Align Technology: Take The Long View
2022.10.11 13:10
- ALGN has been the worst stock in the S&P 500 so far this year
- Declining earnings suggest the sell-off is logical — and may have further to go
- The business is in better shape than the numbers suggest, making ALGN a long-term buy
So far in 2022, dental supplier Align Technology (NASDAQ:) is the worst-performing stock in the index. Looking at the company’s fundamentals, the decline in ALGN stock seems completely logical.
Source: Investing.com
Through the first six months of 2022, Align’s sales have grown less than 2% year-over-year. Its adjusted gross margin has compressed 340 basis points. Adjusted operating income has declined 18%; combined with a higher tax rate, non-GAAP earnings per share has plunged 25%.
In that context, there seems a strong case for ALGN stock to keep falling. Shares still trade at about 24x full-year 2022 EPS, based on Wall Street consensus. Macroeconomic risks are rising. If Align is struggling now, it’s fair to wonder if performance will get worse before it gets better.
But it’s worth taking a step back to view Align’s 2022 performance in a multi-year context. What becomes instantly clear is that while ALGN’s numbers are down from 2021, they’re still up nicely from pre-pandemic levels. Believing that 2021 was a ‘normal’ year is what led ALGN to touch $700 last year; a similar error may be contributing to the plunge back to $200 this year. With valuation coming in, the sell-off at this point is starting to look like an opportunity.
2022 Vs. 2019
The novel coronavirus pandemic upended results for most publicly traded companies, and Align Technology is no exception. In 2020, the company’s revenue increased just 2% year-over-year, as the pandemic shut down dentist offices and kept some patients away even once those offices reopened. In 2021, as normalcy began to return, demand flooded back: sales increased 60% and adjusted EPS more than doubled.
It certainly looks as if the performance last year is driving the seeming weakness in Align’s business this year. Because looking at Align on a multi-year basis, the company’s long, impressive history of growth is, in fact, continuing. Here’s how the first half of 2022 compares with the same period three years earlier:
- Revenue up 69%, or a compound annualized growth rate of 19%
- Gross margins down 60 basis points to 71.9%
- Operating margins down 125 bps to a still-strong 19.9% (2019 calculations here exclude one-time effects, though stock-based compensation is included for both periods)
- Earnings per share up 29%, or about 9% annualized
Both revenue growth and gross margins show that competitive worries haven’t yet materialized. SmileDirectClub (NASDAQ:), as well as Envista Holdings (NYSE:), both have tried to undercut Align on pricing in the clear aligner market. Obviously, neither has succeeded.
Align has seen some pressure in terms of operating and net margins, but there’s a big reason why: the strong dollar. In the second quarter of 2022, operating margin took a 240 bps hit year-over-year solely due to foreign exchange. Below the operating line, Align took another $14.6 million hit from currency losses.
This is not a business that has suddenly ground to a halt. The pressure on earnings this year is coming from external factors. The huge spike in pandemic-delayed demand last year has created enormously difficult comparisons (which Align is starting to lap). Inflation and currency are hitting margins this year. But even in both contexts, multi-year performance is fine. Over a multi-year timeframe, this still is a company that, on a constant-currency basis, is growing revenue and earnings double digits each year.
Valuation And Risks
And for some time, investors were willing to pay dearly for ALGN because of precisely that growth profile. At the beginning of 2020, ALGN traded for $284, or more than 50x its 2019 earnings per share. As noted, this multiple now is down to 24x — and under 23x when considering the cash on the balance sheet.
To be sure, there are potential risks here. Continued dollar strength (which appears likely) can give a boost to rivals outside the U.S., where Align gets more than half its revenue. Commodity inflation is increasing input costs and pressuring margins. Macroeconomic pressure — globally as well as in the U.S. — could reduce demand, given that dental procedures have a greater out-of-pocket component than other healthcare specialties.
But this kind of market sell-off is one that usually creates opportunities for investors willing to take the long view. And from that long-term perspective, what is important is that these challenges for Align are to some degree transitory. Commodities already are normalizing. Align can adapt to the strong dollar. The macroeconomic cycle will rise and fall, as it always does.
Ignoring those factors, what remains is a business that’s still executing well and that’s still miles ahead of its competition. All that has changed is that multiple investors are willing to pay for the profits coming from that business. And that multiple hasn’t changed modestly: it’s been halved.
That simply seems like too much of a correction. ALGN probably will take patience and some tolerance for volatility, but looking out a few years this sell-off is a gift. When the market provides high-quality businesses at lower prices, investors should pounce.
Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.
