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Weekly Dental Survey - Inching Towards a (Deep) Bottom

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

Republished. Original Source: Baird Equity Research
April 6, 2020

In our fourth consecutive week of surveying dentists (n=100/fielded April 2), domestic patient volumes continued to fall (-77% y/y vs. -64% y/y in prior week) and respondents expect their offices to be closed ~5-6 more weeks. The number of closed offices across the U.S., however, may be starting to stabilize, and while we remain concerned about near-term dental fundamentals, dental stocks continue to underperform, to the point we’re starting to believe valuations across the group may be starting to look increasingly compelling for longer-term investors.

On April 2, we fielded our fourth consecutive weekly survey to the same group of U.S. dentists, with results from 100 of those dentists including:

  • Patient volumes have now contracted, on average, 76.7% y/y in recent weeks vs. -63.6% y/y in last week’s survey, with sizable week-to-week worsening of volumes in (in order) the Central, South Atlantic, New England, and Mountain regions.
  • 60% of respondents report their offices are closed to patient care. This is improved vs. 67% of offices that reported being closed last week, although that’s within the 10% margin of error in our survey.
  • Combined with the bigger y/y decline in patient volumes noted above and feedback in this survey that respondents expect their offices to remain closed for nearly six more weeks (vs. ~4.5 weeks in our prior survey), we believe investors shouldn’t over-read this office closure point.
  • On the dental equipment front, y/y spending expectations have now been fairly stable for three straight surveys, albeit at levels that suggest ~50% y/y declines in spending over the coming year.

With the incremental jump in patient volume declines this week, we remain cautious on dental fundamentals in the near-term (an obvious statement, we know). That said, valuations across the group continued to compress last week, with most of our covered dental stocks entering this week trading at multiples to 2021 earnings levels implied even by our pessimistic scenario analyses a couple weeks ago in the 8-13x range (closer to low 20x range for ALGN).

For investors willing to take a longer-term (2021 and beyond) view, we believe these valuations are beginning to look compelling, especially for those names either trading at the lowest end of this valuation range (NVST) or that we view as the highest-quality, lowest cashflow/balance sheet risk of the group (ALGN).

For ALGN, one of our two Outperform-rated dental names, we continue to believe clear aligner cases are only being deferred, not lost, which should hasten (and by 2021 potentially accentuate) the company’s growth rebound. ALGN also has one of the most attractive balance sheets and cash flow profiles across all of medtech, something we believe investors shouldn’t overlook in this environment.

For NVST, our other Outperform-rated dental stock, we continue to believe near-term debt covenant issues are overdone and that N1/Spark behind-the-scenes progress is still occurring, both of which we believe make NVST’s upper-single-digit 2021 P/E multiple look quite compelling.

April 2 Dental/COVID-19 Survey Results

Survey Profile

 
Sample Size: 100 survey participants                  
 
Method:  Survey conducted via online survey tool on April 2
 
Survey Sample Profile – By Practice Focus/Size:
 

  • Practice Focus: 90% of respondents consider themselves general dentists and 10% 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 slightly biased towards general dentists.
  • Practice Size: 55% of our respondents work in a single-doctor practice and 45% 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 ~8% of respondents working in non-dentist-owned corporate practices.  This ~8% of respondents working in corporate-backed settings is just 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 the end of 2019).   

Survey Sample Profile – By Geography

  • Geographic Distribution. Of the 100 dentists who responded to our survey, 38% were from the East Coast, 28% were from the West Coast/Mountain region, and 34% were from the Central states. Compared to BLS data, the most significant deviation was in the Middle Atlantic region, which was overrepresented in our survey.

Dental Volumes/Consumables Trends

Q1. How would you characterize patient traffic flow through your office over the last few weeks relative to the same period last year?

Results:  On average, respondents to our April 2 survey reported a 76.7% contraction in patient volumes over the past few weeks compared to the same period a year ago.  This was a sequential fall-off in patient volumes vs. our survey just one week prior (March 26 survey) that showed a 63.6% contraction in recent patient volumes and a sizable decline from our March 19 survey that suggested only a 4.3% decline in patient volumes.  As a reminder, however, our surveys on March 19 and prior never contemplated such big potential reductions in patient volumes, and as such we had never offered patient decline options in our surveys worse than -20% y/y.  As such, we believe even in our March 19 and March 12 surveys, patient volumes had likely already started contracting more than we found in those surveys.

Looking beyond that issue with our earlier surveys, we weren’t surprised to see overall patient declines worsen again in last week’s survey, as we had predicted in our March 26 survey that patient declines in areas such as the Central U.S., Mountain regions, and the South Atlantic would worsen over the coming week as additional shelter-in-place orders were just being put in place last week and certain Governors seemed to be learning last week for the first time that asymptomatic COVID-19 infected patients could still transmit the virus.  As of this week, however, with 41 states plus the District of Columbia, Puerto Rico, and a number of cities/counties in states without statewide orders now subject to shelter-in-place orders and these orders covering over 310M people in the U.S., we suspect any future worsening of patient volumes will likely prove fairly modest.  That’s especially true as we assume at least a small number of emergency dental procedures are still being performed by some offices when needed, as such we believe patient declines could bottom in the down 80-85% range, but are unlikely to worsen beyond such a level.

