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Berko: Patterson a smart option for long term

By Malcolm Berko

Published: April 21, 2018, 6:02am

Dear Mr. Berko: My stockbroker is recommending that I buy 1,000 shares of Patterson Companies Inc. The stock yields 4.6 percent and has increased the dividend every year since it began paying dividends. He believes that this would be a good long-term investment because management is turning the company around. Please tell me what you think.

— F.J., Waterloo, Iowa

Dear F.J.: In January 2006, I bought 300 shares of Patterson (PDCO-$23) at $34, and in September 2008, as the stock market was imploding, I sold it at $24, taking a 10-point loss. I had a dumb broker!

But I think you’ve got a smart broker who may have ferreted out an undervalued stock. A couple of years ago, in a rising stock market, PDCO was trading upward of $50 a share. Then the fit hit the shan! Members of management got caught with their pants around their ankles. Operating margins crashed from 10 percent to 5.9 percent, and net profit margins imploded from 5.8 percent to 3.2 percent. Return on total capital sank by 25 percent last year. Not good, that!

PDCO began selling dental supplies in 1877. Today this St. Paul, Minn., company has 7,500 employees engaged in two businesses: dental supplies, which provided 43 percent of 2017’s revenues, and animal health, accounting for 57 percent of last year’s revenues. PDCO’s dental division sells consumable products, instruments, sterilization systems and basic, heavy and high-tech equipment. PDCO is also in the dentist’s front office, selling practice management software, equipment maintenance and repair, equipment financing, office forms, and e-commerce solutions. PDCO’s animal health division markets pharmaceuticals, consumable supplies, vaccines, diagnostics, pesticides and prescription and nonprescription diet programs for farm animals and pets.

PDCO had a bad year in 2017. Management and its sales force were sleeping at the wheel, and revenues were down by nearly $400 million, to $5.2 billion. This allowed rival Henry Schein (HSIC-$70), a $12 billion-revenue firm, to snaffle a major long-term client from PDCO. Resultantly, PDCO’s dental business declined by 8 percent, and consumable sales were lower by 4 percent. Equipment and software revenues fell by a huge 17 percent, and share earnings fell from $1.82 to $1.75. And management was befuddled as net profit margins, an excellent measure of management’s effectiveness, continued to decline. Fortunately, PDCO’s strong animal health unit mitigated much of the decline in revenues and earnings. Management finally found religion and realized it had to change product mix, restructure its sales force and improve the process by which PDCO acquires and manages its products from vendors and manufacturers.

PDCO’s animal health unit, purchased in June 2015, is expected to contribute importantly to a revenue and earnings recovery. Because pet ownership continues to grow, because owners are likely to spend more dollars on the health of their companion animals and because PDCO’s large presence in marketing products that aid and increase livestock production, share earnings for 2018 should rise nicely to $2.25 on expected revenues of $5.7 billion. And management may even increase the dividend to $1.10. With PDCO’s net profit margins improving to possibly 3.6 percent, Wall Street believes that next year, revenues will reach $6 billion, share earnings could come in at $2.40 and the dividend could be raised to $1.20.

The animal health unit makes PDCO an attractive long-term investment. In two to three years, it could trade in the $80s or $90s. With the stock yielding a tad over 4.5 percent now PDCO might be a good investment for patient investors.

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