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Henry Schein (NASDAQ:HSIC) is a leading global distributor with business operations in 3 segments: 1) Dental supplies 2) Medical supplies 3) Veterinary supplies. Although the dental supplies business is currently its largest segment, its veterinary supplies business is expanding rapidly as well. The company primarily conducts its business in the US but has been aggressively expanding its international footprint and has been garnering impressive results. Henceforth, this article aims to discuss if the company is worthy of the attention of a long-term investor.

Industry study

Dental:

The aging population around the world is a trend that is known to many. As the number of seniors grows, there will be increasing cases of dental problems which will lead to an increased need for dental services.

Besides the aging population, more and more people are coming to the realization of the importance of having a healthy and good looking set of teeth. This has therefore led to increased demand for dental correction services.

Lastly, there has been an increasing uptake of dental insurance. With all expenses covered by insurance companies, people became much more motivated to head to the dentists.

Healthcare:

Similar to the dental trends, health care usage has increased due to the aging population and the implementation of Medicare and Medicaid services.

Veterinary:

There has been a great increase in pet ownership in the US over the past decade and this trend is expected to continue into the long future. According to APPA, total pet industry expenditures in 2012 amounted to $53.33 Billion, up from $32.4 Billion 10 years ago. With more pet owners now being more concerned with their pet's health, visits to the vet has increased and more supplies are needed.

Company Study

For the distributor business, the wider the selection of products, the more competitive the company becomes. A wide selection of products attracts a large customer base which confers 3 benefits to the company:

First, it attracts prominent vendors with better brands and products into its supply chain. With a better selection of products and brands in its portfolio, the company will in turn attract more customers, creating a very virtuous cycle for the company.

Secondly, it gives them bargaining power against vendors to lower purchase costs. Such, will help in maintaining margins for the company.

Lastly, and the best of all, is the economics of having a larger customer base. As the chances of cross selling are higher in the distributor business, a large customer base becomes a large multiplier for revenues going forward.

Hence, for Henry Schein, the company excels in product scope and customer base. As of 2012, the company offers more than 100000 products and has a customer base of nearly 775000 customers. Besides being the largest distributors in dental supply, they are also the largest distributor of healthcare products and services to office-based healthcare practitioners in the combined North American and European markets. Finally, with the addition of Provet Holdings in 2010, Henry Schein is now the animal health distribution market leader on three continents.

The best thing about Henry Schein is that it would be very hard to duplicate the competitive advantage of having a large product offering consisting of good brands and good quality products. Most distributors would require vendors with good brands to sign exclusive agreements. As such, most vendors would rather sign on with the distributor with a larger customer base and distribution network instead of a smaller one.

Moving on to some financial metrics, the table below compares Henry Schein's important financial ratios between 2 periods.

2003-2007

2008-2012

Annualized Earnings growth

18.25%

12.04%

Ave. Net margins

3.73%

4.83%

Ave. Asset turnover

1.88

1.77

Ave. Debt to equity

96.20%

73.07%

Ave. Return on equity

14.01%

15.57%

Ave. Return on capital

12.94%

15.58%

Even though earnings growth and asset turnover may have fallen over the 2 periods compared, it was largely due to the now larger earnings and asset base. However, they are still high compared to many other companies.

Besides that, most of the financial metrics can be seen improving.

Competitive study

In the dental and medical supplies segment, Henry Schein faces competition from Patterson Co. (NASDAQ:PDCO) and many other smaller regional distributors. While in the veterinary supplies segment, Henry Schein competes against MWI Veterinary Supply (NASDAQ:MWIV), Patterson Co. and many other smaller regional distributors.

HSIC Vs. PDCO Vs. MWIV:

Although all companies are similar operationally, Henry Schein is a stronger competitor due to its aggressive global diversification while Patterson and MWI Veterinary are much more focused on the US. Such diversification allows them to find vendors which supply cheaper products with good quality all over the world.

Also, with such large coverage gives them a very large customer base. (The benefits of a large customer base are described above). Based on 2012's annual reports, Patterson Co. reportedly only served about 150000 customers as compared to Henry Schein's 775000

A comparison of their financial metrics is shown in the table below.

2008-2012

HSIC

PDCO

MWIV

Annualized Earnings growth

12.04%

0.80%

26.54%

Ave. Net margins

4.83%

6.50%

2.58%

Ave. Asset turnover

1.76

1.38

3.11

Ave. Debt to equity

72.87%

80.94%

78.98%

Ave. Return on equity

15.53%

15.54%

14.22%

Ave. Return on capital

15.58%

14.24%

14.21%

As can be seen from the table above, Henry Schein provides better returns and has a better debt position as compared to its competitors. Although it may have a lower earnings growth and asset turnover as compared to MWIV, it would be important to point out that MWIV has a very low starting point (smaller earnings and asset base) as compared to Henry Schein.

HSIC Vs. Smaller regional competitors:

Besides the larger product scope, Henry Schein also has a wider distribution network. The dental, healthcare and veterinary industries are consolidating and practices with national networks are emerging. To function smoothly, these networks often prefer to do business with distributors with large networks.

Furthermore, in recent years, the healthcare industry has been focusing on cost containment. Many small practices have grouped together to form large purchasing groups to negotiate better pricing with distributors. Therefore, a combination of large national practices and purchase groups have put a strain on the finances of many small and regional competitors. As such, many are now seeking to sell their businesses to larger networks. This, in my opinion, is a good trend for the larger distributors like Henry Schein as they get to increase the size of their customer base.

Conclusion

To sum things up, Henry Schein would be a very good long-term investment considering the industry trends and its competitive strengths. However, the current price of $94.40 or PE of 21.83 at the closing on 11th May is a little too high.

My estimated value for the company is $87.19 or a PE of 20.18. Investors would do well if they were to purchase shares of this company at a price level below this.

Source: Henry Schein: A Treasure For Long-Term Investors