I recently did an analysis of Boston Scientific (BSX, Financial) and concluded there are better options in the medical devices sector. Here, I am going to discuss one of those better options: Align Technology Inc. (ALGN, Financial).

Align has been a member of the S&P 500 since 2017 with a market cap just above $16 billion. It has almost $4 billion in revenue each year and $500 million in net income. Investors were huge fans of the stock following the Covid-19 crash with the stock rising over 5 times in 18 months. Recently, it has come back down to Earth a bit.

ALGN Data by GuruFocus

What does Align do and why was it such a darling during the pandemic? The company manufactures Invisalign, which are clear braces people wear to straighten their teeth. Traditional, metal braces may work faster or be more effective with very crooked teeth, but Invisalign has many advantages.

First, the product is clear and not very noticeable. Some customers may be self-conscious wearing the more visible metal braces, so Invisalign is a great alternative.

Second, Invisalign can be administered without as much intervention. Traditional braces require trips to an orthodontist to get them put in, but then they also need subsequent visits to tighten the braces as the teeth move.

Invisalign does not require nearly as many visits, which is why it got so popular during Covid. Customers were able to straighten their teeth without frequent visits to the orthodontist, something people may not have felt comfortable doing during the pandemic.

Revenue is expected to reaccelerate

Revenue in 2023 was about $3.80 billion and analysts expect that figure to cross the $4 billion mark in 2024. By 2026, revenue is expected to creep up to almost $5 billion. What is driving this expected growth?

The market for invisible orthodontics is expected to explode and grow about 10 times in the next decade. Morningstar Research estimates that Invisalign has over 90% of the market for invisible braces, which is massive.

There is absolutely no way the company is going to maintain that 90% market share over the next decade, however. Any investor forecasting $60 billion-plus in revenue by 2033 for Align is going to be in for a surprise.

The reason is competition. Other companies see the opportunity here and are building products to compete with Invisalign to take some of that market share. That sounds concerning, but there are a few reasons I think Align is well positioned against new entrants:

• Invisalign has become synonymous with invisible braces. The product association I think is going to be as strong as Kleenex for tissues or Windex for glass cleaners.
• Even if I am wrong on that first point, the market is going to grow so fast there will be enough for everyone. Let's say that Invisalign loses half of its share. Around 45% of a $75 billion market in 2033 is still over $30 billion in revenue, which is almost 8 times current revenue figures for Align.

Align is putting some eggs in other baskets

Align is not devoting all of its resources to Invisalign. Even though it is a tremendous growth opportunity, management sees other avenues to generate revenue growth. Its latest venture is iTero, a digital scanner used by dentists and surgeons.

The resulting digital scan is more accurate and much faster to perform than the traditional, physical molds that dentists have used in the past.

Earlier this year, Align released its latest version, the iTero Lumina. This is the first new scanner to hit the market since 2019 and it is getting rave reviews. It is on the pricey side compared to other offerings, but its capabilities are much stronger.

The iTero scanners are a part of the Systems and Services segment. About 20% of the revenue generated in the second quarter was from this segment and it increased over 16% compared to the prior-year period. Over half of the equipment sales for the quarter were for the new iTero Lumina system.

Some are forecasting this market will grow 9% a year by 2030. The growth is not as fast as invisible orthodontics, but it is still a growing industry that will supplement Align's Invisalign business.

Now some bad news: Margins are falling

Align's net margin of just over 11% is one of the highest in the industry. It is currently higher than 75% of its peers. That is the good news.

The bad news is margins have been falling the past few years. The 10-year median net margin for Align is just a hair below 18%.

The 2020 net margin is blank because Align had a massive income tax break, which made net income higher than operating income. It is not really meaningful, so it was removed from the chart.

Why are margins falling? There are a few reasons:

• The gross margin on scanners, like iTero, is lower than Invisalign. As the share of revenue increases for scanners, the gross margin (and thus operating margin and net margin) will fall as well.
• Increased competitor threats means Align needs to sometimes lower prices to keep its customers.
• Research and development costs have been steadily increasing as a percentage of revenue. In 2014, R&D was less than 7%, but in 2023 it increased to 9%. This is not necessarily a bad thing as it shows Align is spending money to develop new products, but it is a contributing factor to lower margins.

Valuation ratios are below historical values

Despite the amazing growth prospects in the invisible braces market, the valuation ratios for Align are near historic lows. The price-book ratio of 4.25 seems high, but is lower than the 10-year median of 5.15.

ALGN Data by GuruFocus

Further, the price-book ratio is higher than the industry average.

However, it is important to remember the growth prospects for Align's market are significantly better than other, more mature medical device industries. Once you throw in a return on equity that is better than 80% of the industry and a miniscule 0.03 debt-equity ratio, I have no problem with the price-book ratio being above the industry median.

What is the value for Align?

Generally, I like to look at Wall Street analysts to determine potential price targets and estimates. However, only six analysts actively cover the stock and that is too low for me to be comfortable using those numbers.

Most analysts use non-GAAP measures for net income and earnings per share. For GuruFocus, this is earnings per share without non-recurring items. Over the last five years, the net income without NRI had a margin of just under 18% and was 17% for 2023. The 10-year median price-earnings without NRI ratio was 40.

I am going to be conservative here and expect margins to continue to fall. I think this is a valid assumption given increased competition in the market and the company's focus on its lower-margin iTero system. Using 15% for net margin (without NRI) is lower than historical averages, but reflects the near-term future for Align.

The company is also forecasting about 6% growth in revenue compared to 2023, which would place revenue around $4.30 billion.

All of these assumptions yield an EPS of $8.61 for 2024. Using a 35 times multiple gives a target price of right around $300, which is currently 40% higher than current price levels. I am using 35 rather than 40 because of tighter margins going forward.

Align Technologies is a buy

I really like the invisible braces market. Align is dominating its competitors and has a huge market share advantage. Given the expected growth over the next decade and the company's market position, I expect the stock to take off soon. If you do not own any shares of Align, I would seriously consider adding some to your portfolio.