Dental care has held up better than most analysts expected, and Dentsply's (XRAY) to decision to continue investing in the business during the worst of the downturn should put it in place to gain even more share. That said, the stock's relative outperformance has left it a little expensive when compared to the larger med-tech universe.
A Confusing Q4
Dentsply's financial press releases are never what you might call a vault of information, and this is a company where shareholders should definitely make a point of listening to the conference call or reading the transcript. That said, even with the supplementary information, this was a complicated quarter.
Reported revenue grew 30% with the inclusion of the AstraTech acquisition from AstraZeneca (AZN). Organic growth, though, was not growth at all but rather a 1% contraction. Reverse out the impact of Japanese supply disruptions (which are effectively a force majeure situation) and the organic growth jumps up to 4%.
Comparing Dentsply to its rivals just adds to the muddle. Danaher (DHR) saw better than 5% growth in its dental business for the similar period, while Henry Schein (HSIC) was up more than 4% and Sirona (SIRO) was up about 10%. That said, Dentsply's U.S. business was up better than 7% and that was better than anybody else's reported North American performance. Said differently, Dentsply is doing very well in North America, better than most in Europe, but not particularly well in other markets, like Japan.
Profits were a nightmare of charges and items. Cutting through the clutter, it's fair to say that gross margin improved by about one and a half points. Operating income was up in the mid-single-digits and margins were slightly disappointing.
Can 2012 Be A Year Of Solid Growth?
Although the dental business overall is not a hot growth market, Dentsply should reap the benefit of ongoing product development investments in 2012. New products in chairside consumables should drive some share away from 3M (MMM) and new products (plus the acquisition of AstraTech) could have Dentsply in place to grab some share from Biomet, Nobel Biocare, and Zimmer (ZMH) in implants.
2012 should also, hopefully, see the end of the major supply disruptions to its GAC orthodontic business. With the company's Japanese supplier located about 2 miles from the Fukushima reactor, supplies in many of its orthodonotic product categories has been severely limited and this has given a major boost to Danaher and 3M and perhaps Align Technology (ALGN) to a lesser extent.
Last and not least is the ongoing accretion and leverage potential of AstraTech. AstraTech significantly expands Dentsply's share in implants and in the European markets. Expanding into Europe in 2012 may not be the best move, but there are significant long-term synergies possible from bringing Astra's margins up to Dentsply's level and using Dentsply's unparalleled distribution capabilities to leverage Astra products.
The Bottom Line
Dentsply has a long-term record of solid returns on capital, conservative internal management, and good free cash flow conversion. I expect all of that to come back to the forefront over the next 18-24 months. At the bottom line, this is the leading franchise in a healthcare market (dental care) and one that continually reinvests in ongoing R&D (something not always true of at least some of its rivals).
Still, the stock is not a particular bargain today. Even with high single-digit free cash flow growth (consistent with the past decade), the stock is at best 10% undervalued today. Though I'd be happy to look at this name again after a pullback, there are too many cheaper names in recovering sectors of med-tech to reach for this one.
Disclosure: I am long MMM.