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Is SmileDirectClub a Risky Buy?

By David Jagielski – Updated Jun 5, 2020 at 5:03PM

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A lack of profitability isn't the only thing investors need to worry about.

SmileDirectClub (SDC -4.91%) first began trading last September, and the stock's price today is nowhere near the $23 per share at which it IPO'd. In fact, it's lost more than half of its value since then, and things could continue to get worse for shareholders from here on out. The teledentistry stock might sound like an ideal one to hold during a pandemic, but that may not be the case. Here's why SmileDirectClub may be in trouble:

The company's come under fire about its products

The main selling points of SmileDirectClub's teeth-straightening products are that they cost less than traditional braces and patients don't need to make multiple visits to see a dentist. With the company's at-home kit, patients can even make impressions of their own teeth without needing to visit a SmileShop for an in-person scan.

However, there's been a lot of publicity of late surrounding SmileDirectClub's products and how effective they are. The Nashville-based company has more than 2,300 customer complaints on the Better Business Bureau website, many relating to the quality of the products and how well they fit.

Someone holding a retainer.

Image source: Getty Images.

On May 18, SmileDirectClub announced that it was suing NBC over what it called a "defamatory and error-filled" broadcast on the station's Nightly News program, which the company said "contained more than 40 false and misleading statements about SmileDirectClub." The network highlighted some of the challenges that customers had with using the products, as well as the pain that some were experiencing from using them. However, the company contests the accuracy of the information, saying that "NBC knew it was not telling the truth to its viewers and readers."

The proof will be in the results

This is a problem for investors. Future growth may struggle if the products are indeed of poor quality. In fact, there may already be indications that growth is running into roadblocks. In 2019, SmileDirectClub's sales were up 77% year over year. But in its first-quarter 2020 results, which the company released on May 13, sales were up a much more modest 11% from the prior-year period. On the company's earnings call, CFO David Katzman estimated that after adjusting for the impact of COVID-19, net revenue growth for the quarter would have been 33%. In Q4, the year-over-year growth rate was 53%.

Things are clearly slowing down for SmileDirectClub, and the danger is that a black mark on its products could make for more trouble ahead for its sales. A big test will come for the company when it releases its second-quarter results this year. We'll see whether the negativity surrounding SmileDirectClub's products will weigh on the results, or if COVID-19 and social distancing give the stock an added boost during the quarter.

With many people losing their jobs and needing to stretch their budgets as far as they can, SmileDirectClub -- as the cheaper alternative to braces -- should see an improved quarter in Q2. If that doesn't happen, investors may need to take a long, hard look at the results to decide if there's a reason to believe the company can turn things around and become a good growth stock again.

Is SmileDirectClub a Buy?

The risks of investing in SmileDirectClub go beyond just sales growth. The company hasn't posted a profit yet, and it's not making a whole lot of progress in that direction, either. In Q1, net losses were $107.4 million -- five times the $20.5 million loss in same period last year. Rising expenses are outpacing revenue growth, and that's a problem the company will need to improve upon in order to get to breakeven.

To make matters worse, SmileDirectClub stock is trading at more than 9 times its book value -- a hefty multiple given the challenges facing the company today.

But despite all the problems the stock is facing, shares of SmileDirectClub are down a modest 2% since the start of the year, which is in line with how the S&P 500 has performed thus far.

SmileDirectClub doesn't pay a dividend, its sales growth has sharply declined, and the stock is trading at a high valuation. The negativity surrounding the company's products only seals the deal as to why the stock isn't a buy. There's just too much risk involved at this point.

At a minimum, investors should wait until SmileDirectClub reports its Q2 results before making any decision on the healthcare stock.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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