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Life Science Tools & Diagnostics

Year Ahead Outlook 2020 – Top Ideas: XRAY,

LH, IQV, and CHWY

Life Science Tools and Diagnostics | Sector Forecast

We continue to view less conventional names as an attractive play in healthcare, particularly as

we head into a US Presidential election year, where healthcare access and drug pricing will

remain key topics of debate, driving heightened headline risk and volatility for associated names,

including

Drug Distributors

. In this context, we favor

Animal Health

, a sector inherently

shielded from traditional human health dynamics, where underlying fundamentals remain robust

on healthy pet adoptions, “humanization” of pets, and market-expanding innovation, with the

embrace of new alternative channels also offering support. For

Dental

, our focus is on renewed

innovation efforts, which should offer company-specific catalysts, particularly relevant in a still

lackluster, albeit seemingly stabilizing, North America end market. Meanwhile, biotech funding

levels remain elevated, a trend that should support growth across larger, diversified

CROs

offering attractive, alternative biopharma exposure, sheltered from binary outcomes inherent in

drug development. Lastly, across our current

Life Sciences & Diagnostics

cohort, we favor

companies with more diversified platforms, which should offer multiple levers for growth. Below,

we summarize our best ideas across our broad coverage universe heading into 2020.

■

Dental Top Pick

—Dentsply Sirona (XRAY): XRAY’s management has demonstrated

building traction on its turnaround story with an aggressive restructuring plan and stepped

up innovation now more meaningfully materializing as we head into 2020, and we view it

will continue to reap rewards from these initiatives in 2020 and beyond.

■

Animal Health Top Pick

—Chewy, Inc. (CHWY): As the leader in pet e-commerce,

CHWY is well positioned amid a robust pet care industry, with an expanding customer

base, unique customer engagement, and considerable Autoship adoption supporting strong

recurring revenue streams, with line of sight to (adj. EBITDA) profitability in 2020,

leveraging its technology and expanding product offering, along with its ramping scale.

Importantly, we make no changes to our positive bias on

Zoetis

as an industry leader,

where momentum should continue on innovation catalysts bolstering an already immensely

diversified global portfolio with high visibility on growth and strong cash flow characteristics.

■

Contract Research Organizations (CROs) Top Pick

—IQVIA Holdings (IQV):

Bookings of $5.8 billion merger-to-date related to its Next Gen Solutions should contribute

to more meaningful topline growth, ahead of industry, with recently unveiled medium-term

guidance calling for +6-9% organic growth from 2019-2022. While it has clearly set lofty

LT growth goals, we view it can leverage its unmatched data assets with its size and scale

to capture greater share, while also boasting a relatively diversified customer base.

■

Life Sciences/Diagnostics Top Pick

—LabCorp (LH): We view multiple avenues for

growth across LH’s diversified platform, despite continued headwinds in core clinical

laboratory services, with CRO drivers and strong cash flow generation offering capital

deployment flexibility, particularly relevant given its role as a leading consolidator of smaller

lab operations in a post-PAMA world.

We are adjusting target prices across specific companies on various factors including regulatory

overhangs, demand dynamics, and company-specific factors.

8 January 2020

Equity Research

Americas | United States

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS,

LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business

with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could

affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Research Analysts

Erin Wilson Wright

212 538 4080

[email protected]

Katie Tryhane

212 325 2713

[email protected]

Haley Christofides

212 325 3720

[email protected]

Matthew Urbik

212 325 2152

[email protected]

8 January 2020

Life Science Tools & Diagnostics

Our Recommendations for 2020

Figure 1: LST&D Coverage Universe (Ratings and Target Prices)

Source: Company data, Credit Suisse estimates

We view less conventional names as an attractive play on the healthcare space, particularly as

we head into a Presidential election year, where healthcare access and drug pricing will likely

remain key topics of debate, driving heightened headline risk and associated volatility for

associated names, including Drug Distributors. In this context, we favor Animal Health, a sector

inherently shielded from traditional human health dynamics, where underlying fundamentals

remain robust on healthy pet adoptions, “humanization” of pets, and market-expanding

innovation, with the embrace of newer/alternative channels also offering support. For Dental,

our focus is on renewed innovation efforts, which should offer company-specific catalysts,

particularly relevant in a still lackluster, albeit seemingly stabilizing, North America end market.

