Henry Schein, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Henry Schein is a solution company for health care professionals, providing a wide range of products and services to office-based dental and medical practitioners globally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Henry Schein’s core philosophy centers on providing customized solutions to its customers, a commitment that has driven the company’s strategy for over 90 years.

Business Overview

  • Revenue Distribution: HSIC operates through two reportable segments: Health Care Distribution and Technology and Value-Added Services. The Healthcare Distribution segment provides consumable products, small equipment, laboratory products, large equipment, and specialty products and is comprised of the following subsegments : dental, medical, animal health, government. Technology and Value-Added Services segment provides software, technology, and other value-added services.

  • Industry Trends: The global healthcare market is highly fragmented, marked by intense competition. The increasing role of digital technologies, regulatory changes, consolidation, and the rise of patient-centric care are reshaping the industry landscape. Healthcare spending is expected to continue to grow due to the aging population, increased health awareness and insurance coverage. Consolidation of the industry continues to accelerate across all categories.

  • Margins: The company’s gross margins typically fall between 29-33% across its segments. However, gross margins vary based on a variety of factors, especially changes in product mix. Operating margins are impacted by fluctuations in revenue and operating expenses (mainly payroll and related benefits, sales, marketing and promotional costs, and depreciation).

  • Competitive Landscape: HSIC competes with a variety of players, including large distributors, manufacturers selling directly to customers, and a growing number of competitors in the technology sector. The market for dental and medical products and services remains competitive, but the health-care services sector sees increasing competition.

  • What Makes Henry Schein Different? Henry Schein positions itself as a “solutions company” rather than a pure product supplier, offering integrated and customized solutions, a wide range of offerings, and global market reach. The company emphasizes its strong brand recognition, customer relationships and supply chain network. It emphasizes a commitment to customer service, which is reflected in their “Team Schein” concept where employees are considered their greatest asset.

  • Recent Concerns/Controversies/Problems: In October 2023, Henry Schein experienced a cyber incident affecting their North American and European dental and medical distribution businesses, disrupting operations and sales. The company took steps to secure its systems and mitigate the effects of the incident. This incident impacted financial results for the last quarter of 2023 and is expected to continue to have an impact over the short to medium term. They have received an insurance reimbursement in order to soften the financial impact. A class action lawsuit is in progress claiming fraud. They expect to have a final resolution by 2024. They are also managing various other legal and regulatory challenges that can affect the company’s financial condition.

Financial Analysis

  • Revenue: For the year ended December 31, 2022, HSIC reported net sales of $12.5 billion. The breakdown of net sales is provided by various operating segments, as follows:
    • Health care distribution segment:
      • Dental distribution: $4.1 billion (32.6%)
      • Medical distribution: $5.4 billion (43.2%)
      • Other health care services : $2.2 billion (17.4%)
    • Technology and value-added services: $796 million (6.3%)

  • Income: The net income for the year was $400 million.

  • Operating expenses: Operating expenses totaled $2.7 billion, an increase compared to $2.6 billion in the previous year. This increase was mainly attributable to higher selling, general, and administrative expenses, which were partly offset by a decrease in restructuring costs.

  • Cash Flow: For the year ended December 31, 2022, cash provided by operating activities was $602 million, and net cash used in investing activities was $276 million and the net cash from financing activities resulted in outflow of $431 million.

  • Balance Sheet Health: Their cash and cash equivalents are relatively low. As of September 30, 2023, cash was $176 million compared to $240 million in the prior period. They have a strong amount of goodwill and other intangibles related to the acquisitions. Their total debt has decreased compared to prior year. Total liabilities were $10.1 billion as of Sept 30 2023 and have a similar total equity value of $6.0 Billion, which represents a balance sheet health rating of 4/5, with a scope for improvement.

They have noted some financial risks, such as fluctuations in global currency exchange rates, credit and other risks, which are expected to affect their financial condition. They are also subject to a high number of complex regulatory laws which present a risk to their profitability.

  • ROIC (Return on Invested Capital): ROIC in 2022 was about 11%, while in 2021 it was about 10%

Moat Analysis: 3/5

Henry Schein does have some competitive advantages, however, its overall moat can be deemed as narrow. Let’s discuss why:

  • Intangible assets: HSIC has some degree of brand recognition, especially in the dental and medical supply industry. However, the strength of this brand moat is not incredibly high, as brand is often not the sole decision driver for the buyer. The intangible assets for Henry Schein also comes from customer relationships, as they have been operating for a long time. But these relationships aren’t as sticky as say tech companies’ proprietary software systems. They do hold patents on some of their more novel products, which provides a very small moat. Finally, there are some regulatory hurdles for companies in the health care industry, and they do carry some weight for a moat.

  • Switching Costs: Switching costs are a small moat in their favor. Although they have recurring revenues, their clients can potentially go with other competitors which do not require very complex integrations. However, there is still some switching costs because of the complexity involved with setting up with new providers and the time that takes to transition.

  • Network Effects: They don’t have a great network effect which would give them a clear moat.

  • Cost Advantages: HSIC operates with some cost advantages, mainly in distribution due to having various distribution centers which create value for the company. The scale economies provide the ability to reduce costs compared to smaller players, giving them a small cost moat. However, they still face strong competition due to the fragmented nature of their customer base, therefore their cost efficiencies are limited.

Understandability: 3/5

Henry Schein’s business model is moderately complex, as it operates across multiple segments. The healthcare industry is also a complex industry. However, the business is easy to understand on the surface level, but understanding the nuances requires careful scrutiny of their financials. The intricacies of their operations, financial structures, and regulatory factors contributes to making this business difficult to analyse.

Balance Sheet Health: 4 / 5

Henry Schein has a fairly solid balance sheet. Though they do not have significant amounts of cash, they have significantly reduced their debt. They also have a reasonable equity position, allowing them to better navigate volatile times. A big portion of their balance sheet is also occupied by goodwill and other intangibles. The company needs to maintain a good balance between debt and equity to ensure long-term financial stability, and therefore the balance sheet gets a 4/5 rating.

Conclusion

Henry Schein is a major player in health care distribution and technology services. They have a decent moat because of their brand name, switching costs, scale, and the regulatory environment of their industry. However, many of these advantages are being challenged by new and existing competition. Their main focus should be to work towards strengthening their moats as well as increase cashflows, in order to better protect themselves from market disruptions and competition. While it is not easy to pick the winner in this fragmented industry, HSIC has the scale and resources to be successful in the future. The most prudent thing to do would be to observe the upcoming financial reports to assess how much the cyber incident has affected the business and if the company can return to its previous path of profitability. They also need to successfully integrate all their acquisitions to fully realize the benefits of the company.