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Introduction to a small cap opportunity

On occasion during my weekly research a company of interest pops up in a screen or the news that leads or even begs for further study. Patterson Companies (NASDAQ:PDCO) is one of those studies for me.

PDCO was added to my portfolio in March 2013 and since that time has returned 5.73%. As I approach six months with the new holding I am revisiting it to consider a buy (more), hold, or sell decision. There are some things to like right now.

Patterson Companies, Inc. is a distributor serving three markets: North America dental supply, the United States companion animal and equine veterinary supply, and the worldwide rehabilitation and assistive products supply market. Patterson Companies operating units include Patterson Dental a distributor of dental products in North America and Webster Veterinary a distributor of veterinary supplies primarily to companion-pet and equine veterinary clinics across the United States.

I particularly like continuing to have the exposure in the pet product and veterinary care industry segments. The pet product industry serves a large and growing market and industry wide revenues are expected to grow at around a 5% clip over the next five years for more than $50 billion.

The company reports that effective August 2, 2013 Patterson acquired Mercer Mastery a developer of dental practice software from Lovell Minnick Partners LLC's Mercer Advisors Inc. subsidiary. Also in August 2013 Patterson Companies Inc. completed acquisition of the stock of National Veterinary Services Limited, a wholly owned subsidiary of Dechra Pharmaceuticals PLC.

Patterson Companies, Inc. operates as a distributor serving the dental, companion-pet veterinarian and rehabilitation supply markets. Dental Supply accounted for 65% of revenues in FY 13; Veterinary Supply for 21%; and Rehabilitation Supply for 14%.

According to annual reports the company seeks to emphasize its value-added full-service capabilities using technology to enhance customer service improve operating efficiencies and expand through internal expansion and acquisitions.

Patterson estimates the dental supply market it serves at approximately $6.8 billion annually with its share of this market at about 33%. The company markets its dental products and services through more than 1,500 direct sales representatives 271 of whom are equipment specialists.

PDCO estimates the market for pharmaceuticals and supplies sold to companion animal and equine veterinarians through distribution at about $3.2 billion on an annual basis. Patterson believes its share of this market is about 21%.

Patterson believes the rehabilitation medical supplies and assistive products industry is approximately $5.6 billion worldwide and is expected to grow faster than the overall economy over the next several years. Industry growth is driven by strong growth in the physical and occupational therapy markets and favorable demographic trends associated with the aging of the baby-boom generation. Patterson believes it has a market share of approximately 12% in the highly fragmented rehabilitation products market.

A brief summary of peers and other industry leaders

I think at this juncture it is also important to view PDCO in relationship with the business model and financial ratios of a peer group of companies.

Zoetis Inc (NYSE:ZTS) is engaged in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. It is noted that ZTS is a recent spin off from Pfizer and initial returns are favorable.

MWI Veterinary Supply, Inc (NASDAQ:MWIV)products include pharmaceuticals, vaccines, parasiticides, diagnostics, capital equipment, supplies, specialty products, veterinary pet food and nutritional products. MWI markets the products to veterinarians in both the companion animal and production animal markets.

Owens & Minor, Inc. (NYSE:OMI) is a provider of third-party logistics (3PL) services to manufacturers and suppliers of healthcare and life-science products.

Henry Schein, Inc. (NASDAQ:HSIC) is a provider of health care products and services to office-based practitioners. The Company conducts its business through two segments: healthcare distribution and technology.

So, do numbers prove the worth?

As a shareholder you would have to appreciate the most recent announced plans for share repurchases and quarterly dividend increases.

PDCO repurchased 5.2 million of its common shares during FY 13, and 12 million in FY 12. In March 2013 the company announced a new 25 million repurchase program that extends to March 19, 2018. About 24.4 million shares remained available for repurchase under the new plan as of mid-May 2013. Patterson raised its quarterly cash dividend by 14%, to $0.16 per share, in March 2013. Including share repurchases and quarterly dividends, Patterson returned $223 million to its shareholders in FY 13. In mid-May 2013, PDCO projected FY 14 EPS in the $2.10-$2.20 range, including an EPS impact of $0.06 from investments in information technology.

Here is this week's study by the numbers

Key Ratios Comparison

Trailing Twelve Months, Except Where Noted (Reporting Periods Defined Below)

Ratio

PDCO : Patterson Companies Inc NASDAQ

S&P United States BMI Health Care

S&P 500 Index

Price/Earnings

19.98

18.16

16.85

Price/Forecasted Earnings (FYF)

18.72

13.01

15.20

Price/Tangible Book (MRQ)

11.11

2.65

2.48

Price/Sales

1.17

1.25

1.50

Price/Cash Flow

16.70

11.80

13.15

Return on Equity (%)

15.11

13.63

13.07

Dividend Yield (%)

1.57

1.86

2.10

The dividend yield is probably in all honesty below the ideal for my income portfolio standing currently at 1.57%. Return on Equity is respectable compared to benchmarks.

Financial Ratios in Peer Group Comparison

Fundamentals

Description

Patterson Owens and Minor

MWI

Zoetis Henry Schein

Net Profit Margin

5.8

1.2

2.6

10.1

4.7

Debt to Equity

1.9

0.3

0.0

1.7

0.9

Return on Equity

55.0

15.7

23.9

19.3

78.1

Return on Assets

7.8

4.9

7.7

7.0

7.3

Earnings

Description

Patterson Owens and Minor MWI Zoetis Henry Schein

Earnings per Share

2.0

1.7

4.8

0.8

4.6

Price/ Earnings

19.7

20.7

31.5

34.7

21.9

Price/ Earnings (NFY)

18.3

16.6

27.4

18.0

18.7

Price/ Sales

1.2

0.2

0.9

3.4

1.0

Price/ Earnings/ Growth

1.9

2.3

2.1

2.4

2.0

PDCO actually shows very well against the peers in net profit margins, return on Equity and return on assets.

So, based on the information, news, and financial ratio comparisons, we have come to decision time.

There is a lot to like right now with the acquisitions and the strength in the industry segments and the position as a top market leader.

Further Considerations

As I use more of a value approach (i.e. position within industry, industry position within the current economy, opportunity for capital appreciation, current price performance). PDCO earns checks. Finally, how does PDCO fit within my current portfolio? The yield is of particular interest in the current income strategy and is below the goal however the sector is underweighted versus other industry sectors.

Conclusion

As a result then PDCO now becomes a likely small cap candidate to be a HOLD in my portfolio.

But as the year end approaches and rebalancing decisions are made with an eye toward income we will see.

Disclaimer: These are only personal opinions and all readers should do their own research. Readers are accountable for investment decisions and trades.

Disclosure: Securities prices and yields quoted are current as of September 21, 2013.

Source: Patterson Companies - Doing So Much Right, Right Now

Additional disclosure: I do not know the circumstances, risk tolerance or investment objectives of the readers. There is no guarantee that any investment mentioned in this article will be profitable or appropriate for readers.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PDCO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.