Meanwhile, biotech funding levels remain at healthily elevated levels, a trend that should support

growth across larger, diversified CROs, offering attractive, alternative biopharma exposure,

sheltered from binary outcomes inherent in drug development. Lastly, across our current (albeit

expanding) Life Sciences cohort, we favor companies with more diversified platforms, which

should offer multiple levers for growth. Below, we summarize our best ideas across our broad

coverage universe heading into 2020 as well as the key investment themes within each

subsector.

Dental Contract Research Organizations

Dentsply Sirona XRAY Outperform $65 IQVIA Holdings IQV Outperform $175

Envista Holdings NVST Neutral $30 ICON PLC ICLR Outperform $187

Align Technology ALGN Outperform $320 PRA Health Sciences PRAH Outperform $122

SmileDirectClub SDC Outperform $17 Syneos Health SYNH Outperform $66

Henry Schein HSIC Neutral $70 Medpace Holdings MEDP Outperform $91

Patterson Companies PDCO Outperform $25 Charles River Laboratories CRL Neutral $158

Animal Health Life Sciences & Diagnostics

Zoetis ZTS Outperform $143 Avantor AVTR Outperform $20

IDEXX Laboratories IDXX Outperform $293 Danaher DHR Outperform $65

Elanco Animal Health ELAN Restricted - LabCorp LH Outperform $182

Phibro Animal Health PAHC Neutral $25 Quest Diagnostics DGX Neutral $105

Covetrus CVET Neutral $11 Fulgent Genetics FLGT Neutral $12

Chewy CHWY Outperform $34 Lantheus Holdings LNTH Neutral $20

Petmed Express PETS Underperform $16

Distributors

AmerisourceBergen ABC Outperform $98

Cardinal Health CAH Outperform $56

McKesson MCK Neutral $145

Owens & Minor OMI Underperform $3.80

8 January 2020

Life Science Tools & Diagnostics

Figure 2: Healthcare Subsector Price Performance

Source: Company data, Credit Suisse estimates, Factset, *Dental excludes Align Technology

Dental Companies

Underlying demand dynamics remained perplexing in 2019 following a couple years of notably

lackluster growth, with overall consumables trends, particularly in the US, still lagging behind

what would be expected in an improved macroeconomic environment. That said, we are

beginning to see

signs of stabilization

across the underlying end market, with constituents

posting slight year-over-year improvements in 2019, a dynamic we expect to continue into

2020. Meanwhile, equipment trends were mixed in 2019, with improvement across pockets of

the market driven by benefits from an IDS year and relative

exposure to meaningful

innovation

, where constituents such as Dentsply Sirona are beginning to reap rewards from

focused R&D efforts.

Figure 3: Recent Quarterly Dental Demand Trends as Reported by Industry Constituents

Source: Company data, Credit Suisse estimates

Following a year of company-specific operational issues and management turnover in 2018, we

began to see

traction on self-help initiatives

in 2019 (e.g. salesforce execution, renewed

2012 2013 2014 2015

Biotechnology 57.6% Specialty Pharma 91.7% Managed Care 42.6% Contract Services 42.0%

Hospitals 37.3% Drug Retailers & PBMs 81.2% Biotechnology 38.8% Managed Care 19.8%

Contract Services 37.2% Biotechnology 71.4% Specialty Pharma 37.3% Diagnostics 18.9%

Drug Retailers & PBMs 32.7% Drug Distributors 63.8% Hospitals 36.9% Dental* 14.3%

Diagnostics 31.8% Contract Services 57.1% Drug Retailers & PBMs 29.1% Animal Health 11.4%

Animal Health 27.7% Healthcare Technology 46.1% Medical Devices 28.1% Clinical Laboratories 10.3%

Life Science Tools 22.0% Hospitals 44.0% Drug Distributors 25.9% Life Science Tools 8.9%

Medical Devices 16.9% Medical Devices 40.9% Dental* 23.9% Drug Retailers & PBMs 7.9%

Drug Distributors 14.0% Managed Care 40.3% Diagnostics 23.2% Medical Devices 7.7%

