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The market decided it didn’t initially like dental equipment maker Sirona Dental Systems’ (NASDAQ: SIRO)
third-quarter results, and subsequently marked the company down by more
than 5%. Investors may well have reacted negatively to the margin
declines in each of Sirona’s business segments, but that shouldn’t
detract you from its positive long-term prospects. In fact, here's why
now looks like a good time to pick up the stock.
Sirona generates growth
I’ve described Sirona as a "dental equipment maker," but this
shouldn’t make you think of it as a boring low-growth company. On the
contrary, it’s actually a proprietary technology company set to generate
long-term growth, primarily thanks to its revolutionary CEREC CAD/CAM
system. The system allows for same-day teeth restorations, and generates
significant cost savings for dentists. It also allows patients to be
treated more quickly, and with less intrusive procedures.
While the benefits of the system are obvious, the CEREC system’s
up-front costs can be prohibitive to emerging-market customers. Indeed,
it is noticeable that much of the strong growth in the third quarter
came from Sirona's U.S. and German operations. Constant currency revenue
growth was up 15.7% overall with U.S. growth cited as being up a
whopping 28.8%.
Furthermore, Sirona stated in its results presentation that
international sales were up 10% in constant currency, “led by an
exceptionally strong performance in Germany.” Going forward, it will be
challenged to continue generating growth in the U.S. and Germany, while
finding a way to increase penetration rates in other markets as well.
Sirona’s growth plans
Sirona’s plans to increase market penetration include its ‘CAD/CAM
for Everyone’ initiative. The latter involves trying to segment the
market by offering a range of products and solutions. In fact, Sirona
has 25 new products in its portfolio to sell through to customers.
Dentists can buy the solution best tailored to their needs, at a price
point that they find comfortable.
A big part of the plan involves training Sirona’s distribution partners, principallyPatterson Companies(NASDAQ: PDCO) and Henry Schein (NASDAQ: HSIC).
Patterson is Sirona’s exclusive distribution partner in the U.S., and it’s notably bullish on its prospects to generate growth by distributing high-tech products such as the CEREC system. Patterson
needs to focus on these areas, because its core equipment sales to
dentists have been slowing. Dentists remain cautious in their spending
habits.
Sirona’s chief European distributor, Henry Schein, has similar plans.
Low growth in its dental consumables sales is spurring it to focus on
selling Sirona’s systems in Europe. In summary, both distributors are a
large part of the ‘CAD\CAM for Everyone’ plan, and with their
distribution expertise, they should be able to sell the new products on
successfully.
Margins declining, product mix responsible
Unfortunately, gross margins declined in every one of Sirona’s segments.
Source: company accounts.
However, it’s not time to panic.
Firstly, CAD/CAM margins were down thanks to increased sales of the
new Omnicam camera system. Incidentally, you can learn about the
differences between Omnicam and Sirona’s older system, Bluecam, in a video linked here.
Omnicam’s ticket price is higher than
Bluecam, but its costs are, too. In its conference call, Sirona outlined
that while gross profits are similar for the two products, margins are
lower on Omnicam because of those higher costs. In other words, the
acceleration in Omnicam purchases is likely to create profit growth at
margins' expense. That's not a big deal as long as profits are still
growing strong.
Second, margins in imaging usually bounce around for Sirona, so the
decline this past quarter shouldn't be worrying. It owed to changes in
the product mix. Moreover, despite the decline in Sirona's treatment
center margins, they remain above its targeted figure of 40%.
And finally, potential investors need not worry too much about small
movements in margins with treatment centers and instruments sales,
because they only make up around 20% of gross profits at Sirona.
Source: company accounts.
Where next for Sirona Dental?
In conclusion, the margin declines at Sirona are really not a
big deal, and the company's long-term plans make good sense. Sirona’s
distributors are keen to push its new products, and with CAD/CAM
penetration rates in the low teens in the U.S. and low-single-digits
internationally, its long-term growth prospects look favorable. Sirona’s technology presents a rare way to get exposure to a secular growth trend in a stable industry like dentistry.
Sirona now trades at a relatively cheap valuation compared to where it has been over the last few years.
The market reaction looks overdone, and this could be a good
time to take a position. Analysts have low-teens growth penciled in for
the next few years, and the stock looks attractively priced for its
long-term prospects. In fact, I found Sirona compelling enough to buy some shares for myself.
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