Thread by @borrowed_ideas

1/ Thread on $XRAY

I spent the last few days reading on XRAY. While XRAY's last 10yrs were difficult, long-term returns were still pretty good.

Unfortunately, it's a pass for me. Here's why.

2/ Quick background: The 2016 merger between Dentsply International (consumables) and Sirona Dental Systems (equipment) led to XRAY as the largest manufacturer of dental consumables and equipment.

TAM ~$24 Bn. $XRAY has ~15-17% market share. US, and EMEA is 75% of global market.

3/ Two reporting segments.

Consumables (43% of revenue): ~25% adj operating margin in 2019, ~30% revenue from the US

Technologies & Equipment (57% of revenue): ~19% operating margin in 2019, ~40% revenue from the US

4/ Dental manufacturing industry is largely oligopolistic with the main players being $HSIC, $NVST, $MMM, $PDCO, $ALGN, $STMN.CH, and $XRAY.

Pre-Covid, two secular themes were affecting dental manufacturers.

a) The rise of High Deductible Insurance Plans (HDIP)...

5/ ...HDIP was 8% as % of total covered lives in the US in 2009. In 2019, it was 30%. The rise of gig economy contributed to this problem.

What happens when you have HDIP plan? You don't want to go to your doctor unless it's *really* necessary.

6/ ~40% dental spending is out-of-pocket expense (vs ~10% for overall healthcare spending). So rise of unemployment and consumer weakness affects dental spending much more.

b) The rise of DSOs has also been a headwind...

7/ ...Dentists who do solo practice also need to look after administrative work. DSOs alleviate this burden.

~64% of all dentists were solo practitioners in 2000. In 2017, it was ~50%.

As a group buyer, DSOs have much better leverage which creates reimbursement pressure.

8/ Both these secular trends are only going to intensify in the current and post-Covid world.

More people are unemployed/underemployed. HDIP popularity should rise even further.

More dentists are likely to abandon solo practice and become a DSO memebr. This will be...

9/ ...particularly true for young dentists. Avg student debt for dental graduates was ~$100K in 2000, now it's $300K. They are likely to be much more prone to pursue an employment with DSO to get a sense of relative safety.

A potential second wave could be very challenging.

10/ Only ~10-20% dental visits are considered essential. So the elective procedures can be deferred (or even cancelled) far longer.

Even if there is no lockdown and dentist offices remain open, a lot of patients won't come back. See the CEO's comment in a recent call.

11/ If dentists don't do well, it's not easy to see how dental manufacturers are going to do well.

$XRAY talked about protecting margins and cutting down capex. But they also mentioned ~25-33% costs are variable in nature. So it may take some time to right size the costs.

12/ One positive thing that can come of this pandemic for $XRAY is smaller players will be much more challenged in this situation. Given 1.2x leverage, XRAY can acquire some smaller players at good valuation.

Pre-pandemic, XRAY's organic revenue growth target was 3-4%...

13/ Given the uncertainty, the range of possible outcomes have certainly widened, and mostly in the downside.

Current CEO Don Casey (since Jan 2018 and third CEO during 2016-2018 period) wanted to restructure the business by centralizing supply chain, procurement, and...

14/ ...a more efficient sales force. Difficult to execute these strategies when you are also dealing with how to protect your topline.

Is the stock cheap? Doesn't look crazy cheap to me. It's trading at 20x P/E based on 2021 consensus earnings, and I seriously doubt on...

End/...the validity or anyone's ability to forecast 2021 earnings for dental manufacturers.

For all these reasons, it's a pass.