Patterson Companies, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Patterson Companies, Inc. is a value-added distributor serving the U.S. and Canadian dental and animal health supply markets, maintaining a strong brand identity and diverse product offerings.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Patterson Companies, Inc. (PDCO) operates primarily as a distributor within the dental and animal health industries. Here’s a breakdown of their key areas:

Dental Segment: This segment distributes a wide range of products to dental practitioners, including consumable dental products, equipment, and software solutions. The core of this business lies in providing dentists with everything they need to operate their practices efficiently. This is a mature market with a fairly stable demand profile, making it a reliable source of income.
Animal Health Segment: Patterson provides veterinary products to clinics, animal hospitals, and production animal providers. This includes a variety of pharmaceuticals, vaccines, equipment, and other consumable products for both companion and production animals. The animal health sector has shown strong growth potential, although it can be prone to market fluctuations stemming from disease outbreaks or changes in the economy.

Notably, in 2022, sales of both the animal and health segments were affected by supply chain disruptions, and the company has been working to improve that. Both segments are largely present within the United States and Canada.

Competitive Landscape

Dental: The dental market is quite fragmented, characterized by a blend of large, established distributors and smaller, regional providers. The competitive landscape can be intense because of similar product offerings and ease of entry. The dental supply industry is primarily driven by the relationships that distributors have with individual dental practices, while technology and specialized offerings may also provide an edge over rivals.
Animal Health: The animal health market is similarly competitive, comprised of large distribution networks that can offer a wide range of products. There’s also pressure from manufacturers looking to establish direct relationships with customers. Differentiation is driven by cost and supply chain efficiency.

What Makes Patterson Companies Different

Brand Recognition: Patterson operates with a well-established brand name, particularly in the dental industry. They have been selling supplies for decades, giving them a strong reputation.
Scale: While perhaps not leading in every category, they are one of the larger suppliers within both the animal and dental supply markets. This scale allows them to leverage supply-chain efficiencies and offer a comprehensive product portfolio, giving them a competitive edge in these fragmented industries.
Value-Added Services: The company’s strategy involves providing value-added services including customer financing, technology and software support, inventory management, and e-commerce solutions. All of these strategies create lock-in from the customer to the company, making competitors’ options less attractive.
Geographic Coverage: It should be noted that Patterson is largely focused in the United States and Canada and has very limited global diversification, which does come with some geopolitical risks.

Financial Analysis

Patterson’s financials demonstrate mixed results. Let’s delve into the key areas:

Revenue Distribution: The company’s revenues are split among segments and geographies (almost entirely within U.S. and Canada) with a slightly larger percentage of revenues and higher profitability from the dental sector compared to the animal health sector.
Gross Margins: While gross margins have been reasonably steady, they tend to be lower in the animal health segment and higher in the dental space due to stronger pricing power.
Profitability: A good way to understand the company is by looking at their ROIC. Based on my analysis, The average ROIC for the company is hovering around 10%. This is a reasonably decent return, but this isn’t too high, and their ROIC has seen a downward trend over the last decade.
Growth: The company’s revenue growth has been low in the last 3 years with many ups and downs, which is indicative of a mature industry. Management notes that their markets are large, and they are looking for organic revenue opportunities. However, they are also relying on acquisitions to achieve growth.

The overall performance of the company is dependent on both acquisitions and organic growth initiatives, and while the revenue has been stable, the recent trend in profitability and ROIC has shown a slight downward trend.

Recent Concerns and Management Outlook

Patterson has faced challenges related to supply chain disruptions, particularly in the dental sector, and a slowdown in capital spending from customers in the dental industry. On the animal health side, a decline in the market for animal production has also affected results.

Recent earnings calls have focused on these issues, with management emphasizing their strategies to improve margins and free cash flow. They also have been putting emphasis on the success in improving supply chains, and the expectation of demand to bounce back. Management has been focusing more on organic growth by increasing product offerings, pricing optimization, and selling complementary products to existing customers. Their long-term strategic focuses are automation of services, value added partnerships with manufacturers, and growth through M&A (mergers and acquisitions).

Notably, their dividend has remained steady at 26 cents a share. Their long term debt has been increasing over the last few quarters, although they have a revolving credit agreement with capacity to borrow up to $1.1 billion dollars if need be.

Moat Analysis (2/5)

Patterson possesses a narrow moat, supported primarily by: * Customer Relationships: The customer relationships built in the past decades and the stickiness that comes with their integrated solutions provides a moderate barrier to entry. * Scale: Being one of the larger players in their field means that competitors will have a tough time competing with their logistical infrastructure and large inventory. * Reputation/brand recognition: They have built up some degree of trust with their consistent service over the past decades.

This moat is quite narrow, because the company does not enjoy any kind of unique product or pricing power. The company faces heavy competition and a fragmented market where growth opportunities are limited. Ultimately, Patterson needs to rely on customer relationships and their scale, which may not be enough to overcome industry pressures and competition.

Risks to the Moat

Competition: Both the dental and animal health industries are highly competitive, and price pressure is likely to remain strong. Low switching costs for many customers and potential entrants, could erode their market position.
Dependence on Third-Party Suppliers: Patterson’s reliance on a variety of manufacturers for the products they distribute puts them in a vulnerable position, and can harm their profitability.
Technological Disruption: A shift in customer preferences or technological advances could disrupt their core business. For example, some dental practices are switching to new methods of imaging and practice management.
M&A Execution: Patterson’s emphasis on acquisitions to drive growth means they can make missteps in allocating capital if they make a bad purchase or integration doesn’t go as planned.

Business Resilience

Patterson has a history of sustained profits and a stable revenue, it has shown resilience to temporary economic downturns and is in a fairly mature market. Due to the essential nature of healthcare services, the demand in the dental and animal health industry remains relatively stable in comparison with other cyclical industries. However, the dependence on their supply chain and their debt are something to be monitored. They are also affected by consumer sentiment, and the state of the economy. Their management also has a history of making moves to address and overcome challenges when they arise.

Understandability (3/5)

The core of Patterson Companies is relatively simple: a distributor. Their main business involves buying and then selling products to either dental or veterinarian practices. While it does get complicated when you dig into their financial statements, and strategies (such as acquisitions) and their reliance on supply chains, at its core, the company is easy to understand and analyze.

Balance Sheet Health (4/5)

Patterson has a relatively strong balance sheet, though it should be noted that their long term debt is higher than it has been in the past.

Debt Levels: While debt is present on the balance sheet, it does not make up too big of a portion of its overall capitalization.
Liquidity: The company has a very large cash pile, sufficient to weather market volatility and any economic downturn.
Cash Flow: Patterson is a consistent cash generator. They have stable revenues that allows for reliable future cash projections.