Dental Industry Provides Opportunities
The dental industry has attractive long-term characteristics.
Although the stock market has rebounded as of late, we don't think it's too late to go on the hunt for value. The dental sector is a decent place to start, as it has shown some resistance to economic recessions in the past. This time around has not been much different, as some of the stocks we cover in this industry, including Dentsply International (XRAY), Patterson (PDCO), and Henry Schein (HSIC), have all outperformed the broad market year to date. The overall industry has definitely shown signs of slower growth over the last year, particularly with respect to elective and cosmetic procedures. However, we think it has the ability to rebound faster than the overall market when the current recession begins to reside, partly as consumers start to pile into dentist offices for treatments previously canceled or delayed for financial reasons.
Of the four dental-related companies we cover, three are currently rated 4 stars or higher. While the share prices of these firms have bounced back off their lows from earlier this spring, we feel these companies still have some room to run over the next year or so for several reasons. The dental industry benefits from a relatively stable outlook along with a number of trends that support long-term growth. While spending has slowed recently in lockstep with the current recession, it is expected to recover to a 4.3% growth rate by 2010, on its way to a more normalized run rate of 6% annual growth, according to the Centers for Medicare and Medicaid (CMS). There are several other trends that underscore long-term stability. People are maintaining their teeth longer in general and the demand for cosmetic procedures has grown. Overseas, awareness of the need for healthy teeth is growing, with demand for dental services and products moving in lockstep with this sentiment. We think the international market will likely be a sweet spot for future growth for dental players large and small.
Fair Value Estimate $36
Dentsply is the leading manufacturer of dental products globally, and it sells general consumable products, like pastes and sealants, as well as higher-end dental equipment. The company is a brand name in dental supply, and it places a high value on research and development, which allows it to offer a number of new products annually. This innovative streak coupled with the company's brand recognition gives it some pricing power over its end-market customers. With respect to consumable products, however, Dentsply has no real pricing advantage, as these products are essentially commodities and lack pricing power over the company's main customers--the large product distributors. On the positive end, these consumable products are somewhat resilient during slower economic periods, as they are necessary for dentists to run their practices. We think Dentsply's product portfolio, both diverse and somewhat recession-resistant, will protect the company during leaner times. Furthermore, given the positive long-term prospects of the industry, we expect the firm to rebound faster than the broader market, once the current economic fog begins to lift. The company's economic house is in order, with $226 million in cash as of the first quarter of this year and with ample access to further liquidity. Dentsply continues to generate healthy profits against the tough economic backdrop, and we think its long-term outlook is positive.
Henry Schein (HSIC)
Fair Value Estimate $56
Patterson Companies (PDCO)
Fair Value Estimate $36
Henry Schein and Patterson Companies are the two largest distributors of dental products worldwide. While both firms also specialize in other areas, including medical equipment and vet supplies, dental products remain the main driver of revenue. The dental distributor model provides a number of advantages for both Schein and Patterson, and it allows the firms narrow economic moats that protect them from the competition. Both firms have power over their manufacturing suppliers, given the commoditylike nature of the majority of dental consumables. In fact, both firms have created their own private-label businesses to sell similar products at a higher margin, given the lack of marketing expenses associated with selling a generic product. These products are essentially cheaper substitutes when compared with their branded competition, further diminishing the pricing power of manufacturers.
While Schein and Patterson have power over their suppliers on one end of the dental supply chain, they also wield control over their end customers--dental practices. Dentistry is one of the few areas in health care not represented by a group purchasing organization, which means that suppliers like Schein and Patterson face little to no pricing pressure from these individual practices, which on their own have no real bargaining power. The two companies dominate the supply chain, with a combined market share of almost 70%. There is a laundry list of advantages these two firms have over the competition, starting with scale. The sheer size of the Patterson and Schein distribution networks allows the companies to operate much more efficiently than smaller players. Furthermore, the sales infrastructure and dominance in market share has created tough barriers for a new entrant, which would have to create a similar network from scratch to attempt to compete with either firm.
Despite these advantages, the two firms are still somewhat beholden to economic weakness, as recent quarterly results have demonstrated. Short-term spending, particularly on products related to elective procedures, has been weak over the last year, and there will be continuing uncertainty surrounding the two companies over the next several months. However, we think Schein and Patterson are well-positioned over the long term, given the plethora of positive industry trends going forward over the next several years. We think the combination of these trends and strong business models will allow both firms to prosper.
Bill Buhr does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.