Do you have a natural symmetrical smile? In fact only 25% of people don't have any misalignment of teeth, also known as malocclusion. This means the market for orthodontic treatment is very large, about 12 million people each year go for treatment across the major developed countries.
While the conventional treatment was a pair of metal braces, new technologies are bringing about more subtle treatments. Align Technology, Inc (NASDAQ:ALGN) is the leader in this fast-growing market, with its proprietary Invisalign product. With braces always being problematic, The Global Investor thinks this 21st century product can rapidly win market share and therefore offers huge growth.
Align Technology was started in 1997. To date, the Nasdaq company has treated over 9 million patients using its transparent and removable dental retainers which are hooked up to software record measurements and progress.
Growing the addressable market
At its 2020 Investor Day in November last year, management stated there is an incremental opportunity to grow, stating that nearly 75% of all annual orthodontic treatments could benefit from its Invisalign method. In short, that means Align's estimated addressable market has grown from a previously stated 300 million to 500 million people now.
Although Invisalign is relatively expensive, for many it's an appealing alternative to the conventional "train-tracks" option. In the biggest orthodontic market - teenagers – Invisalign is fast-growing, with the company having treated its two-millionth teen patient last year 2020.
The market is starting to recognize this growth opportunity. Align Technology is valued at about $45 billion, after growing nearly 30x in the last ten years. In the last year alone the stock has doubled as the benefits of its digital dentistry platform became more apparent thanks to Covid-19.
The business
Invisalign is sold to patients through almost 200,000 dentists and orthodontists who have been specially trained. The treatment starts with a trained practitioner sending their patient’s details and imagery to Align. With this information, Align makes a 3D ClinCheck’ treatment plan with its proprietary technology. Effectively this uses a simulation of how a patient's teeth will change during the course of their treatment and predicts when alterations need to be made to the retainers.
After the dentist approves this plan, Align uses the ClinCheck data to make several transparent retainers that can be swapped as the teeth move over the course of the treatment. In fact, Align, which was founded in Silicon Valley, is the world’s biggest producer of custom 3D printed materials.
"Moaty" growth
Thanks to Invisalign's success, Align's revenues have compounded at 24% annually over the last five years to $2.5 billion today. 80% of this comes from sales of clear aligners and the other 20% comes from Align's imaging systems.
Align Technology's technology has helped it become the best-known brand in the clear aligner segment. It's cutting-edge intellectual property has helped it secure gross margins of over 70% for each of the last five years and an operating margin over 20% for every period except last year, as it was hit in Q2 by pandemic-induced shutdowns. It has also expanded into over 100 countries.
In the group's 2020 10-K report the company stated it believes its intellectual property portfolio represents a substantial business advantage. As of December 31, 2020, Align had 553 active U.S. patents, 592 active foreign patents, and 648 pending global patent applications.
Along with its track record of very good treatments, the appealing characteristics of clear retainers and its very wide distribution network, these patents mean that Align’s margins are protected by strong barriers to entry, which Warren Buffett and Charlie Munger would call an economic moat.
The competition
Fast growth and high margins attract competition and patents don't last forever, so Align is facing growing competition from a range of companies from established players in the medical sector with practitioner relationships to direct-to-consumer businesses bypassing practitioners through a remote dentistry model.
However, Align is differentiated by promoting the professional and advanced nature of its Invisalign treatment which requires a doctor's prescription and an in-person physical examination of the patient’s dentition before treatment can begin. In terms of Michael Porter's competitive strategy Align is focusing on the higher end of the market, which protects it from competition by the lower-end direct-to-consumer competition. This differentiation and focus on the premium end of the market is a good sign, meaning the company is not trying to be all things to all people, a "stuck in the middle" strategy which ends up being nothing to nobody kind of strategy.
Investment
Align continues to spend money to develop and improve its products. It spent $175 million on research and development last year, which was about 7% of net sales, a level roughly in line with each of the past four years.
Its research and development spend is directed toward developing the technology innovations that it believes will deliver its next generation of products and platforms which it hopes will establish Invisalign as the gold standard in treating malocclusion. In terms of its imagery business it's aiming for its intraoral scanning platform to become the preferred scanning protocol for digital scans.
Align also spends big on marketing. These costs fall into its selling, general and administrative expenses, which come in at about half of revenues. Marketing spend goes on advertising, trade shows and other industry events. Marketing spend has increased in the last few years with advertising across TV, social and print media along with partnerships with professional sports teams and other influencers to promote the brand.
This R&D and marketing spend is always risky, as it's not always guaranteed to pay off. However, a medical technology business in a growth area does need to spend on R&D to stay ahead of the game and dental products don't tend to sell themselves through word of mouth, so advertising is important to build awareness.
The Global Investor is comfortable with this expenditure as the company has a strong cash position. As at 31 December 2020, cash and cash equivalents were $961 million, up more than 75% from year-end 2019. Currently the company does not pay a dividend as the group is still in its rapid growth phase, but it understands the importance of shareholder returns and has bought back $500 million of a May 2018 authorized $600 million share buyback program.
Risks: great expectations
One risk that must be pointed out is that the stock has had a high correlation with the Nasdaq over the last five years, making it vulnerable to changes in technology market sentiment.
Align's business model also depends on healthy consumer confidence as the product is on the premium side of its segment. However, dentistry is an essential service and Align has so far been resilient to the pandemic-driven recession. So the risk is, if consumer confidence falls or disposable income falls, do people trade down on their dentistry needs? The Global Investor thinks many people will opt for Align's superior products for aesthetic reasons alone, positioning the product well against any prolonged economic downturn.
While Align did beat Street consensus forecasts in Q4, with net revenues of $835 million versus expectations for the quarter penned at $791 million, the stock is priced fairly high at close to 50x forward earnings. The Global Investor believes earnings per share can go from $5.30 in 2020 to $12 by 2020 as the group ramps up sales overseas having recently served its two-millionth patient in the EMEA region.
Also, Align is switching to an increasingly digital workflow which has paid off during this ongoing health crisis. This also should position the group even more competitively in the long-term. As management stated recently:
From an Align standpoint, practices across every region are embracing digital treatment in new ways and more purposely than ever before
Valuation
Align’s stock currently trades at about 50x forecast earnings; more or less in line with US medical device peers Intuitive Surgical (ISRG) and Abiomed (ABMD). This valuation can be justified by both Align’s track record of high-growth and its growth opportunity in front of it. Its attractive margin and overseas expansion also gives The Global Investor confidence that this growth is reasonably priced.
