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New Tech For Teeth Raises Growth For Align Technology

By: Investor's Business Daily
Posted: 11/8/2013 5:12:00 PM
Referenced Stocks: CFN;GRFS;HOLX;ISRG;VAR

Just when it looks like Align Technology has about perfected the tech behind its invisible braces, the company finds yet another way to improve it.

Early this year the San Jose, Calif., maker of alternatives to metal braces introduced a new material for its Invisalign clear aligner system. It's SmartTrack, a highly elastic material that better maintains its shape and a more constant force over the two weeks a patient wears the aligners. It conforms better to tooth morphology and attachments, and is easier to insert and remove.

According to orthodontists or general practitioners, the old material would hold its form very well the first four to five days but then quickly lose its shape, says Jonathan Block, managing director at Stifel Financial.

"So it's acting as a retainer for the last week or week and a half. What SmartTrack holds its shape much better and therefore has been shown to move teeth more effectively," he said. "Our due diligence suggests it's allowing -- notably -- orthodontists to do more complex cases and that's helping increase case volume."

In a recent study by Stifel Financial, 80% of respondents said they believe the new material will help them treat more complex cases and 55% said it has already allowed them to do that. In addition, 40% of Stifel's respondents believe SmartTrack already shortened treatment times for their Invisalign patients.

Product Innovations

In June, Align Technology also introduced Realine, an entry-level, five-stage clear aligner product that helps with very minor crowding and spacing issues that a general practitioner can help fix. Treatments Invisalign Express and Lite also help with minor corrections, while taking less time to implement. And finally, Align Technology sells 3D scanners and software to help dentists create digital molds of patients' mouths.

These new introductions certainly have helped the company's results. After flat and then single-digit year-over-year earnings growth the prior two quarters, earnings per share shot up 62% in the third quarter on a 21% increase in sales, both above analyst forecasts. The stock surged 26% on the news to near 58 on Oct. 18 and has been trading near it since.

Align Technology holds the highest Composite Rating -- 98 of a possible 99 -- of all companies in IBD's Medical-Systems & Equipment industry group. It is also the best in the group in EPS Rating, with a 95.

The industry group itself ranks 28th among 197 that IBD tracks. Align Technology is seventh largest in the 66-member group by market cap, afterIntuitive Surgical ( ISRG ),Grifols ( GRFS ),CareFusion ( CFN ),Varian Medical Systems ( VAR ),Hologic ( HOLX ) andIdexx Laboratories (IDXX).

Align Technology's new product launches are part of the company's goal to introduce one big product per year, Block says. Another goal the company has been pursuing is breaking down the barriers in the teen market.

Youth Tooth Market

Teenager Invisalign cases have been steadily growing since the end of 2012. Last quarter, the company had a total of 29,000 teenage cases, a 23% increase from the prior-year period. But the market penetration is still relatively small.

"We have a very positive outlook on the company, even within teenagers," said analyst J.T. Haresco of JMP Securities, noting that the marker remains only about 10% to 15% penetrated in the U.S., if that.

"And given that they have a monopoly on invisible braces," he said of Align Technology, "it's easy to paint a very good long-term picture for how they're going to do."

Growing Business Abroad

A third area of growth for Align Technology is international. During the third quarter, the company had 22% of its worldwide cases originate internationally. International revenue soared 31% vs. a year earlier and represented 24% of total revenue.

"There's a lot of opportunity to pursue (internationally)," Haresco said. "It's purely a cash-pay business -- as opposed to the U.S., where there is some reimbursement -- and they have a little economic sensitivity, but it hasn't softened yet. There are not really any alternatives out there."

Japan and China provided strong volume growth. The company repurchased its Asia-Pacific distributor in May, allowing it to directly sell its products in that market and command end-user pricing. This deal has quickly become accretive to earnings, noted Block.

Europe also performed well, with case shipments growing 20% in the third quarter vs. a year earlier. The growth was led by Spain, France, Italy and Germany. The U.K. market was the only one to post a slight decrease due to the soft economic environment.

An advantage in pursuing international growth is that Align Technology is able to command higher prices abroad vs. in the U.S.

"It is one of the very few medical device companies that has arguably as high a gross margin structure internationally as it has in the U.S.," Block said. "The unwritten law in med tech is 'you're selling products a little bit cheaper internationally than you do in the U.S.' -- but not for them."

Normally, he says, what you have is faster growth internationally but it comes at a lower margin.

However, for Align Technology, "arguably you can have faster growth internationally while maintaining that very attractive margin profile," Block said.

Align Technology's operating margins have been creeping up slightly from one year to the next, with the most recent number at 23.1% in the third quarter. Nevertheless, quarterly margin and earnings numbers can be pretty volatile.

Block expects margin growth to speed up going forward. He estimates it will reach 25.7% in 2014 and 28% in 2015. He believes drivers for this stronger growth will be lower general, administrative, legal, sales and marketing expenses. "Even if you flat-line them and revenue grows, you'll get leverage out of that line item."

Align Technology also added about 40 to 50 Invisalign reps in 2013 in North America, which will start being accretive to revenue next year.

Risks for the company include a lethargic economy and quarter-to-quarter variability in their results. Align holds 538 patents and another 201 pending worldwide. The first of the patents are due to expire in 2017-18.

The company had $400 million in cash at the end of last quarter and no debt. It's been using some of its cash to do share buybacks.

"They're a disruptive technology in a very large market that, arguably, might be in the very early innings of executing," Block said.