S&P 500 Index 13.4% Life Science Tools 38.9% Contract Services 22.1% Biotechnology 7.6%

Specialty Pharma 9.0% Dental* 37.0% Clinical Laboratories 21.7% Drug Distributors 6.9%

Large Cap Pharma 7.5% S&P 500 Index 29.6% Animal Health 19.7% Specialty Pharma 3.8%

Dental* 6.7% Diagnostics 27.9% Large Cap Pharma 14.0% Large Cap Pharma 2.2%

Managed Care 5.9% Large Cap Pharma 27.1% Life Science Tools 12.0% Healthcare Technology 1.5%

Healthcare Technology 3.2% Animal Health 24.0% S&P 500 Index 11.4% S&P 500 Index -0.7%

Clinical Laboratories 0.6% Clinical Laboratories -1.3% Healthcare Technology -6.6% Hospitals -17.9%

2016 2017 2018 2019

Animal Health 24.6% Managed Care 47.5% Medical Devices 17.3% Contract Services 46.2%

Clinical Laboratories 16.5% Life Science Tools 40.5% Healthcare Technology 19.6% Specialty Pharma 39.2%

Managed Care 12.1% Diagnostics 37.9% Diagnostics 15.4% Life Science Tools 37.3%

Medical Devices 11.1% Animal Health 35.5% Managed Care 9.3% Medical Devices 34.1%

Contract Services 10.0% Healthcare Technology 33.1% Large Cap Pharma 8.6% Dental* 30.5%

S&P 500 Index 9.5% Contract Services 28.7% Animal Health 2.6% Clinical Laboratories 30.5%

Healthcare Technology 4.6% Medical Devices 22.5% Contract Services 2.5% S&P 500 Index 29.5%

Dental* 3.0% Biotechnology 22.3% Life Science Tools 2.3% Animal Health 24.3%

Life Science Tools 2.5% S&P 500 Index 19.4% Hospitals -6.0% Managed Care 19.7%

Large Cap Pharma -1.4% Dental* 16.9% S&P 500 Index -6.2% Diagnostics 17.2%

Diagnostics -8.3% Clinical Laboratories 15.7% Biotechnology -8.6% Drug Distributors 17.1%

Drug Retailers & PBMs -9.6% Large Cap Pharma 10.9% Specialty Pharma -14.7% Hospitals 17.0%

Biotechnology -21.9% Drug Distributors 4.5% Clinical Laboratories -18.1% Large Cap Pharma 14.8%

Drug Distributors -24.3% Hospitals -3.8% Drug Distributors -25.1% Biotechnology 14.4%

Hospitals -29.9% Specialty Pharma -12.8% Drug Retailers & PBMs -26.5% Healthcare Technology 4.6%

Specialty Pharma -36.2% Drug Retailers & PBMs -22.0% Dental* -27.8% Drug Retailers & PBMs -2.1%

4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19

Consumables -- Negative Negative -MSD -L-MSD -LDD + Slightly -MSD +LSD +LSD -LSD +LSD

Equipment -- Positive +LSD +LSD -MSD -HSD + Slightly -MSD ~Flat +LSD/+MSD -LSD -MSD

Consumables -2.8% -4.3% -3.6% -4.4% -7.4% -6.7% -5.2% -2.2% -1.9% -0.9% -0.4% -0.1%

Equipment -1.0% -16.9% -15.1% -17.7% -10.6% -20.2% 5.4% -0.9% 5.6% 13.1% -6.6% 12.3%

Consumables 1.9% 2.5% 0.8% 1.3% 1.9% 2.7% 4.7% 4.3% 2.5% 2.5% 1.3% 1.2%

Equipment 2.7% -5.5% 14.8% -0.7% 18.1% 4.4% 6.2% 5.9% -4.3% 3.3% -2.9% -4.5%

Consumables 2.5% 8.0% 1.4% 3.4% -2.6% 2.4% 3.0% 3.5% 3.4% 5.5% 2.3% 4.1%

Equipment -3.9% 3.1% 3.6% 2.6% 7.7% 3.1% 4.7% -4.2% 1.3% -1.2% -2.0% 7.9%

Consumables 3.5% 2.4% 2.0% 4.3% 3.9% -1.3% 3.3% -3.0% 5.4% -0.6% -4.1% 3.2%

Technologies 0.0% -12.7% -10.0% -1.1% 5.9% -1.6% -1.1% -9.3% -4.2% 7.9% 9.3% 11.0%

Oral Care -1.0% 5.0% 0.0% 3.0% 3.0% 0.0% 3.0% 2.0% 4.0% +LSD +LSD +Slightly

Coltene

Consumables

2.0%

2.7%

4.2%

1.8%

2.8%

3.3%

Dentsply Sirona

Envista

Patterson

HSIC N.A.