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: Similar to our past few surveys, responses to this question suggest that patient volume trends in December through February were fairly consistent with 2018 and 2019 trends across the U.S. but fell off dramatically in March.  Because our survey respondent base on April 2 was consistent with our March 12-13, March 19, and March 26 bases (same dentists surveyed in all periods), we also find it interesting (but not surprising) that in just one week’s time, respondents went from qualifying their March results on a scale of 1-10 from 5.67 (March 12-13 survey) to 3.71 (March 19 survey) to 2.51 (March 26 survey) and to now 2.04 in our most recent survey.  Again, this seems to provide further evidence of the rapid fall-off in dental patient volumes we’ve seen across the U.S. in recent weeks.

Q3. On a scale of 1-10, what have you seen in your practice over the last week or two with regards to the following? Please rate with:1 = significant decrease, 5 = no change, 10 = significant increase.

Results/Our take: This question, and the next two, are new to our dental survey over the past few weeks, so we only have four data points for historical context.  But even with just four weeks of data, it is clear that appointment cancellations have remained at fairly high levels after seeing a large increase a few weeks ago, and patient exam numbers have fallen over the past couple weeks, with purchasing trends for both dental consumables and equipment also softening over the past couple weeks.  If we really squint and are trying to find a positive out of this question and throughout our whole survey, it seems like equipment purchase plans over the balance of 2020 have begun to stabilize, with respondents still expecting to spend less on equipment this year vs. last, but the extent of the y/y spending decline on equipment now fairly stable over our past two surveys.  We found a similar response to Question No. 11 below.

Finally, while the consolidated average finding for “appointment bookings for future exams” fell again in our April 2 survey (to 3.5 from 4.0 and 4.1 in our prior two surveys), we will keep any eye on specific feedback for this question in future surveys as we believe an uptick for this point could be a leading indicator of recovery across the dental space.

Q4. In response to ongoing coronavirus/COVID-19 issues, which of the following, if any, have you done recently?

Results/Our take: We’ve now asked this question in each of our past four surveys, and while we saw an increasingly number of respondents plan to close their offices for a week or longer in our first three surveys, from 4% of respondents in our March 12 survey who expected to close their office for a week or longer, to 60% of respondents in our March 19 survey and 67% of respondents in our March 26 survey.  In this week’s survey, however, the percentage of respondents who have closed their office for a week or longer fell back to 60%.

Of course, with the margin of error in this survey of 100 dentists at 10%, the change from 67% of offices closed in our March 26 survey to 60% in this survey may simply reflect math and statistics.  Another explanation that we hadn’t thought of until reading through a recent survey from the ADA is that some dental offices may have initially closed to all patient care but have since re-opened for emergency dental care on an as needed basis.  In a survey of over 19,000 dentists that the ADA ran the week of March 23, 5% of respondents stated that their practices were open, but seeing fewer patients than normal, while 19% of respondents stated their offices were closed completely.  That left a full 76% of offices, however, closed, but still seeing patients on an emergency basis.  With that in mind, we believe there could be a bit of variation in how some dentists might be answering our survey each week, whether “closed” means completely closed to all patients, or “closed to all but emergency patients.”  We’ll try to tighten this question up and better delineate between those two options in future surveys.

To be clear, what we don’t yet believe this fall-off from 67% of offices closed in our March 26 survey to 60% of offices closed in our April 2 survey signals is a re-opening or recovery in office closures.  Admittedly, when reviewing the findings for this question on a region-by-region basis (see charts below) it does seem like that could be the case, but with shelter-in-place orders remaining in place or even growing across many of the regions shown below where office closures declined from our March 26 to April 2 survey, we don’t yet believe investors should consider these responses to be an encouraging data point for the broader dental industry.

Q5. If you have reduced your office hours but not closed your office completely in response to coronavirus/COVID-19 concerns, what is your best guess as to when you might resume normal office hours at your practice?

Q6. If you have recently closed your office completely in response to coronavirus/COVID-19 concerns, what is your best guess as to when you might re-open your office to patient care?

Q7. Regarding the timelines for the above two questions, on a scale of 1-10, what do you believe your overall visibility is when it comes to re-opening your office and/or normalizing your patient care hours? Please rate with: 1 = no visibility whatsoever, not at all confident on timing, 10 = high visibility, very confident on timing

Results/Our take: We just added these three questions to our March 26 survey, and while we doubt dentists have any better insight than the rest of us regarding when the world – and dental care – might return to normal, we also thought the “expected time” to office re-openings or office hour normalization that we are now tracking with this question could provide an early signal about potential for recovery in the dental end markets once that number starts to fall. In comparing our April 2 survey to our March 26 survey, however, it’s clear that dentists expect their offices to be closed for quite a while still, as the average time expected until normal business hours resume and until closed offices re-open expanded to 5.98 and 5.54 weeks, respectively, in this survey vs. 4.42 week and 4.52 weeks in our March 26 survey.  

