SmileDirectClub Is a Flawed but Fun Short-Squeeze Play

SmileDirectClub (NASDAQ:SDC) stock represents a company that promises to bring down the cost associated with teeth straightening. SDC stock has made headlines recently, but the attention has little to do with its fundamentals.

a Smile Direct Club storefront

Source: Helen89 / Shutterstock.com

One of the main draws of the company is that its products are significantly cheaper than traditional wire braces and other clear aligners. The cost of SmileDirectClub’s products ranges from $1,950 to $2,386.

A survey conducted by Colgate notes that clear aligners cost anywhere between $2,000 to $6,000. Comparatively, traditional braces incur costs in the upper end of that range.

But while its business model has certain benefits, that’s probably not why investors are interested in SDC stock currently. Retail traders are smiling brighter because of the social media and meme stock phenomena that have swept up SmileDirectClub. 

SDC Stock Is the Latest Meme Trade

SDC stock is currently the fifth-most-heavily shorted stock on the market. Its 32.74% short interest makes it a prime candidate for a short squeeze. Retail investors are hoping to trigger that squeeze into existence, thus forcing institutional shorts to cover their positions as prices rapidly rise. 

SmileDirectClub became a popular theme on Reddit forums recently. It has suffered a series of poor quarterly results, with its most recent quarter adding to concerns. This drew the interest of short sellers, who were then followed by the short-squeeze crowd. 

As I stated earlier, the company’s recent results were disappointing. It registered an earnings per share (EPS) loss of 14 cents on expectations of a 10 cent loss. Revenues hit $174 million, about 12% below consensus expectations.

The company attributed its underperformance to an April cyberattack, which resulted in a $10 million loss. SmileDirectClub also places part of the blame on the continuing economic impact of Covid-19.

But the truth is that SDC shares have been rocky for quite some time. The company has seen its cash position fluctuate wildly on a quarter-to-quarter basis for more than a year. Since Q2 2020, its debt has increased from about $400 million to $744 million. 

That’s certainly a recipe for a bearish sentiment. 

SmileDirectClub Has Many Quantifiable Issues

SmileDirectClub’s $174 million Q2 2021 revenues represented a 63% year-over-year (YOY) increase. But, as mentioned previously, that was significantly lower than anticipated. Those revenues were 13% lower than those in the previous quarter. 

Furthermore, the company continues to record net losses quarter after quarter. SmileDirectClub lost $55 million in Q2. However, this was far less than the $95.7 million net loss it recorded a quarter earlier.

In some cases, investors reward such improvement even though net losses remain significant. I would assume that in this case, they didn’t because the company’s overall performance has been so shaky over the past year. 

This is likely because investors have no reliable indicator that those net losses will shrink in the coming quarters. Reading through the company’s financial statements, SmileDirectClub’s future feels like a flip of the coin: Losses could compound or improve with equal likelihood. 

Targeting the Rest of World

Another issue is that SmileDirectClub is focused on a questionable business opportunity. As the company’s most recent earnings report notes, it is focused on rest-of-the-world (ROW) markets:

“75% of our business opportunity resides in ROW markets. After only two years, ROW markets have achieved a level of brand awareness it took the U.S. five years to achieve. To build on this brand awareness and replicate the comparable levels of penetration achieved in the U.K. and Australia, we are overinvesting in ROW markets.”

The risk here is clear. ROW markets contributed only 16.4% of SmileDirectClub’s revenue in Q2. Further, the ROW profit margin is just under 70%. That’s roughly five percentage points lower than that of sales in the U.S. and Canada.

Yet the company’s average revenue growth projections of 20% to 30% over the next five years are predicated on 85% margins. 

You can see why Wall Street is betting against SDC stock moving forward. If you want to play the short squeeze game with the Reddit crowd, that’s fine. But there’s little to suggest SDC was wrongly shorted.

On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Alex Sirois is a freelance contributor to InvestorPlace whose personal stock investing style is focused on long-term, buy-and-hold, wealth-building stock picks. Having worked in several industries from e-commerce to translation to education and utilizing his MBA from George Washington University, he brings a diverse set of skills through which he filters his writing.


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