Overview
COMPANY DESCRIPTION
Align Technology is a renowned global medical technology company renowned for its groundbreaking orthodontic treatment system called Invisalign. Founded in 1997, the company is headquartered in Arizona. As of December 31, 2022, it employed approximately 23,615 individuals. Align Technology operates in two distinct segments:
The Clear Aligner segment accounts for 82% of the company's net revenues.
The Imaging System and CAD/CAM Services (referred to as "Systems and Services") comprise the remaining 18%.
Additionally, the company offers consumer accessory products and distributes them through agents and distributors. Operating within a highly specialized sector, Align Technology exhibits a truly innovative business model. The key components of their process can be summarized as follows:
Connect: At the initial stage, the company drives customers to their websites.
Scan: During this stage, patient data is captured through intraoral scanning, enabling doctors to make accurate diagnoses.
Plan: Dentists can digitally visualize and plan orthodontic treatments for their patients.
Treat: Dentists carry out the necessary procedures to treat their patients.
Monitor: Doctors can track their patients' progress between visits and communicate treatment updates to them. 2
Retain: Customers can observe the final position of their treatment results.
Through this diverse business model, Align Technology aims to provide innovative orthodontic solutions, empower dental professionals, and enhance the quality of life for patients worldwide. They offer an end-to-end digital platform that integrates software, systems, and services.
LIQUIDITY
Upon observation, it is evident that the company's liquidity is deteriorating. Both the current and quick ratios are declining. In 2016, the current ratio was recorded at 2.69, whereas as of December 31, 2022, it plummeted to 1.26. The decline is similarly reflected in the quick ratio. The root causes of this liquidity deterioration can be attributed to the disproportionate increase in current liabilities compared to current assets, driven by rising deferred revenue due to increases in the Clear Aligner segment. In terms of solvency, it is noteworthy that the Debt/Equity ratio stands at 3.5%, indicating a significant level of indebtedness for the company.
PROFITABILITY
To evaluate the profitability of the company, we have identified four key financial indicators crucial for assessing its financial health over the last five years. These indicators include Return on Equity (ROE), Return on Invested Capital (ROIC), net revenue, and EBIT margin.
ROE (Return on Equity): ROE is an important indicator that measures the profitability of the company. Prior to the Covid-19 pandemic, there was an increase in ROE, reaching 77.5% on December 31, 2020. However, in subsequent years, there was a significant decrease in ROE, with it dropping to 22.5% on December 31, 2021, and further declining to 21.31% on December 31, 2022. As we compare these indicators with the industry averages, we can observe that the company demonstrates optimal profitability.
Return on Invested Capital (ROIC): The ROIC for the year 2022 stands at 8.30%. In 2020, there was a notable peak with a ROIC of 70%, followed by a decline in 2021.
Net revenue: The company has consistently achieved growth in net revenue over the years, with an annual growth rate of 25%. However, in 2021, there was a decline in revenue by 5.5%, and this decrease further continued in 2022. These declines can be attributed to changes in volumes and the impact of macroeconomic slowdown on the company's international operations, which are denominated in U.S. dollars.
EBIT margin %: The EBIT margin, which serves as an indicator of the company's operational profitability, remained stable at 20%. Nevertheless, the Covid-19 pandemic had a significant impact on the EBIT margin in 2020, causing it to drop to 15.7%. Subsequently, there was an increase to 24.7% in 2021, but it decreased once again to 17.6% in 2022.
STOCK VALUATION
The Discounted Cash Flow (DCF) model is a widely used valuation technique employed to estimate the intrinsic value of a company. This model incorporates future cash flows, discounted to their present value, in order to ascertain the present value of a company's assets. This approach is grounded in the notion that the intrinsic value of an investment corresponds to the present value of its anticipated future cash flows. To calculate the present value of a company using the DCF model, we
conducted a projection of future cash flows for Align Technology, taking into consideration factors such as revenue growth, operating expenses, capital expenditures, and taxes for a given terminal period. Subsequently, these projections were discounted to their present value employing the company's weighted average cost of capital (WACC).
