Align Technology Stock: Not Aligned (NASDAQ:ALGN)

Modern dental drills and empty chair at the dentist

Simon Skafar

shares of align technology (NASDAQ:ALGN) have fallen to historically low levels, reason enough to update a thesis that dates back to spring 2019, when I concluded that Align wasn’t smiling not yet written in investors’ faces when trading at levels where stocks are still trading at some three years later.

At the time, the company was facing headwinds from slower top-line growth and margin pressures, and even when expectations have plummeted, expectations were high. What happened in the three-year gap was a huge boom, as shares continued to rally in 2021, climbing to levels around the $700 mark that have now lost three-quarters of their value at $180 a share.

Some perspective

Founded in 1997 as a manufacturer of clear aligners, Align received FDA approval for its Invisalign system a year later, prompting the company to quickly go public and embark on a multi-year shareholder value drive. Aligners may be less effective than braces for patients with mild misaligned teeth, but they are more comfortable, cheaper and, as positive features, are invisible.

By 2017, sales had grown to nearly $1.5 billion, generated from the sale of about a million Invisalign cases priced at around $1,400 each. The company has been solidly profitable, with GAAP earnings of $231 million, which translates to less than $3 per share, while adjusted earnings were $4 per share.

After a strong first half of 2018, the company was on track to report 2018 adjusted earnings of $5 per share, with revenue growth slowing to 20% for an earnings multiple of 40. That valuation was a bit too demanding, in my view, given slower growth in China, slower adoption in the US, and concerns about pressure on margins while the competition likes it Smile Direct Club (SDC) did well, at least back then.

Boom – bust

Between late 2019 and now, Align’s stock has experienced a tremendous boom, particularly in the second half of 2020 and 2021 as the market extrapolated operating momentum and took stocks, including Align’s, to stratospheric highs.

In February 2021, the company announced very strong 2020 results. Despite the pandemic, the company was able to squeeze out a 3% increase in full-year sales to nearly $2.5 billion as momentum was much stronger in the fourth quarter. Despite the modest growth, the company saw adjusted earnings fall from $5.97 to $5.25 per share, yet the run rate was already far stronger based on fourth-quarter results as the company was a major casualty of the pandemic and alignment volume meanwhile severely impacted the initial breakout time.

After a solid first quarter, the company forecast 2021 sales to average $3.8 billion. In the end (early 2022), it turned out that revenue grew to levels as high as $3.95 billion. The company reported GAAP operating income this year of $976 million, GAAP net income of $772 million and earnings per share of $9.69.

Non-GAAP earnings were $11.22 per share, although most of that difference is due to the exclusion of stock-based compensation expense, making a $10 per share earnings rate realistic. Net cash of $1.3 billion equated to an additional $16 per share based on nearly 80 million shares outstanding.

Needless to say, with shares trading at $700 at their peak, valuations were already more than 60 times earnings, even with operating margins already hovering around 20%. This was driven by euphoria and strong growth with sales growth of around 60%.

With that in mind, it became very difficult to maintain momentum, let alone grow sales, as it became terribly difficult to compare. After a first-quarter revenue increase of 9% (annualized), second-quarter revenue declined 4% as margin pressure was seen, in part due to the strong dollar.

Those effects were even more pronounced in the third quarter, a period in which revenue declined 12% to $890 million, as GAAP operating income fell a full 10 points to nearly 16% of revenue. That drives earnings down to $72 million, or $0.93 per share. With GAAP earnings so far this year at just over $4 per share for a realistic figure of $5 per share, I’m afraid to use adjusted earnings numbers since most of the voting is stock-based compensation relates.

Net cash is down to $1.14 billion due to continued share repurchases, with 78 million shares outstanding now down to a net cash position of $15 per share. With shares trading at $180 per share, an unleveraged company is trading at $165 per share, a realistic 33x earnings multiple, giving the company a current company valuation of $13 billion .

What now?

Despite deteriorating results, shares have underperformed more as the company increased the pace of share buybacks, including some reassurance from its CEO, Joe Hogan. The economic sensibility of the deal shows that as we know, this is not a pandemic game, but really a luxury product, therefore affected by economic conditions. A strong dollar cited as the reason for the shortfall only tells part of the story, as constant currency growth has also been negative and margins have taken a huge hit.

With a valuation of $13 billion and trending sales of nearly $4 billion, the company trades a little over triple sales, which is a reasonable sales multiple for a medical device, although of course this isn’t a pure medical device. For now, current earnings multiples remain elevated at around 30x earnings, but it appears that fundamental support is at levels not too far from here.

The supporting element seems gone, but it seems too early to smile and buy the stock.

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