Align Technologies Takes One in the Teeth

Align Technologies (ALGN), which is known for the Invisalign system that corrects misaligned teeth, sold off more than 8% on Tuesday morning thanks to a Northcoast Research downgrade to Sell from Buy. The research firm came out with an extremely bearish note on ALGN and lowered their price target to $13 from $21 because of a number of headwinds now facing the company. For starters, there is increasing competition for their product from the likes of Dentsply (XRAY) and privately held OrthoClear. The Dentsply product is new to the marketplace and is expected to be substantially cheaper than Invisalign. OrthoClear’s product was able to gain significant traction soon after it hit the market back in 2005, and Northcoast fears further market share loss for ALGN when Dentsply’s product is made available. This and other reasons have made Northcoast less optimistic for their growth prospects and may put earnings at risk going forward.

We make note of this analyst’s call not necessarily because we agree or disagree but because it stands out among the crowd that is tilted heavily to the bullish side. Among the 10 analysts tracked by Yahoo finance, 6 of them have strong buy, 1 has a buy, 3 have a neutral rating on ALGN, and none are bearish. The company had proven its ability to exceed consensus estimates, as they have done just that in all but one quarter in the last three years. Perhaps Wall Street analysts have finally ratcheted up expectations high enough, or possibly too high as they underestimate the headwinds. Furthermore, traders have placed their bets on the long side, as there are only a few million shares held short, which we consider rather small for a stock that has more than 75 million shares outstanding.

It seems that Northcoast is among the first to really make the bears case, and the market is taking notice. Coming into the day, the stock had steadily risen more than 150% over the last year thanks to an improving outlook in the recession plagued dental procedures market. Heavy volume this morning in the sell off suggests at least some investors are cashing in their profits.

At Ockham, we examine a company’s current fundamentals versus what the market has historically been willing to pay, and in the case of ALGN historical valuations have ranged fairly widely. For example, in just over 9 years that ALGN has traded publicly, it has historically traded for 18.2x to 42.8x times cash earnings per share. The current price-to-cash earnings rests comfortably in the middle of that range at 33.2x. Furthermore, we see nothing out of the ordinary with a price-to-sales for this year of 3.92x compared to the historically normal range of 2.17x to 6.67x. Based on the historical analysis and five other fundamental factors we measure, we have a Fairly Valued stance at this time as we downgraded it in early March due to valuation concerns.

Clearly, the market has awarded ALGN with relatively high multiples because of their growth trajectory, and any threats to growth as noted by Northcoast would likely bring lower multiples. We are anticipating ALGN will trade on the lower to middle of historical price-to-cash earnings and price-to-sales ranges; based on current fundamentals this implies an expected price range of $11 to $18. With the majority of analysts overwhelmingly bullish and a the trader community seemingly biased to the long side, a backlash would not be out of the question and lower prices would likely follow.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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