HSIC Int'l

8 January 2020

Life Science Tools & Diagnostics

innovation efforts), with potentially strengthening, albeit still moderated relative to historical

trends, performance in 2020. Overall, we remain positively biased on the dental market in light

of favorable longer term demographics, with notably less exposure to US policy uncertainty

plaguing more traditional healthcare names, particularly as turnaround stories more meaningfully

manifest.

Theme #1: Renewed Focus on Innovation Offering NT Upside/Catalysts

Following several years of internal disruption driven by mega mergers (

DENTSPLY Sirona

) and

management turnover (

Patterson Companies

), as well as lack of prioritization as part of a

larger entity (

Envista Holdings

, prior to

Danaher

spin), meaningful innovation across the

dental markets remained seemingly out of focus, exacerbating an already lower growth

environment. That said, management stability and reinvigorated prioritization initiatives across

core constituents has been an encouraging dynamic, where we highlight XRAY’s turnaround

efforts are gaining traction under new management, while NVST is now positioned as a more

nimble, standalone entity following its spin-off from DHR in September. As we head into 2020,

renewed focus

on the development of more meaningful innovation should drive an

acceleration in growth across targeted segments, particularly as dentists are inspired to increase

capital outlays in order to adopt the latest technology, a dynamic that should also benefit

traditional distributors.

In terms of high-tech equipment, the

digitization of dentistry

should remain a supportive long

term tailwind for the market, particularly given 43% of practitioners still do not utilize newer

intraoral impression scanners or CAD/CAM technology, according to our YTD proprietary survey

work (see note Survey Says: Dental Demand Remains Subdued). That said, penetration has

been limited by high required cost outlays (e.g. too expensive), limited ease of use (e.g.

complexity), and inadequate education efforts. However, more recent notable innovation by

discerning constituents (XRAY’s Primescan; NVST’s KaVo X Pro / X500) across the digital

impression market attempt to

address key sources of friction

, with focus on enhancing ease

of use with gesture control capabilities and captive touch buttons, reducing scan times, and

supporting increased interoperability with open-architecture systems, with some offerings also

focused on addressing cost (KaVo X500). All in, these products, particularly Primescan, where

XRAY already has an established presence in the digital impression market, should offer a

tailwind in 2020

for both the respective manufacturer as well as its distributor partners.

Outside of high-tech equipment, we are also encouraged by

targeted innovation

efforts

across pockets of traditional consumables and specialty segments, representing potentially

meaningful growth drivers in 2020. For XRAY, we note its TruNatomy offering (traditional

consumables) and new implant system from AstraTech (specialty), among others, while for

NVST we highlight its particular focus on specialty, with recent/pending launches including its

N1 implant system (specialty) and Spark clear aligner system (specialty). All in, following a

prolonged innovation drought, enhanced R&D efforts at select manufacturers are clearly

beginning to bear fruit, offering upside catalysts in 2020 and beyond.

Theme #2: Efficiency & Restructuring Initiatives Remain Key to Stories

amid Still Lackluster, albeit Potentially Stabilizing, Underlying Market

In a lackluster, albeit potentially stabilizing, market, where consumable trends have remained

perplexing over the past several years despite a healthy macroeconomic backdrop, compounded,

in some cases, by a period of relationship shifts and management misexecution, restructuring

and efficiency initiatives have become increasingly important component of earnings growth (vs.

operating leverage). We remain positively biased toward companies that have demonstrated

tangible traction

on necessary restructuring efforts and who continue to prioritize diligent cost

management thereon, initiatives that should improve associated companies’ market positioning

across the broader dental market longer term.

