Are There Investment Opportunities at Your 6-month Teeth Cleaning?

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For most Americans, going to the dentist is right up there with paying taxes as things we don’t particularly look forward to.  Of course, a healthy smile is a useful thing to have, whether you’re going to a job interview or a first date.  The recurring nature of the business and its increasing use of technology make it a fertile ground for investment opportunities.  While the supply distribution side of the business is dominated by only a couple of companies, like Patterson Companies (NASDAQ: PDCO) and Henry Schein, there is always room for an innovative competitor.  So, which companies are worth a look?

Preventing tooth decay around the world

Dentsply International (NASDAQ: XRAY) has one of the largest product portfolios and geographic footprints, with operations in 120 countries as of December 2012.  The company makes thousands of consumable dental products for teeth cleaning and cosmetic dental procedures, including sealants, whiteners, and alloy fillings.  Dentsply also moved into the specialty arena in a big way with its 2011 purchase of implant specialist Astra Tech for $1.8 billion.  While the purchase saddled the company with over $1 billion in debt, it positioned Dentsply for growth as people in developing nations spend higher amounts of their disposable income on preventive care.

In its latest fiscal year, Dentsply reported solid financial results, with increases in revenues and adjusted operating income of 15.4% and 21.1%, respectively, versus the prior year.  The company’s top-line growth was enhanced by a full year of results from its acquisition of Astra Tech, as well as volume gains in its consumables segment.  However, Dentsply's operating margin continues to remain somewhat depressed due to the rising costs of manufacturing and delivering thousands of products to locations around the globe.

Getting into the back-office

Looking ahead, Dentsply is trying to offset margin erosion by increasing its sales of higher-margin technology products, like imaging equipment.  That strategic focus puts Dentsply into more direct competition with Patterson Companies, a competitor and a customer due to its roughly 33% share of the domestic dental supply market.  Patterson has used its position as a leading distributor of a diverse portfolio of dental products to increase its sales of company-branded dental equipment, which account for roughly one quarter of its total sales.

In its latest fiscal year, Patterson’s dental segment reported mixed results, with a 4% increase in sales and flat income growth compared to the prior year.  While the company’s top-line growth benefited from increases in purchases from the country’s dental offices, its operating margin was negatively impacted by continued investment in the development of its technology offerings.  Patterson’s Eaglesoft technology has an installed base of 25,000 users, out of a potential domestic market of 186,000 dentists, and is one of the company’s focus points as it tries to find higher sales growth in the dental back-office.

The rise of the upstart

Of course, both dental supply powerhouses should have probably noticed consumers’ dissatisfaction with traditional teeth alignment products, a trend that has propelled Align Technology (NASDAQ: ALGN) to a strong five-year stock price gain and a multi-billion dollar valuation.  The company’s Invisalign system uses clear plastic removable aligners, rather than metal braces, to treat malocclusion, a teeth misalignment condition that afflicts roughly half of the population in developed countries.  Since receiving marketing approval from the FDA in 1998, Invisalign has been used by 2 million people in 45 countries, with a current dental practitioner base of roughly 34,000 around the world.

In its latest fiscal year, Align reported mixed results with a 16.7% increase in total sales, but a decline in operating income due to a goodwill write-off in its scanner business unit.  The company’s top-line benefited from a 17% increase in volume, but its profitability suffered as more consumers opted for limited, less expensive treatments.  However, Align continued to generate substantial operating cash flow, $134 million for the period, allowing it to reinvest in new products, including its Smarttrack next generation aligners that conform better to the teeth.  In addition, the company has put the weak comparable results of last year’s third and fourth quarters behind it, recently reporting a 13% increase in volume for FY2013 and a continued expansion into international markets, with a focus on the Asia-Pacific region.

The bottom line

The dental business is going high-tech, with metal-less braces and equipment that allows practitioners to get more accurate and timely information on the health of their customers.  While U.S. spending on dental services is likely to plod along at a low upward trajectory, international spending on dental services should rise as more people ascribe greater value to oral care.  With a focus on international growth, Dentsply International and Align Technology are the ones to watch.

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Robert Hanley owns shares of Align Technology. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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