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Summary

  • Patterson reports results which are largely in line with expectations.
  • The company has a great history of growing the business and reducing its share base.
  • Yet earnings have been stagnant amidst margin pressure.
  • Margin recovery could create upwards potential, yet I don't notice urgency with management to immediately address long-term margin pressure.

Patterson Companies (PDCO), the conglomerate focusing on dental, veterinary and medical businesses, reported its first-quarter results for its new fiscal year for 2015.

Results were largely in line with estimates. While I like the long-term growth in sales and consistent share repurchases, I don't like shares at a modest premium compared to the overall market. This is unless the company will finally tackle the compression of long-term margins after building a more diversified conglomerate over the past decade.

As such I remain on the sidelines for now.

A Solid Start To The Fiscal Year

Patterson posted first-quarter sales of $1.06 billion for the fiscal year of 2015, being up by 20.4% compared to last year. Reported revenues came in just ahead of consensus estimates at $1.04 billion.

Despite reporting rapid top-line growth, earnings growth has been lagging as earnings improved by just 9.6% to $50.3 million. Amidst modest share repurchases, earnings were up by five cents to $0.50 per share on a diluted basis. Earnings were exactly in line with consensus estimates of analysts.

Growth, Aided By Deals

Of course the 20.4% reported headline sales growth looks great, but this growth was seriously aided by the acquisition of National Veterinary Services which added $174 million in quarterly sales. Adjusting for this sales were up a paltry 0.6% across the remainder of the company.

Total dental sales came in at $552.7 million, a 0.3% decline versus last year. Most of this declines was the result of adverse currency movements which impacted sales by some $3.3 million. Operating earnings were actually down slightly as well with margins falling to 9.6% of sales, being down roughly 40 basis points compared to last year.

Veterinary sales rose nearly doubled on the back of the NVS deal, yet organic growth was relatively solid as well, being up by roughly 6.2% on an annual basis driven by higher sales of consumables. Operating earnings were up as well, but lagged overall revenue growth. Margins came in at a paltry 3.6% of sales, being down 90 basis points compared to last year. The NVS deal added two pennies to reported earnings of this year.

Sales from the rehabilitation supply business fell by 4.5% to $120.6 million. Despite the fall in sales, operating earnings were up with margins improving to 14.6% of sales, being up by 130 basis points. Sales were hurt by modest divestments of non-core assets with comparable sales being flat versus last year.

Looking Into The Year

The company maintains the earnings guidance for the upcoming year looking for earnings of $2.20 to $2.30 per share.

Valuation

At the end of the quarter, Patterson held some $302 million in cash and equivalents while total debt of $725 million leaves the company with a net debt position of around $425 million.

With 100.2 million shares outstanding at the end of the quarter, which are currently trading at $40 per share, equity in the business is being valued at $4.0 billion.

On a trailing basis, Patterson has posted sales of around $4.2 billion on which the company reported earnings just north of $200 million. This values equity in the business at roughly 1 times sales and 20 times trailing earnings.

A History Of Growth In Operations And Shareholder Value

Over the past decade Patterson has increased its annual sales by a cumulative 75% to $4.2 billion, growing sales at 5-6% per annum. Despite the top-line sales growth, earnings have been remarkably constant around the $200 million mark resulting in no growth in earnings in terms of real dollars.

It should be noted that the company has retired nearly 30% of its shares outstanding over the time period, boosting earnings per share in the meantime, although debt has increased slightly as well. The resulting debt position is perfectly justifiable with commonly used net debt/EBITDA ratios.

At the moment, the company is currently authorized to repurchase another 21 million of its own shares, enough to repurchase roughly one in every five shares outstanding. These repurchases are being complemented with a current 2% dividend yield.

For the future, Patterson is upbeat being ¨Committed to growth¨ according to its recent investor presentation. The company stresses the strong market share of its businesses in its markets and the potential for long-term growth aided by favorable long term tailwinds. That being said, long-term margins have been pressured, increasing the need for the cost rationalization of the business in terms of IT, logistics and business services.

For the longer term the company assumes 3-5% growth in its markets, while Patterson anticipates to grow earnings per share at a rate double of that. This is based on the assumption of relatively very modest margins gains of 10-20 basis points on an annual basis.

Final Recommendations

Patterson failed to create shareholder value for those buying into the shares at a historical peak around $50 back in 2005. Shares have fallen steadily to $20 amidst the crisis and worries about the earnings stagnation before that. Ever since shares have doubled again, as absolute earnings have been completely stagnant while earnings rose on a per share basis thanks to sizable share repurchases.

At the moment shares trade at 20 times earnings which is a modest premium compared to the overall market valuation. A steady pace in sales growth, acquisitions and share repurchases have really driven sales on a per share basis.

Earnings per share growth has been to limited and does not warrant the premium valuation, although the earnings multiple is coming down to 17-18 times earnings using 2015s anticipated earnings. Crucial will be to recover margins by 1-2% points on a net after tax basis. Such an accomplishment could allow shares to attack its previous highs at $50 per share.

Last year when the company acquired VNS, I last had a look at the prospects for the shares. I applauded the company for making the nice deal, but argued shares of Patterson itself hardly offered appeal with shares being dead money ever since.

I don't really get the idea that the company is feeling the urgency to improve margins after a multi-year slump. As such I see no current triggers to jump into the shares.

Source: Patterson Companies - Margin Recovery Can Boost Appeal, But Is There Urgency To Do So?