Thursday, December 20, 2012

Sirona Dental Systems Stock Research

Sirona Dental Systems (NASDAQ: SIRO) delivered another set of results that got investors smiling. I’m a fan of this company and its long term prospects and am somewhat puzzled as to why it doesn’t get more media attention. Its long term growth drivers are an attractive mix of favorable demographics (more old people plus more teeth per person means more restorations) and secular growth from proprietary technological change with is CEREC CAD/CAM system which ensures same day restorations. Plenty more growth to come here.

Sirona’s Q4 Results

Investors can be forgiven for thinking that management is too cautious with guidance. Going into the start of its reporting year it had mentioned that it saw some weakness in its end markets. This caused constant currency revenue guidance to be indicated at 6-8% for the full year. This was then indicated towards the upper end of that range and then, as I wrote in an article in August, it was then raised to 8-10%. In the end it came in at 12.6%, so it seems things got progressively better as the year went on.

I have three observations to make on the surprise growth in Q4.

First, Q4 benefitted from the extension of its exclusive distributor relationship with Patterson Companies (NASDAQ: PDCO) in the US. I’ve discussed Patterson in an article linked here amidst noting how bullish it was about prospects for selling Sirona’s hardware.  Patterson gives earnings soon and they will be worth looking out for to see if it has managed to increase sales in its higher margin products.  My point is that it looks like there could have been some pull forward in revenues as non-Patterson clients might have accelerated orders in the quarter.

Incidentally, while Patterson handles the US, Henry Schein (NASDAQ: HSIC) is its main European distributor. The latter caused some concerns when it gave less than stellar results in its dental business recently but Sirona doesn’t seem to have been affected.

Second, none of this growth includes significant contributions from the new Omnicam or the intraoral sensor Schick 33. Hopefully the interest shown in the products will result in strong adoption and sales in the coming quarters. I get the sense that this could provide some upside to guidance.

Third, there is an interesting dichotomy here. Sales in the CAD/CAM segment for the year (up 13.9% in constant currency) were described as strong globally but particularly good in the US while the strongest growth for the year was reported in Treatment Centers (up 15.1% in constant currency) driven by non-European international markets and Germany.  Imaging Systems growth was less strong at 11.5% in constant currency but this is largely due to tough comparisons against strong growth in Germany the previous year.

Growth Prospects?

I want to develop some points from my third observation above.  I think the CEREC CAD/CAM system will see its strongest growth in developed markets and investors shouldn’t expect too much too soon internationally. The basis of the argument for a dentist to buy a CEREC is that -although the ticket price is $100-120k for a system- it should generate good return on investment provided X amount of restorations at a price of Y are made. However the ‘X’ and ‘Y’ numbers are highly likely to be much higher in the US/Germany than they are in other parts of the world. Investors shouldn’t assume equal rates of adoption.

However growth will surely come from an increase in penetration rates in the US where Patterson argued that the CEREC system only has 10% penetration in the US and this figure will be in low single digits worldwide for Sirona. In other words multi-year growth looks likely. I would have appreciated some more color in the commentary of growth via CEREC connect (a system that allows less active practices to tap into the system for a lower initial cost) because I think this will be a key driver in non-developed markets.

Imaging systems too look set for good growth. Sirona’s model involves selling an imaging system into a practice and then in time expanding sales of other sensors into the installed customer base. This year saw some tough comparisons with product launches (the XG-3D product) last year but going forward Sirona expects good growth.

As for Treatment Centers, investors should understand that revenues here are largely immune from reimbursement issues and tend to be tailored towards the high end patient. In other words, they are less economically and politically sensitive than most other parts of healthcare.

Putting these points together makes an interesting comparison with another company in the sector such as Align Technology (NASDAQ: ALGN) whose Invisalign braces are seen as largely offering a cosmetic benefit. Sirona’s benefits are tangible from a cost perspective and also involve a clear technological edge. Therefore I think its solutions offer the safest and most secular growth prospects in the industry. Its revenues are likely to be much less exposed to cyclical movements in discretionary spending than Align’s would.

Where Next For Sirona?

For 2013 Sirona is guiding towards 9-11% revenue growth in constant currency and 10-13% growth in non-GAAP adjusted EPS. All of which is fine but does leave the evaluation looking a bit stretched on a current EV/EBITDA of 14.2x. I’m a great believer that article writers should disclose positions and performance and I won’t hesitate to say that Sirona hit my price target before these results came out.

On that basis it is hard for me to argue that the stock looks cheap. I think it will have to carry on beating estimates to see a significant re-rating. Nevertheless it is a great company and investors will be well advised to keep it on the monitor list and watch developments closely. I know I will.

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