Human demographic and companion pet trends favor markets that the company serves.
The company’s economies of scale and ability to effectively service fragmented markets favor their business.
Substantial share buybacks and steady dividend increases reward the company’s shareholders.
Commentators and some options activity indicate the company may be a takeover target.
Patterson Companies (NASDAQ:PDCO) is a well-run company with three divisions as discussed below that will perform well over the intermediate term as demographic trends and an improving economy will favor the company's businesses. While an investor waits, they will receive about a 2 percent dividend (which has been raised 4 times since the dividend's inception in 2010). In addition, PDCO is actively repurchasing their stock, most recently under a March 2013 25 million share repurchase program. Finally, there are investors and activity in the company's options that suggest PDCO could be an acquisition target.
PDCO was traditionally a dental products and services company. Over about the last decade PDCO acquired multiple companies to enter the veterinary products and services market and to become a distributor of general medical rehabilitative devices such as braces and wheel chairs. Today, PDCO is a major product distributor and service provider in the markets of dentistry, animal health, and medical rehabilitation where each segment represents about 54 percent, 34 percent, and 11 percent of their total revenue, respectively.
Fiscal 2015 first quarter earnings
PDCO reported consolidated sales totaled about $1.05 billion in their fiscal first quarter, an increase of more than 20 percent from $880.1 million in the year-earlier period. Net income was $50.3 million, or $0.50 per diluted share, compared to net income of $45.9 million, or $0.45 per diluted share, in the year-ago period. Fiscal 2015 first quarter results included $173.6 million of consolidated sales and an earnings contribution of $0.02 per diluted share from an acquisition that closed in 2013. The CEO of PDCO characterized the quarter and the company's current fiscal year as follows:
"We are pleased with the trends we saw in the fiscal first quarter and the business generally performed within our expectations … With the actions we took in fiscal 2014 to increase our efficiency, coupled with the long-term investments we are making to build on our capabilities, we believe we have better positioned the company for success through fiscal 2015 and for the long-term."
In the fiscal 2015 first quarter, the dental division generated sales growth to $552.7 million in both consumables and basic equipment. PDCO's dental divisions comprised a little more than half of the company's total sales in the quarter. The CEO indicated in regard to PDCO's dental division:
"In the fiscal first quarter we saw positive trends in sales of dental consumables. We remain confident in the growth prospects for our dental equipment for fiscal 2015."
In the fiscal 2015 first quarter, the veterinary division sales increased nearly 94 percent from the prior year period to $386.3 million (including veterinary acquisition that closed in 2013). PDCO's veterinary division now constitutes more than one-third of the company's total sales. U.S. sales, which exclude NVS, were up nearly 7 percent from the previous year, totaling approximately $212.7 million. With respect to the veterinary division the CEO indicated:
"We saw strong growth in consumable sales, reflecting an improved selling environment in North America, as well as the addition of new product lines."
In the fiscal 2015 first quarter, sales for PDCO's medical rehabilitation supply and equipment business totaled $120.6 million. PDCO's medical division represented about 11 percent of total company sales. With respect to the medical division the CEO indicated:
"Fiscal first quarter performance in our medical business was in line with our expectations. With the divestitures behind us and a new management team in place, we are positioned to execute on our growth strategies."
During the fiscal 2015 first quarter, Patterson repurchased approximately 1.1 million shares of its outstanding common stock, leaving approximately 21 million shares for repurchase under the current authorization. The company also maintained their guidance for fiscal 2015 of $2.20 to $2.30 per diluted share.
Competitors and the industry
PDCO's primary competitors are Dentsply International (NASDAQ:XRAY), Henry Schein (NASDAQ:HSIC) and MWI Veterinary Supply (NASDAQ:MWIV). With respect to competition, PDCO's economies of scale as one of the few national distributors of dental and animal health products in the U.S. provide it with competitive advantages. In the dental market, PDCO competes with only one other national distributor, HSIC. PDCO holds about 33 percent of the dental distribution market share in the U.S., with HSIC and PDCO holding about 75 percent of the total domestic dental distribution market. PDCO holds 20 percent of the veterinary market behind both MWIC and HSIC with these three distributors again accounting for the majority of that market. PDCO holds about 12 percent of the medical distribution market.
In the dental and veterinary markets, PDCO is an important distributor that services a highly fragmented group of customers and suppliers, which helps protect the company's pricing power. PDCO serves a significant portion of the dentists and veterinarians in the U.S. market. Patterson's relationships with suppliers and customers are difficult to replicate, in our opinion, especially given the scope of its product offerings and delivery speed. Few distributors offer Patterson's products and services. For PDCO's smaller rehabilitative medical service division, the greater likelihood of government-based reimbursement risk adversely affects their pricing power in this market.
A takeover target?
PDCO is a favorite among some money managers including Mario Gabelli, who, in addition to holding PDCO's shares through his investment company, believes PDCO is a takeover target. Mr. Gabelli's track record for predicting which companies would be taken over is impressive. His firm owned shares of Beam, Inc. (NYSE:BEAM) which was acquired in early 2014. In addition, his firm owned Hillshire Brands (NYSE:HSH), which was acquired earlier in 2014 in a bidding war.
In addition to the beliefs of money managers, there were some interesting PDCO options trading in July 2014, where a trader purchased 1,500 of the January $37 call options in PDCO at a price of $3.40 per contract. The commenter on this options trade suggested that Zoetis Inc. (NYSE:ZTS), which develops, manufacturers and markets animal health medicines and vaccines (with a focus on both livestock and pets) might be an acquirer of PDCO.
Analysts' views and our views
Analysts see near term growth challenges for PDCO due to trends in consumer out-of-pocket spending and government measures affecting the growth of national healthcare spending. We believe, however, that while spending in the dental and animal health markets have slowed since the recession, that the intermediate term outlook on PDCO's dental and veterinary operations is optimistic. An aging human population and growing demand for more sophisticated hardware and software should support long-term growth in the dental market. Companion animal spending should also remain strong as owners spend more disposable income on pets. An additional advantage for PDCO's dental and veterinary divisions is that high out-of-pocket spending in those markets reduces the threat of reimbursement pressures that occur in the health-care industry. Medicare reimbursement pricing pressures, however, will likely continue to pressure PDCO's smaller rehabilitative care division.
PDCO will benefit from human demographic trends, companion pet trends, their economies of scale, their relationships with their suppliers and customers and an improving national economy. In addition, the veterinary business will continue to benefit from the love affair pet owners have with pets in the U.S. Until PDCO's near term growth issues are worked out, investors can collect a solid dividend, benefit from an ongoing and substantial buyback of PDCO shares and perhaps benefit from a potential third-party acquisition of PDCO. Finally, the possibility of an acquisition of PDCO is likely given the attractiveness of the company's profitable business, competitive position in the markets they compete in and the demographic trends that favor the company's businesses. We recommend investors watch PDCO and consider a moderate position in the stock during the next pullback in the overall market.