A High Tech Healthcare Stock Profiting from an Ageing Population

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Sirona Dental Systems (NASDAQ: SIRO) is a dental healthcare stock which is exposed to favorable demographic tailwinds and the expansion of the rollout of its global leading technology.  The evaluation and prospects look compelling and, there is upside potential to the stock price.

Sirona's Profit Drivers

Sirona has two key earnings drivers.

First, consider the ageing demographic. As people get older they require more teeth maintenance. Furthermore, as people tend to have more teeth decay as they are older, dentists can expect more restoration work. Ultimately, Sirona should see more demand for its products.  

Secondly, its proprietary technology currently has low market share and, provides dentists with many cost and quality advantages.

Whilst the demographic argument is well worn in healthcare plays, it should carry more weight with Sirona because of a relative lack of insurance reimbursement issues with dentistry products and solutions. Indeed, the industry is shifting towards private from public pay and, much of what Sirona does is aimed at the high end market.

The company is very well run and a global technology leader. Sirona spends around six to seven percent on research and development every year and is investing $15m in setting up a major new innovation centre in Bensheim, Germany. The balance sheet is solid, having seen the company engage in deleveraging the business over the last few years. Sirona is now in a position to make some acquisitions and, I would expect some activity on this front. Sirona has its origins as a spin off from German industrial giant Siemens (NYSE: SI)

Business Divisions

A breakdown of how Sirona generates its profits from the latest Q1 figures

<table> <tbody> <tr> <td> ($m)</td> <td> Revenue</td> <td> % Revenue</td> <td>Gross Profit </td> <td> % Gross Profit</td> </tr> <tr> <td> CAD/CAM</td> <td> 84.2</td> <td> <em>32.6</em></td> <td> 59.7</td> <td> <em>40.4</em></td> </tr> <tr> <td> Imaging Systems</td> <td> 94.4</td> <td> <em>36.6</em></td> <td> 54.1</td> <td> <em>36.6</em></td> </tr> <tr> <td> Treatment Centers</td> <td> 51.3</td> <td> <em>19.9</em></td> <td> 20.6</td> <td> <em>13.9</em></td> </tr> <tr> <td> Instruments</td> <td> 28</td> <td> <em>10.8</em></td> <td> 13.4</td> <td> <em>9.1</em></td> </tr> <tr> <td>Total </td> <td> 258.1</td> <td> </td> <td> 147.8</td> <td> </td> </tr> </tbody> </table>

Sirona is best known for its CAD/CAM system Cerec, which allows dentists to make a tooth restoration in a single client visit in 95% of cases. This is advantageous for the patient because he gets an immediate treatment as opposed to a seven to ten day wait, which involves the restoration being created and then fitted in a second visit. Among Sirona's distributors are companies like Patterson (NASDAQ: PDCO) and Henry Schein (NASDAQ: HSIC)  who have helped establish the Cerec system into low double digit penetration in developed markets. Although impressive, it does suggest that there is plenty of room for growth. It is a proprietary system which is backed up by patents and Sirona's research leadership. 

Clearly, many dentists will baulk at paying the sticker price of $100-120k for the system but it actually delivers an impressive return on investment. Sirona estimates that with 25 restorations a month, the cost savings of using the Cerec system should pay for itself within one year. Nevertheless, it is not hard to see that penetration has begun with the high end practices. For less active practices, Sirona has Cerec connect which gives dentists in option to tap into the Cerec technology but at a lower initial cost.  

Sirona Imaging Systems

Sirona are also a leader in Imaging Systems and, this division saw strong growth. However, there was some margin compression due to pricing pressure. The company is a constant innovator and investors should look - in the short term - for the new Ortho Plus XG 3D product to spur growth.  

Thinking longer term, Sirona has 40-45% penetration in this market place. Although, this level sounds high and therefore prohibitive to future growth, the 'penetration' actually refers to at least one sensor in the practice. Therefore, Sirona should have the opportunity to be able to sell more of them into this established base. Sirona intends to sell a few sensors into a given practice after establishing a presence.


Treatment Centers 

Sirona saw very impressive growth in constant currency and margins. Sirona's treatment centers are focused on the high end and have seen a resumption to growth as the economy recovers. Demand growth was stronger in Asia and Europe (Sirona is very strong in Germany) and I would expect this to continue as teeth surgery for cosmetic reasons is something that the wealthy can afford.

Sirona Stock Evaluation 

Sirona does a good job of converting income into cash flow and debt has fallen dramatically over the years. However, it is noticeable that working capital requirements (accounts receivables in particular) have risen to accommodate the growth in the quarter. This is likely due to the increase in new sales in Asia.

At the Q1 results, Sirona raised the bottom end of their full year guidance by $2m. Revenue growth of 6-9% is expected for 2012 with operating income growth (including amortization) expected to grow in single digits. Growth will slow in 2012, but this is mainly to do with tougher comparables coming from a new product cycle in the previous year.

Longer term, growth looks assured and I think investors should look beyond the short term and, see a business with plenty of upside. A forward PE of 20 (based on forecasts for $3.08 in EPS for 2012) would put Sirona at a price of $61 and, I think this is reasonable given that they typically translate over 100% net income into free cash flow.


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