Q8. 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, and is there any specific color you can provide?

Results/Our take: Again, we’ve now asked this question for four surveys in a row, and while we began to see a modest fall-off in the percentage of respondents seeing constraints for PPE in our March 26 survey, numbers seemed to be flat to slightly up in our April 2 survey.  As we discussed in our March 26 survey, however, we believe it is difficult to try and read too much into week-to-week changes for responses to this question as some respondents might not actually know if there are specific product shortages right now because their offices are currently closed, while other respondents may be feeling fewer shortages right now simply because they have recently reduced their office hours and as such are ordering fewer supplies.

Q9. 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: Though we did see a slight rebound in sentiment in our March 26 survey regarding the outlook for dentists’ businesses over the next 3-6 months and feedback in our April 2 survey remained closer to our March 26 rather than March 19 survey, we believe the slightly improved 3-6 month sentiment from respondents in our past two surveys could simply reflect a bit of reality setting in and less of the shock-and-awe dentists, and the whole world, was likely feeling in mid-March when COVID-19 closures were rapidly expanding.  What will be more interesting to look for, in our view, would be a sustained pick-up in both current and 3-6 month expectations for dentists regarding the outlook for their business, something we believe we could begin to see once COVID-19 cases and deaths across the U.S. potentially begin to plateau over the next couple (hopefully) to several weeks.

Dental Equipment Spending Outlook

Q10. 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...

Q11. 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?

Q12. Along the same lines but asking in percentage terms, how much more or less do you plan to spend on dental equipment over the next 12 months relative to what you spent over the past 12 months for each of the categories below?

Results:  Question No. 10 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 Questions No. 11-12 are 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?”).  For this question, respondents average spending expectation on a scale of 1-10 was 2.57 in this survey, translating to expected spending over the next year being somewhere between “modestly” and “much” lower.  This 2.57 average finding was a bit worse than last week’s 2.94 as spending inches closer to “much” lower rather than “modestly” lower, although findings for this question have averaged between 2 and 3 for three straight surveys now, suggesting to us that we’re starting to see at least some level of stability when it comes to dentists’ expected equipment spending outlook.

For Question No. 11, respondents expect to spend about $16,000 on dental equipment over the coming year, down ~$16,500 vs. average spending on equipment of $32,500 on a trailing twelve-month basis.  That $16,500 in lower spending on equipment over the coming year vs. the prior year is slightly less bad than the $19,000 in lower year/year spending on equipment we found in our March 26 survey but slightly worse than the $14,000 in lower expected spending we found in our March 19 survey.  Again, our view is that this modest variability in expected y/y change in equipment spending over our past three surveys likely suggests dentists’ viewpoint on this topic is starting to stabilize.

To be clear, however, this viewpoint seems to be stabilizing around a point that suggests spending on dental equipment is still likely to fall fairly meaningfully over the coming year, with dentists over the past few weeks essentially saying in surveys that on an absolute basis, they expect to spend over the coming year somewhere in the neighborhood of half of what they spent on dental equipment over the past year.  Ultimately we’d hope that dental equipment spending isn’t truly down 50% y/y for our dental manufacturers and dealers over the coming year, and when using the Great Recession as a proxy, we remind investors that spending on dental equipment seemed to fall closer to 5-10% on a y/y basis in 2009, with spending on basic equipment (chairs, cabinetry, etc.) down closer to 20% y/y and spending on high tech equipment (CAD/CAM systems, imaging units, etc.) down only slightly.  But with most dental offices likely closed across the U.S. and much of the globe for at least another month or two, we wouldn’t be surprised to see dental equipment sales across the industry fall by 80% or more in the near-term, with the bigger question likely being how quickly dentists might be willing to invest back in their practices in a post-COVID-19 world?  We don’t yet have an answer to that question, but believe the longer dental practices stay closed, the more likely some offices either never re-open or that meaningful damage to practice (and even dentists’ personal) balance sheets happens, something we believe could push out a recovery for the dental equipment market even longer.

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 05 April 2020 21:44EDT/ Published on 06 April 2020 01:05EDT.

Covered Companies Mentioned
All stock prices below are the 4/3/2020 closing price.

Align Technology, Inc. (ALGN – $154.20 – Outperform)
DENTSPLY Sirona, Inc. (XRAY – $35.45 – Neutral)
Envista Holdings Corporation (NVST – $12.98 – Outperform)
Henry Schein, Inc. (HSIC – $46.35 – Neutral)
Patterson Companies, Inc. (PDCO – $13.47 – 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. for non-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 HoldingsCorporation in the past 12 months.
3 Robert W. Baird & Co. Incorporated and/or its affiliates have received investment banking compensation from Envista HoldingsCorporation in the past 12 months.
Appendix – Important Disclosures and Analyst Certification
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