PATTERSON COMPANIES INC PDCO S
May 10, 2017 - 4:37pm EST by
gman
2017 2018
Price: 44.16 EPS 2.30 2.39
Shares Out. (in M): 97 P/E 19.2 18.5
Market Cap (in $M): 4,290 P/FCF 37.6 22.2
Net Debt (in $M): 1,093 EBIT 373 383
TEV ($): 5,383 TEV/EBIT 14.4 14.1
Borrow Cost: General Collateral

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  • Distributor
  • amazon threat

Description

Amazon.com's decimation of formerly solid businesses has been no secret. The landscape is littered with formerly large succesful enterprises that AMZN disrupted into oblivion. It started with Barnes & Noble, Borders and Musicland. Then it spread to Toys R Us, Sports Authority, Bed Bath & Beyond. Then came Sears, JC Penney, Macy's and Dillards. More recent victims include the Mall REITS, PEI, DDR, TCO, GGP etc. and most recently the MRO distributors: FAST, MSM, LAWS, ESND, GWW etc. The lesson learned is when AMZN moves into your space, you are most likely going to lose.

There are many large US businesses that were build on a distribution model, and many of these companies have operated for decades generating consistent earnings and free cash flow. AMZN seems especially effective at disrupting these distribution business models. Now AMZN is moving into Dental supplies.

Patterson Companies (PDCO) Distributes Veterinarian and Dental supplies with Veterinarian  supplies making up 53% of sales and 23% of operting profit. Dental supplies are 47% of sales and 77% of operating profit. They have masked sluggish revenue growth with the acquisition of National Veterinarian Services in 2013 and Animal Health International in 2015. Note that both of the acquisitions were in the much lower margin Veterinarian supply business. Return on capital has declined from 10.4% in 4/2012 to 8.1% and Gross margin has declined from 32.9% to 23.7% over the same time period.

In November 2016, PDCO announced that they were ending a distribution agreement with Dentsply Sirona in September 2017 and the stock cratered 17%. Now comes the real trouble....

Typing in "Dental Supplies" on Amazon.com shows over 304,000 items offered. I know alot of dentists and they tend to be a value concious group. Many dentists are starting to bypass the dental distributors and are now starting to order directly from Amazon. Pricing is better and shipping is both quick and free. Ask the person in your dentist office if they are starting to order from AMZN. Once buying habits are changed, they seldom reverse and PDCO's reason for existence will be difficult to discern. I am not suggesting that PDCO and HSIC for that matter are going to zero, just that the stock prices do not reflect the increasing threat of AMZN's enroachment into their businesses. The stock price has pretty much been stuck in neutral for the last 4 years even though we've been in a strong bull market.

In Q1 of 2017, we shorted the MRO companies using the same logic. These were companies that distributed mundane maintenance, repair and operating supplies to businesses. Most traded at mid 20 PE multiples and had been consistent cash generators. Pull up the price charts of this group of stocks after Q1 earnings were released. The conference calls were interesting in the avoidance of mentioning the "Amazon" word even though it was the elephant in the room.

In today's highly valued market, there are plenty of mundane companies trading at 20x earnings. Patterson isn't a candidate to go to zero as they are well financed and my best guess is their revenues and earnings will slowly erode. A price target of $32 implies a 14 multiple on the current $2.30 earning estimate.

 

 

 

 

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) slow erosion of revenues and earnings

2) market realization that these are no longer "steady and consistent" slow growers resulting in PE contraction

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    Description

    Amazon.com's decimation of formerly solid businesses has been no secret. The landscape is littered with formerly large succesful enterprises that AMZN disrupted into oblivion. It started with Barnes & Noble, Borders and Musicland. Then it spread to Toys R Us, Sports Authority, Bed Bath & Beyond. Then came Sears, JC Penney, Macy's and Dillards. More recent victims include the Mall REITS, PEI, DDR, TCO, GGP etc. and most recently the MRO distributors: FAST, MSM, LAWS, ESND, GWW etc. The lesson learned is when AMZN moves into your space, you are most likely going to lose.

    There are many large US businesses that were build on a distribution model, and many of these companies have operated for decades generating consistent earnings and free cash flow. AMZN seems especially effective at disrupting these distribution business models. Now AMZN is moving into Dental supplies.

    Patterson Companies (PDCO) Distributes Veterinarian and Dental supplies with Veterinarian  supplies making up 53% of sales and 23% of operting profit. Dental supplies are 47% of sales and 77% of operating profit. They have masked sluggish revenue growth with the acquisition of National Veterinarian Services in 2013 and Animal Health International in 2015. Note that both of the acquisitions were in the much lower margin Veterinarian supply business. Return on capital has declined from 10.4% in 4/2012 to 8.1% and Gross margin has declined from 32.9% to 23.7% over the same time period.

    In November 2016, PDCO announced that they were ending a distribution agreement with Dentsply Sirona in September 2017 and the stock cratered 17%. Now comes the real trouble....

    Typing in "Dental Supplies" on Amazon.com shows over 304,000 items offered. I know alot of dentists and they tend to be a value concious group. Many dentists are starting to bypass the dental distributors and are now starting to order directly from Amazon. Pricing is better and shipping is both quick and free. Ask the person in your dentist office if they are starting to order from AMZN. Once buying habits are changed, they seldom reverse and PDCO's reason for existence will be difficult to discern. I am not suggesting that PDCO and HSIC for that matter are going to zero, just that the stock prices do not reflect the increasing threat of AMZN's enroachment into their businesses. The stock price has pretty much been stuck in neutral for the last 4 years even though we've been in a strong bull market.

    In Q1 of 2017, we shorted the MRO companies using the same logic. These were companies that distributed mundane maintenance, repair and operating supplies to businesses. Most traded at mid 20 PE multiples and had been consistent cash generators. Pull up the price charts of this group of stocks after Q1 earnings were released. The conference calls were interesting in the avoidance of mentioning the "Amazon" word even though it was the elephant in the room.

    In today's highly valued market, there are plenty of mundane companies trading at 20x earnings. Patterson isn't a candidate to go to zero as they are well financed and my best guess is their revenues and earnings will slowly erode. A price target of $32 implies a 14 multiple on the current $2.30 earning estimate.

     

     

     

     

     

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    1) slow erosion of revenues and earnings

    2) market realization that these are no longer "steady and consistent" slow growers resulting in PE contraction

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