Friday, February 11, 2011

Sirona is an Attractive Healthcare Growth Stock

Sirona CAD/CAM Systems Give Single Visit Restorations

Sirona Dental Systems $SIRO is a dental healthcare stock which is exposed to favourable demographic tailwinds and the expansion of the rollout of its global leading technology. Sirona gave results recently and they were very well received by the market. However, the evaluation and prospects look compelling and, it looks like there is more to run. Analysts will be keen to upgrade estimates in their equity research reports


Growth Drivers for Sirona

Sirona looks set to benefit from an ageing demographic, because as people get older they require more teeth maintenance. Furthermore, the trend is towards people having more teeth as they are older, which means more restoration work and ultimately more demand for Sirona's products.

Whilst the demographic argument is well worn in healthcare plays, it should carry more weight with Sirona because of a relative lack of insurance reimbursement issues with dentistry products and solutions. Indeed, the industry is shifting towards private from public pay and much of what Sirona does is aimed at the high end market.

The company is very well run and a global technology leader. Sirona spends around six to seven percent on research and development every year and is investing $15m in setting up a major new innovation centre in Bensheim, Germany. The balance sheet is solid, having seen the company engage in deleveraging the business over the last few years. Sirona is now in a position to make some acquisitions and I would expect some activity on this front.


Sirona Business Divisions CAD/CAM

A graphical breakdown of Sirona's business divisions for Q1

Q1 2011Revenue% total RevGP% total GPGP Margin
CAD/CAM83.435.4%5942.2%70.7%
Imaging76.332.4%46.133.0%60.4%
Treatment Centres49.821.1%2215.7%44.2%
Instruments26.111.1%12.79.1%48.7%
Total235.6139.8
Source: Company Accounts, Earnings View

...and then looking at how margins and revenues have moved...

% constant currencyRev GrowthGP growthGP Margin growth (bp)
CAD/CAM18.518180
Imaging11.26.5-50
Treatment Centres2320.1290
Instruments8.43.2150
Source: Company Accounts, Earnings View

Sirona is best known for its CAD/CAM system Cerec, which allows dentists to make a tooth restoration in a single client visit in 95% of cases. This is advantageous for the patient because he gets an immediate treatment as opposed to a seven to ten day wait, which involves the restoration being created and then fitted in a second visit. Among Sirona's distributers are companies like Patterson and Henry Schein, who have helped establish the Cerec system into low double digit penetration in developed markets. Although impressive, it does suggest that there is plenty of room for growth. It is a proprietary system which is backed up by patents and Sirona's research leadership.

Clearly, many dentists will baulk at paying the sticker price of $100-120k for the system but it actually delivers an impressive return on investment. Sirona estimates that with 25 restorations a month, the cost savings of using the Cerec system should pay for itself within one year. Nevertheless, it is not hard to see that penetration has begun with the high end practices. For less active practices, Sirona has Cerec connect which gives dentists in option to tap into the Cerec technology but at a lower initial cost.

Looking at the results for CAD/CAM it is noticeable that International sales (up 23.3% in constant currency) far outpaced US sales (up .9%) and this is seen as being a result of a tougher US comparison. Sirona had record US sales growth in the comparable quarter last year. Margin expansion was good and came as a result of natural leveraging and a favorable shift in the sales mix.


Sirona Imaging Systems

Sirona are also a leader in Imaging Systems and, this division saw strong growth. However, there was some margin compression due to pricing pressure. This will be somewhat alleviated in the second half of the year when/if Sirona gets FDA approval to sell the new Ortho Plus XG 3D product. It may well be that dentists are holding off buying some of Sirona's other products while they wait for this to be approved.

Thinking longer term, Sirona has 40-45% penetration in this market place. Although, this sounds prohibitive to future growth, the 'penetration' refers to at least one sensor in the practice. Therefore, Sirona should have the opportunity to be able to sell more of them into this established base. Sirona intends to sell a few sensors into a given practice after establishing a presence.


Treatment Centres

Sirona saw very impressive growth in constant currency and margins. Sirona's treatment centres are focussed on the high end and have seen a resumption to growth as the economy recovers. Demand growth was stronger in Asia and Europe (Sirona has very strong in Germany) and I would expect this to continue as teeth surgery for cosmetic reasons is something that the wealthy can afford.


Sirona Stock Evaluation

Tabulating previous results for Sirona and some estimates assuming the current share price of $49.86 and a market cap of $2.76bn with an Enterprise Value of 2.86bn....

(m)200820092010Trail to Q12011E
Rev757713770791850
Gross Profit346346399417470
margin45.6%48.5%51.8%52.7%55.3%
Op Income6485128141158
margin8.4%11.9%16.6%17.8%18.6%
Net Income295390101124
Change WC-42-271-26-25
Op Cash Flow95120176158200
Free Cash Flow5999152130150
% revenue7.7%13.9%19.7%16.4%17.6%
FCF/EV2.0%3.4%5.2%4.5%5.2%
Source: Company Accounts, Earnings View

...demonstrates that Sirona does a very good job of converting income into cash flow and debt has fallen dramatically over the years. However, it is noticeable that working capital requirements (accounts receivables in particular) have risen to accommodate the growth in the quarter.

The full year results to Sep 2011 are expected to be front end loaded, but Sirona raised full year guidance to revenue growth of 9-10% (previously 7-9%) and operating income (excluding amortisation of $54m) of $208-216m which represents over 23% growth in operating income.

Current consensus EPS figures are for $2.88 to Sep 2011 but I think Sirona will report closer to $3.05 and I also think that the estimated free cash flow figure (above) is a bit light because they are spending $15m on a new innovation centre. The usual capex run rate is 3-4% so assuming 4% (34m) gives adj FCF=$166m. Assuming a 'fair' evaluation is a forward FCF/EV, of around 5% I think Sirona is better priced at closer to $58.

I bought some.