Shares of Align Technology (NASDAQ:ALGN) have fallen to historically low levels, sufficient of a reason to update a thesis which goes back all the way to spring 2019, when I concluded that Align was not putting a smile on investors’ faces yet, trading at levels at which shares still trade today, some three years later.
At the time, the company was seeing headwinds from slower revenue growth and margin pressure, and even as expectations have come down a lot, expectations were elevated. What happened in the three-year intermediate period has been a huge boom, as shares joined the rally in 2021 as well to levels around the $700 mark, now down three-quarters of their value again at $180 per share.
Founded in 1997 as a producer of teeth clear aligners, Align obtained FDA clearance for its Invisalign system a year later, after which the company quickly went public, starting a multi-year shareholder value creation run. For patients with mild misalignment of teeth, aligners might be less effective than braces, yet they are more comfortable, cheaper, while being invisible as positive attributes.
Through 2017, sales rose to nearly $1.5 billion, generated from the sale of about a million Invisalign cases at prices around $1,400 apiece. The company was solidly profitable, with GAAP earnings posted at $231 million, equal to less than $3 per share, as adjusted earnings came in at $4 per share.
After a strong first half of 2018, the company was on track to post adjusted earnings at $5 per share in 2018, with revenue growth slowing down to 20%, translating into a 40 times earnings multiple. That valuation was a bit too demanding in my eyes amidst slower growth in China, slower growth of its adoption in the US, and concerns about margin pressure while peers like SmileDirectClub (SDC) were doing well, at least at the time.
Boom – Bust
Fast forwarding between late 2019 and today, shares of Align have seen a huge boom, notably in the second half of 2020 and 2021 as the market was extrapolating operating momentum, putting up stocks including those of Align into stratospheric highs.
Forwarding to February 2021, the company announced very strong results for the year 2020. Despite the pandemic, the company squeezed out a 3% increase in full year sales to nearly $2.5 billion, as momentum was a lot stronger in the fourth quarter. Despite the modest growth, the company posted a fall in adjusted earnings from $5.97 to $5.25 per share, yet the run rate was far stronger already based on fourth quarter results as the company was a prime victim of the pandemic, hurting alignment volumes a lot during the initial outbreak period.
Following a solid first quarter, the company guided for 2021 sales at a midpoint of $3.8 billion, non-GAAP operating margins around 24%, and significant buybacks after holding a strong net cash position. In the end, it appeared (early in 2022) that revenues rose to levels as high as $3.95 billion. The company reported GAAP operating profits of $976 million, GAAP net earnings of $772 million, and earnings of $9.69 per share that year.
Non-GAAP earnings came in at $11.22 per share, albeit that the vast majority of this difference stems from excluding stock-based compensation expenses, making a $10 per share earnings run rate realistic. Net cash holdings of $1.3 billion were equivalent to another $16 per share, based on nearly 80 million shares outstanding.
With shares trading at $700 at their peak, it was needless to say that valuations were nosebleed high already more than 60 times earnings, even as operating margins came in around 20% already. This was driven by euphoria and strong growth, with sales growth seen at around 60%.
Against this backdrop, it became very difficult to maintain momentum, let alone grow sales, as comparables were getting awfully difficult. After posting a 9% increase in sales in the first quarter (on an annual basis), revenues fell 4% in the second quarter with margin pressure observed, in part the result of the strong dollar.
These effects were even more pronounced in the third quarter, a period in which sales were down 12% to $890 million, as GAAP operating profits fell a full 10 points to nearly 16% of sales. This results in earnings being down to $72 million, or $0.93 per share. With GAAP earnings so far trending at just over $4 per share so far this year, for a $5 per share realistic number, I am fearful to use adjusted earnings numbers as most of the reconciliation relates to stock-based compensation.
Net cash is down to $1.14 billion amidst continued share buybacks, with 78 million shares outstanding now working down to a $15 per share net cash position. With shares trading at $180 per share, an unleveraged business trades at $165 per share, for a realistic 33 times earnings multiple, giving the company a current $13 billion enterprise valuation.
Despite worsening results, shares have been underperforming more as the company has been upping the pace of share buybacks, including, by its executive Joe Hogan, a comforting sense. The economic sensitivity of the business reveals that this is not a pandemic play, as one knows, but this is really a luxury product, hence impacted by the economic conditions. A strong dollar, given as a reason for the shortfall, tells just part of the story as constant currency growth was negative as well and margins have taken a huge beating.
With a $13 billion valuation and sales trending at nearly $4 billion here, the company trades just over 3 times sales, which is a reasonable sales multiple for a medical device play, although this is not a pure medical device play, of course. Right now, current earnings multiples remain elevated at around 30 times earnings, yet it seems that fundamental support to come at levels not too far from here.
The bracing element seems to be gone, but it seems too early to smile and buy the shares.