As observed, we computed the unlevered Free Cash Flow (FCF) and discounted it using the discount rate WACC. Following that, we calculated the Terminal Value, which represents the value of an asset or business beyond the forecasted period when future cash flows can be reasonably estimated. Next, we derived the Enterprise Value and adjusted it by subtracting cash and debt to obtain the equity value of the stock. Dividing the equity value by the number of shares yielded a share price of 237. However, it is worth noting that the stock appears to be underestimated by a downside of 17%. All forecasts were based on an average of the last five years. We calculated the Weighted Average Cost of Capital (WACC) using the following inputs: a risk-free rate of 3.8% based on a 10-year yield on U.S. market, a beta of the company equal to 1.6, and a market risk premium of 5.9% obtained from the Damodaran table. After factoring in the cost of debt, we arrived at a WACC of 12.87%.
SENSITIVITY ANALYSIS
The sensitivity analysis is a valuable technique utilized to evaluate how changes in critical assumptions or variables can impact the valuation of a company, project, or investment. It aids in comprehending the sensitivity of the valuation to various factors and enables decision-makers to assess the potential risks and uncertainties associated with the valuation process. In this context, two key metrics that have been chosen for analysis are the Weighted Average Cost of Capital (WACC) and Terminal Growth Rate (TGR) due to their significant influence on the valuation outcomes.
By performing a sensitivity analysis on the WACC, one can assess how variations in the cost of capital, influenced by factors such as changes in interest rates or market conditions, affect the overall valuation. This analysis allows for a better understanding of the impact of different financing costs on the company's value.
The Terminal Growth Rate (TGR) is another critical metric in valuation, representing the expected long-term growth rate beyond the forecasted period. Conducting a sensitivity analysis on the TGR helps in examining how changes in growth assumptions impact the valuation. It provides insights into the potential effects of different growth scenarios on the company's value, allowing decision-makers to evaluate the sensitivity of the valuation to growth-related factors.
By considering the sensitivity of the valuation to changes in WACC and TGR, decision-makers gain a more comprehensive understanding of the risks and uncertainties inherent in the valuation process. This analysis enhances their ability to make informed decisions, considering different scenarios and potential outcomes, and mitigating potential risks associated with the valuation of a company, project, or investment.
MULTIPLE COMPARABLES
As a method of control, we employ a multiple comparables approach. Peers are selected based on their business model. For this purpose, we have chosen three comparable multiples: EV/REVENUE, EV/EBITDA, and P/E ratio. However, in this particular case, the multiple comparables method may not be optimal due to the challenge of identifying appropriate peers, as they are relatively smaller companies.
Upon analyzing the EV/REVENUE multiple, we observe that the company exhibits a favorable valuation compared to the sector average. Align Technology, for instance, has an EV/REVENUE multiple of 4.1, while the sector average stands at 18.1.
Regarding the EV/EBITDA and P/E ratios, we note that the company appears to have a higher valuation. However, this can be attributed to the fact that the peers used in the comparison have negative EBITDA and net income figures. As a result, the company's positive EBITDA and net income contribute to a relatively higher valuation when compared to these peers. It is important to consider the limitations of the multiple comparables method in this scenario, given the difficulty in finding suitable peers.
While the company's EV/REVENUE multiple indicates a favorable valuation, caution should be exercised when interpreting the EV/EBITDA and P/E ratios, taking into account the negative figures associated with the selected peers.
RISKS
There are numerous risks on the horizon that can potentially undermine Align's business model, which can be summarized as follows:
Macroeconomic and External Risks: For instance, a decrease in demand for dental services can lead to dentists postponing investments and reducing the company's revenue.
Business and Industry Risks: Align operates in a highly cyclical business, and its revenues are heavily dependent on two treatments: the Invisalign system and iTero scanners. Any decline in sales or average selling prices can adversely affect net revenues, gross margins, and net income.
Operational Risks: These encompass factors such as increased manufacturing costs, liquidity and solvency concerns for customers, and the inherent cyclical nature of the business model. Failure to accurately predict customer demand can have ramifications not only in manufacturing but also in workforce management since the company tends to employ a significant number of individuals to fulfill demand.
Regulatory Challenges: The dental industry is subject to regulatory oversight, and changes in regulations or compliance requirements can impact Align Technology's operations.
It is crucial for Align Technology to actively monitor and address these risks in order to safeguard its business model and ensure continued success.
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