Henry Schein (HSIC) Stock: Resiliency Premium Still In Situ

Investment Summary

We’ve been pleased to see our buy thesis on Henry Schein, Inc. (NASDAQ:HSIC) pull through with a 16% upside to our previous price target of $87 at the time of writing. We’ve covered the name extensively, and I encourage you to check previous publications out here [chronological order]:

1. Henry Schein: Tailwinds And Headwinds From COVID-19; Near-Term Upside Only
2. Neutral On Valuation, Covid-19 Sales Slowdown
3. Buy Henry Schein To Receive ‘Resiliency Premium’ In Equity Portfolios

Last time, we mentioned, that “[m]aintaining a constant weight to quality and resiliency are paramount to reduce portfolio variance and reduce equity beta…[w]e are seeking exposure to names that exemplify quality and cash generation to capture this theme”. Turning to the present investing climate this also rings true. It’s not surprising for us to see HSIC curl up its 52-week lows towards the end of year as the market found equilibrium and began rewarding bottom-line fundamentals once more.

Exhibit 1. HSIC rally off 52-week lows in late ‘FY22.

We continue rate HSIC a buy given 1) its strong profitability [rated A with Seeking Alpha’s quant system], 2) organic and M&A growth strategy, 3) incremental growth in ROIC, 4) reinvestment of earnings into growth initiatives with high rates of return, 5) ability to distribute residual earnings as free cash flows to equity holders, 6) ‘resiliency’ premium. Net-net, we reiterate HSIC stock a buy, with the resiliency premium still in situ.

HSIC adding to growth profile

Being a mature business, clipping $12Bn in TTM revenues to Q3 FY22′, on face value it’s surprising to see HSIC with quite thin gross–net margins [30% to 5%, respectively]. Looking to the company’s P&L, further analysis reveals there’s still healthy value created for shareholders. We’d remind our readers that YoY growth rates [revenue, operating income, earnings, etc.] aren’t the best measure to gauge growth. Moreover, it says nothing on accretion to corporate value.

HSIC recently acquired a majority stake in long-term referral partner Unitas PPO Solutions, in January. Terms of the deal weren’t disclosed, so we await language from the firm’s full-year numbers on this – yet, the acquisition complements the eAssist Dental Solutions subsidiary. It also has a string of acquisitions under its belt dating back to FY16′ [see below].

HSIC acquisition trail

Regarding our thesis on HSIC, we can obtain data on its investment success and the cost of funding its future growth initiatives, and potentially extrapolate this to forward-looking estimates. We use a rolling TTM period from FY ’20–’22 to do this. It accumulated $8.2Bn in post-tax earnings during this time, growing the NOPAT print by an additional $83mm. The capital investment required for this growth was $1Bn, or 12.2% of post-tax earnings, and hence we expect the 8.3% incremental ROIC [Exhibit 3]. We compared this to the long-term profile of FY ’12 to the TTM in FY ’22 [Exhibit 4].

Exhibit 3.

Exhibit 4.

To add more colour to our buy rating, despite its mature growth percentages in the testing period [100bps in NOPAT, ~140bps in earnings] the company continues to distribute almost all of its residual post-tax earnings to equity holders. It doesn’t pay a dividend, but remember, equity value is the claim on residual earnings [once generated] or the capital injection into the business. You want to see a growth and/or return on each – which HSIC has delivered. Hence its swift recovery from the FY22′ bear market, by estimation. Subsequently we estimate HSIC’s decision making around the Unitas transaction are likely to hold within the bounds of its previous return on investments.

Additionally, HSIC unveiled its “BOLD” strategic plan for FY22–24′: Build, Operationalize, Leverage, Digital [transformation], Drive [value]. Given its number 1 sales position across key developed markets in North America, Australia/NZ, Europe, also in Brazil, we expect the company to retain and potentially consolidate additional market share in its dental and speciality markets. Given the above data, it’s not unreasonable to expect HSIC to penetrate deeper customer networks. The “Digital” portion of the BOLD plan could reduce capital intensity and drive its ROIC/WACC spread higher [see: Appendix 1].

Valuation

Regarding the discussion on valuation, we’d note the stock is trading at 18x forward P/E, 25% discount to the sector. We also see HSIC trading at a discount to our P/E estimate of 24.8x, based on the growth, ROIC and reinvestment assumptions listed above. To be clear, and reiterate what we said in the last publication – you are paying a ‘resiliency’ premium in buying HSCI, i.e., a defensive compounder that could smooth the equity risk in a cross-asset portfolio. This isn’t a growth play by any means, yet, based on the company’s economics, is a long-term value play.

Exhibit 5.

Exhibit 6.

Conclusion

Hence, at 18x P/E, we believe the stock is still attractively priced. Net-net, we continue to rate the stock a buy. We are looking to the $117–$118 range for next upside targets, supported well in our point and figure studies [1×3 box reversal, see: Exhibit 6]. We look forward to providing additional coverage on the company’s FY ’22 numbers.

Appendix 1.