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Bear of the Day: Align Technology (ALGN)

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On July 24, Align Technology (ALGN - Free Report) delivered a big EPS beat of 21% and slightly better revenues. But Invisalign case shipments missed estimates (377K vs 380K+ consensus) and Q3/2H19 guidance was disappointing due to both slower adoption in China and some softness in US young adult growth. 
Here were the headline prints from Bloomberg and the CEO summary, and then we'll look at analyst reaction...
--Align Technology reports Q2 EPS $1.83 vs consensus $1.51 and Q2 revenue $600.7M vs consensus $599.38M. 
--Align Technology sees Q3 EPS $1.09-$1.16 vs consensus $1.24 and Q3 revenue $585M-$600M vs consensus $623.65M.
--Align Technology sees FY19 revenue at low end of 20%-30% growth target vs consensus $2.45B. Sees FY19 Invisalign revenue and volume growth at low end of long-term operating model target. Sees FY19 operating margin below low end of long-term model at roughly 22%. 
Commenting on Align Q2 results and the outlook for Q3, Align Technology president and CEO Joe Hogan said, "Our second quarter revenues were at the high-end of our guidance, reflecting Invisalign volume growth primarily from international doctors, as well as very strong sales from iTero scanner and services. Q2 Invisalign volumes were up 24.6% year-over-year reflecting continued adoption from teenage and younger patients, as well as increased utilization among orthodontists and expansion of our customer base which totaled 60,000 active doctors worldwide. In Q2, total Invisalign case shipments were lower than expected, primarily due to a softness in China related to a tougher consumer environment and slower growth in young adult case in North America. Given the uncertainty in China, our outlook for the third quarter reflects a more cautious view for growth in the Asia Pacific region."
Now here's a sampling of analyst reactions...
Jefferies: Analyst Brandon Couillard explained that the 25% drop in ALGN shares on July 25 was all about the Q2 Invisalign case volume miss and Q3 guidance shortfall, due to a consumer-led slowdown in China and competitive noise in Americas. However, the analyst does not see the latest "snaggle in two pockets of the business as structural issues." Near-term, he thinks the Q3 guidance tilts conservative and believes the valuation should offer support. Couillard lowered his price target for ALGN to $275 from $345.
Credit Suisse: Analyst Erin Wilson Wright lowered her price target for Align Technology to $320 from $340 on lower outlook following quarterly results. The analyst reiterates an Outperform rating on the shares.
Stifel Nicolaus: ALGN price target lowered to $290 from $360 at Stifel on "messier than anticipated" quarter. "We expected some noise in the quarter, but results were admittedly messier than anticipated, and our 2019-2021 revenue and EPS estimates move lower." The Stifel analysts also believe management's 3Q19 case volume guidance will prove conservative. Regarding increased competitive pressures, they see that ALGN can still grow case volumes 20%+ long-term due to traction in more insulated/high-growth markets like Teen, International and LATAM.
Growth Hiccup on International Expansion and Competition
We have owned and traded ALGN shares for over two years in my Healthcare Innovators portfolio. In fact, we rode a big wave from $130 to $330 for 150% gains between May 2017 and May 2018. I believed that the premier brand of dental aligners combined with iTero, the digital scanning platform ideal for emerging markets penetration, would continue to grow at 25-30% annually and hit $5 billion in sales in 2021.
That would justify a price-to-sales valuation of over 5X and sustain shares above $300. But the growth hiccup is here and will slow down the path to $5 billion with only 21-22% growth. Here's what I told members on July 25... 
My take: The selling overreaction here is brutal and likely way over-done. But estimates will come down and make ALGN a Zacks #5 Rank soon. Estimates were already creeping down enough in the past week to push it to a #4 Rank yesterday morning before earnings.
Estimates did indeed come down since then with next year's topline projection falling under $3 billion and the Zacks EPS consensus slipping from $7.22 to $6.69 among eight analysts.
Unfortunately, this meant that I had to sell Align Technology and wait for the estimates to turn back up, or at least stop going down. Here's what I told members on July 26...
This is a tough decision because I believe that both investors and analysts are overreacting to the China growth miss.
But as I indicated yesterday, the stock will become a Zacks #5 Rank soon as estimates come down, so I would be selling at some point next week anyway.
In the interest of helping you make your own decision, I provide more analyst views and moves, courtesy of
BofA/Merrill: Align Technology downgraded to Neutral on reduced visibility as analyst Michael Ryskin weighed the company's lighter Q2 volumes and Q3 volumes guidance that was well-below expectations. He noted that while Align has had volatile results in the past, this report stands out given the number of issues that cropped up in the quarter amid positive commentary from management in recent months. Ryskin added that this was "the first time that Align spent significant time discussing incremental pressure from competition." He lowered their PT from $350 to $220.
Piper Jaffray: Analyst Matt O'Brien lowered his price target for Align Technology to $240 from $350 saying the company's case volumes were a "little light" for Q2 and management issued second half of 2019 guidance "well below" expectations. This is the first time Align has acknowledged the impact of competition and there was also a slowdown in China, O'Brien told investors in a research note. He believes that while these issues will not resolve quickly, the company "will be able to navigate them." Further, there were some clear positives from the quarter, including "impressive" scanner growth and "excellent" doctor training numbers, contends O'Brien. He keeps an Overweight rating on Align Technology.
Of note is the huge move in price target from the BofA/ML analyst who had just raised his target to $350 only weeks before ALGN's report. One might suspect he felt fooled by company optimism this year. And if some investors feel that way too, ALGN shares may drift in purgatory for some time near $200.
But longer-term, they are probably a buy very soon. The Zacks Rank will let you know.
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