Hardly anyone looks forward to their next dental visit but as we paid a routine visit to our nearby dental clinic last week, we managed to spend the time while on the chair during the check up, to perform certain valuable industry channel checks. By channel checks we specifically mean that we had the opportunity to get an update on the industry, traffic (well up post-Covid) and on new products or innovations in the field. This one got the creative juices flowing as we decided to take a deeper dive into the world of dentistry and all things related to dental devices and dental distributors. This has been our first deeper dive since we passed on dentalcorp Holdings IPO last summer. Given the current market volatility, a refresher into this low beta industry was more than welcome, as was the diagnosis of zero cavities after the checkup (which of course, was covered by a private insurance policy).
dentalcorp Holdings (DNTL) is the Canadian leader in patient dental care. With over 500 dental practices Canada-wide (as of Q1/2022), the company has gown its dental practices at a CAGR of 32% since 2013 (50 locations). Now encompassing over 1,500 dentists and 1,800 dental hygienists, the corporate approach to growth has been multi-pronged, ranging from both organic and acquisitive growth, while also emphasizing operating productivity (margin expansion via labor and purchasing efficiencies). Case in point, this past Q1/2022 the company added 42 dental practices to its inventory, which are expected to add another $25M in pro-forma adjusted EBITDA. The acquisition playbook is one which has been tried and tested since 2013 and the model is often repeated and highly scalable. Given that the Canadian dental landscape is very fragmented (unconsolidated), a long runway for acquisitions and consolidation can be envisioned ahead (just last week, privately held 123Dentist and Altima Dental announced a merger to create an entity with over 350 dental practices nation-wide. Financial details not disclosed). Note that dentalcorp currently has a pipeline of at least 200 practices that categorized as “in advanced stages of negotiations”. What makes the dental industry so appealing is the low-beta nature of the business which is characterized by stable, recurring cash-flows (adjusted FCF of $40.4M and adjusted net income of $28.6M in Q1/2022 ) and robust margins (adjusted EBITDA margins of nearly 18% in Q1/2022). Why is this so ? – 75% of Canadians have a regular visit to the dentist (1-3 times per year) with that numbering increasing to 90% of children. Most importantly, 75% of Canadians have dental insurance and do not pay out-of-pocket.
Though pure-play market exposure to the dental sector in Canada is largely limited to dentalcorp Holdings, when expanding our investment geography to encompass the U.S as well, a plethora of new subsectors and investment themes emerge, some being more interesting than others, all of which should be evaluated in conjunction within the broader sector. Top of the list in our opinion is the dental products market which encompasses Medical/dental devices (Envista (NVST), Align Technologies (ALGN), Dentsply Sirona (XRAY)) and Medical/dental distributors (Henry Schein (HSCI), Patterson Companies (PDCO)). We feel this category to be particularly interesting given not only the aforementioned recurring cash-flows but also given the fact that the U.S exhibits similar fundamentals as to Canada in both the consolidation front and on the insurance front. Additionally, positive tailwinds are expected to continue given accelerated adoption of new technologies (digital, 3D printing) and an increasing focus on customer aesthetics coupled with an ageing population. As mentioned before, given the very recurring cashflows as is typical from the sector, all but Align Technologies have exhibited a historic beta of approximately 1.0 or below (1.0 equating to the general market risk of the underlying S&P500 Index). Less volatility in these currently turbulent times can only be a good thing.
Align Technology (ALGN) – Disrupting the orthodontic market, Align Technology is looking to replace brackets and wires (braces) with a comprehensive aligner solution for tooth straightening. Treatments include the use of the patented Invisalign clear aligner system which offers a new replacement to the traditional bracket and wire system. This new method involves the 3D printing of clear aligners, customized individually to the patients needs. The Aligner system reduces the necessary patient visits while also reducing the time needed for doctor training. Being clear, this new treatment allows for a more aesthetically pleasing treatment for the patient.
Dentsply Sirona (XRAY) – With products sold in over 120 countries, Dentsply Sirona specializes in anesthetics, plaque and gum disease prevention (prophylaxis) and tooth polishers. The company is also one of the leaders in designing and constructing artificial teeth. Though the company has been restructuring in recent years and concentrating its efforts in computer aided design and manufacturing (CAD/CAM), it has been entering higher growth segments such as imaging, the digitization of practices and clear aligners as well. The company’s flagship product is the 2019 launched Primescan CAD/CAM product which is currently the industry’s most advanced digital scanning system. In late 2020, Axeos was launched as the new standard in 2D/3D imaging for ortho, implant, upper airway or facial surgery.
Envista Holdings (NVST) – With over 25 acquisitions spread over the course of the last 15 years, Envista Holdings has built itself to become a leading dental manufacturer. Spun out from Danaher (DHR) in 2019, the company is a diversified leader in the orthodontics, general dentistry and implantology segments while also looking to offer a streamlined digital workflow for tailored treatments. In short, using the in-house portfolio of diagnostic equipment and clinical software solutions, Envista aims to offer an all-in one method to capture and visuzlize the patients needs and then personalize treatment. Though 40% of FY/2021 revenue was derived from implants, orthodontics accounted for 20% while imaging was nearing the 15% mark.
Henry Schein (HSIC) – A leading distributor of health care products, Henry Schein was founded originally as a single pharmacy in Queen’s NY in 1932. It has since grown to be a global distributor of medical and dental equipment, as well as a provider of specialty and technology offerings. The company is recognized as the largest global leader in dental supply with a comprehensive product portfolio encompassing over 120,000 branded and in-house products, along with over 180,000 additional products available as special order products. HSCI serves over 1.0M customers spread across 31 countries. It currently has 40% of the North American market share for distribution, with Patterson Companies (PDCO) in second place with approximately 22%.
Though certain companies have failed to live up to expectations due to operational, regulatory and/or have succumbed to unsustainable leverage (Align Technologies, SmileDirectClub), the distributors such as Henry Schein and Patterson Companies have managed to navigate the current market downturn to YTD performances of -0.5% and +3.2% respectively. This is a testament to the relative inelastic qualities of the broader dental market and a reflection of each company’s dominant (with high barriers to entry) market share within the North American distribution space.