – Important Disclosures and Analyst Certification

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