Dentsply Continues to Face Strong Headwinds in Europe

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Although Dentsply’s revenue growth continues to fall slightly short our expectations, management’s ability to offset the medical device tax combined with the integration of Astra Tech kept total earnings growth near analyst’s forecasts.

Excluding precious metals, Dentsply’s revenue increased 3.4%, or 2.7% on a constant currency basis, which is slightly below last year’s internal growth but on par with the second quarter. While sales growth in Dentsply’s U.S. and other global markets continue to show some signs of improvement, European dental sales still linger on weak macroeconomic conditions, particularly for higher-end specialty dental procedures and products. We expect these trends will persist for Dentsply into 2014, which could leave our current nonprecious metal revenue forecast of 6% next year a bit too optimistic, particularly in high-end segments like dental implants.

Despite our concerns over near-term top-line growth, further margin expansion should keep earnings growth near our expectations. Gross margin for the quarter fell 30 basis points from a year ago primarily due to the medical device tax, but the Astra Tech integration and other efficiency efforts lowered relative selling and administrative costs, resulting in a 60-basis-point improvement in operating margin for the quarter.

Although the company’s margin expansion should slightly exceed our forecast by year-end, we think most of our future margin expansion and earnings growth expectations can only occur with greater top-line growth. Since dental procedures represent a lagging indicator of economic conditions, we may not see much improvement in Dentsply’s European growth for some time.

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