A Dentist's Pair Trade: Buy Dentsply, Sell Sirona Dental

• DENTSPLY International Inc XRAY shares have been on a downtrend, after touching a high of $57.29 on August 12. Sirona Dental Systems, Inc. SIRO shares are down 3.73 percent since August 18.
• Morgan Stanley’s Steve Beuchaw upgraded the rating on DENTSPLY to Overweight, while downgrading Sirona Dental to Equal-weight.
• Good free cash flows are a positive for both the companies, although Sirona’s current valuation already reflects the company’s growth prospects, Beuchaw said.

Analyst Steve Beuchaw raised the price target for DENTSPLY from $56 to $70. He said that working capital optimization is the most underappreciated part of the company’s story, while adding that DENTSPLY is poised to reap the benefits of working capital optimization and a greater focus on efficiency and execution.

In the report Morgan Stanley noted, “We expect a FCF/share CAGR of 22% from '15 to '17, 500bps faster than the median of our coverage and up 500bps from our previous ests. Benefits from working capital optimization and a greater focus on efficiency and execution lead to the highest FCF yield in our coverage at 7.5%.”

DENTSPLY’s shares have underperformed the dental peers by 400bps over the last one year. Beuchaw added that the Russia/Lab drag appears to be abating and the company’s EPS is expected to grow 900bps faster in 2015-2017 than it had done in 2013-2015.

Beuchaw believes that the underlying dental end-markets in Europe and the US are improving and the company’s aim to invest its cost savings into growth initiatives will bear fruit. “Our recent meetings with mgmt give us confidence that organic growth can approach mid-single digits in the next two years assuming stable market growth,” the report added.

Sirona Dental: Valuation Reflects Growth Expectations

Beuchaw maintained Sirona’s price target at $101. The company is likely to remain a leader in the digital dentistry market, the analyst said, while noting that its P/E relative to the S&P and dental peers is above 5-year averages. The company’s current stock valuation already reflects the robust organic growth expectations.

Accelerating dental market trends, the SL3D launch and increased CADCAM functionality and the launch of the company’s US treatment center along with tax incentives are expected to drive Sirona’s growth prospects, the Morgan Stanley report stated.

“The key offset is tougher comps in Germany after a solid IDS show in March. In total, we see growth of 6-12% as likely over the next 1-2 years,” Beuchaw added.

Although Sirona’s shares are fully valued, Beuchaw wrote that “an outright negative view on the stock is inappropriate given we expect upside to consensus estimates.”