Debt, Rivals Leave SmileDirectClub Investors With Little to Smile About

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Investors in Nashville-based SmileDirectClub (NASDAQ:SDC) entered the fourth quarter with a highly volatile stock in their portfolios that has lost over half of its value so far this year. The 52-week range for SDC stock has been $4.63 – $16.08, and the shares are now hovering around $6.50.

a Smile Direct Club storefront

Source: Helen89 / Shutterstock.com

SmileDirectClub stock has become an attractive target this year for Reddit-driven short-squeeze rallies. Retail investors on social media recently joined forces to push SDC shares higher, leading to a significant surge in the average daily trading volume. The 10-day average volume stands at 19.2 million shares versus the three-month average of 15.2 million shares. The five-year monthly beta is a whopping 2.47.

SmileDirectClub has been aggressively marketing its clear aligner therapy dental treatment over the past few years. It sells mouth aligners, impression kits, whitening gel, and other dental products. Management has been marketing its aligner as a lower-cost alternative to Align Technology’s (NASDAQ:ALGN) Invisalign brand of clear device.

Yet, the dismal second-quarter earnings reveal the company is mostly losing out in its competition with Align. Prior to the pandemic, SDC stock traded at $15. The shares plunged close to 25% over a single week after the release of its recent earnings report.

Along with soaring competitive pressures and a fragile balance sheet, long-term prospects remain hazy for SDC stock. While the short-squeeze frenzy may provide a boost to the stock price in Q4, investors should nevertheless remain cautious. Let’s see why.

How SDC Stock’s Recent Earnings Came

SmileDirectClub issued second-quarter financial results in early August. Revenue went up by 63% YoY to $174 million. The top line not only fell 12% short of consensus expectations but also represented a 45% decline over the second quarter of 2019. The decrease in aligner shipments during the pandemic contributed to the disappointing top-line result.

The company reported a net loss of $55 million, down from a $95 million loss in the prior-year quarter. Diluted net loss per share stood at 14 cents. SDC burnt through $35 million cash through the second quarter. Cash and equivalents ended the quarter at $389 million.

On these results, CFO Kyle Wailes remarked, “The short-term headwinds from residual impacts of the April cyber-attack, the lasting economic effects from COVID on our target demographic and the slower scaling of some of our new international markets due to COVID prevented us from achieving our anticipated second-quarter results.”

Despite $377 million in cash and equivalents, the company also has over $716 million in long-term debt, on which they need to pay more than $50 million every year in interest expense. As the economy heads into a rising interest rate environment, paying a high percentage of gross profit in interest expense implies significant bottom-line issues for a growth company.

For the third quarter, the firm is forecasting shipment of 83,000 to 87,000 aligner orders, representing an increase of 49% from the second quarter. SmileDirectClub’s price-to-sales (P/S) and price-to-book (P/B) ratios stand at 3.12x and 10.71x, respectively.

A Saturated Dental Market

Over the years, SmileDirectClub has seen an impressive increase in sales as more and more consumers seek less-expensive treatments for straighter and whiter teeth. The firm sells teeth aligners through its website, professionals, corporate partners and a retail store network of 300 SmileShops where customers can acquire a free 3D image of their teeth.

Oral care is a large and diverse industry, which analysts forecast will grow at a compound annual growth rate of 5.9% over the next seven years to reach almost $50 billion. On the political front, Democrats want to include dental care in Medicare, which could at some point in the future introduce SDC and other dental services to an aging U.S. population. In addition, the firm’s international operations constitute another significant area of growth, as management sees 35% of its addressable market in global markets.

While the industry is a fast-growing one, SmileDirectClub operates in a saturated market with considerable rivals. The company banks on effective marketing and product improvements to remain a competitive player. Aside from Align Technology that keeps reporting solid profits and extends its lead, other key players in the market include 3M (NYSE:MMM), Danaher (NYSE:DHR), and Dentsply Sirona (NASDAQ:XRAY), the maker of the Byte aligner.

The Bottom Line on SDC stock

At present, 33% of SDC shares are currently held short. Put another way, Wall Street might witness a further short squeeze in the coming months. It is a speculative meme stock play, so all bets are off on what retail traders might decide to do.

SmileDirectClub is currently in a distressed financial position, and could thus need to raise capital in the near future. As it is mainly financed by debt and seems to burn cash at a high rate, dilution seems to be a substantial short-term risk for SDC stock. There are too many unknown variables in its business environment to justify a substantial investment in a single-product company.

On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tezcan Gecgil, Ph.D., has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all three levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation.

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