Company-specific disruption during the 2016/2017 period contributed to volatile earnings and

share price performance, and ultimately led to a complete overhaul of top management at both

Dentsply Sirona

and

Patterson Companies

. At XRAY, the job at hand was clearly daunting,

with new management tasked with transforming a failed mega merger (of

DENTSPLY

8 January 2020

Life Science Tools & Diagnostics

International

and

Sirona Dental Systems)

by rightsizing core functions and driving

successful cross-selling efforts across Sirona’s equipment installed base and DENTSPLY’s

consumables, a key rationale behind the initial merger. Despite a checkered experience at

previous firm Cardinal Health, since CEO Don Casey has taken the helm, XRAY has taken

tangible steps forward, and while goals seemed aggressive out of the gate, targeting 20% EBIT

margins by 2020; 22% by 2022), it has demonstrated solid execution, with its restructuring

plan currently ahead of schedule, potentially offering upside to Street estimates as we await an

update on long term targets in early 2020.

On the other hand, while PDCO’s turnaround story has progressed at a glacial pace, investor

expectations remain notably low, with shares still trading at 9.3x 2021 EV/EBITDA, a

meaningful discount to its historical average (10.8x) and to

Henry Schein

(11.3x). Meanwhile,

internal initiatives are beginning to take hold, with management recently outperforming

expectations, predicated on success with strategic private label focus, as well as improvement

across its salesforce, with growth drivers also stemming from successful innovation from leading

dental constituents (e.g. XRAY’s Primescan). New CFO Donald Zurbay’s efforts to implement

more rigorous financial functions over the past ~year is also encouraging, as it should support

PDCO’s ability to manage expectations going forward.

We also note

Align Technology’s

tax restructuring initiatives, which could offer an earnings

and FCF benefit in 2020. Meanwhile, HSIC will begin a new restructuring program (excl. from

non-GAAP metrics) to reduce stranded costs related to the spin/merger of Henry Schein

Animal Health/Vets First Choice (now

Covetrus

) over time, among other initiatives, with cost

savings partially reinvested in certain IT initiatives (not quantified). Importantly, while XRAY’s and

PDCO’s restructuring plans target a meaningful operational overhaul, HSIC’s plan will be less

impactful to its overall story (on a relative basis).

Theme #3: Rapidly Evolving Clear Aligner Market

The rapidly evolving clear aligner market has undoubtedly been a key focus across the dental

sector, with investors closely scrutinizing the potential implications of a more competitive

doctor-directed

market, as well as the development of the newer, and more controversial,

direct-to-consumer

market. While we view volatility will likely continue, to some extent, into

2020 for participants with concentrated clear aligner portfolios, including

Align Technology

and

SmileDirectClub

, on evolving market dynamics, we also emphasize that the broader,

global orthodontics market remains vastly underserved from a clear aligner perspective, with

clear aligner participants penetrating less than 1% of the 500 million addressable patient

population today. All in, despite an increasingly competitive landscape, we continue to view the

sizeable market is large enough for multiple players, where a rising tide can lift all boats, with

incremental marketing/education efforts and product launches supporting the adoption of clear

aligners as the new “standard of care” (vs. traditional brackets & wires).

More specifically, in the doctor-directed markets, investor concern initially rose heading into the

annual AAO conference in 2018, at which several well-known constituents, including

Henry

Schein

and

Dentsply Sirona

, among others, introduced clear aligner offerings, which intended

to compete alongside (e.g. displace) ALGN’s current offerings. By mid-2019 investor concerns

seemingly eased as the newer doctor-directed offerings demonstrated limited penetration

success and less comprehensive scope of treatment (vs.

Align

), and as focus shifted to the

potential implications of a lower cost direct to consumer (DTC) market, whereby doctors and

associated offerings used in the practice would be disintermediated in the retail setting

(discussed further below).

However, as focus around the DTC market and its disruptive potential has subsided over the

last few months of 2019, concerns around the doctor-directed markets have picked back up,

compounded by new commentary from key dental constituents. Notably,

Envista Holdings

recently announced its intention for a domestic launch of its Spark clear aligner following a pilot

launched late last year, a dynamic that comes earlier than expected following better than

expected initial market reception. While these newer offerings will potentially drive incremental

volatility for ALGN along with incremental headline risk, meaningful penetration is likely a much

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