Fewer Smiles for Cosmetic Dentistry

05/28/2008 12:00 am EST

Focus: STOCKS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts, says cosmetic dentistry will suffer as strapped consumers tighten their belts, and he suggests how to play it.

As fewer people spend money on cosmetic medicine, the next segment to suffer is its cousin, the dental suppliers.

Cosmetic dentistry is nearly a $6-billion business (according to the American Academy of Cosmetic Dentistry, or AACD), and I believe this significantly underestimates procedures and revenues in practices still focusing on traditional dentistry.

The typical [cosmetic dentistry] patient is very similar to the cosmetic medical patient—53% of patients are between 41 and 60 years of age. Growth has been in the double digits, but fourth-quarter sales of supplies by three major distributors showed it is slowing to the 4%-6% range.

On average, cosmetic dentistry is expensive—more than $5,500 per patient, according to the AADC—and entirely elective. With many feeling their personal wealth reduced due to the housing depression and the economic recession, demand for cosmetic dentistry is slowing.

I believe these companies will take a hit that's not yet seen in stock prices. This view is supported by comments made during recent executive conference calls for two of the leading dental product manufacturers, Danaher (NYSE: DHR) and Henry Schein (Nasdaq: HSIC).

So, how can we play this?

There are profits to be made from rotting dental manufacturer Patterson Companies (Nasdaq: PDCO).

The company derived 75% of revenues from dental equipment and supplies in (calendar) fourth quarter of last year, and it is one of the purest short-side plays on this market segment.

A lower-risk way to play this name is to ride it down during the next several months, and the best way to do this is to buy the PDCO January 30 Puts (ZMGMF) under $1.60. (The stock closed below $34 Tuesday, and the puts traded at $1.45—Editor.)

While these companies sell equipment and supplies with very high profit margins, this is the part of the business where growth is declining—down to roughly 4% to 5% growth for Henry Schein, which spells trouble ahead for the company and for those who are bullish on the stock.

A long-term position in Henry Schein for our short-side portfolio is attractive at its current levels, as the company derives 40% of its revenues from dental supplies and equipment. The best way to play this name is to buy the HSIC January 50 Puts (OECMJ) under $2. (The stock closed below $56 Tuesday, while the puts traded at $1.80—Editor.)

I anticipate that both Patterson and Henry Schein are going to have a dismal remainder of the year, with even more trouble ahead for their respective bottom lines and big short-side profits for us.

(Editor’s Note: Short selling is suitable only for highly risk-tolerant investors who can afford to lose the money they’re putting up in these trades.)

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