Originally Posted on January 10, 2020 – Best Ideas 2020: Patterson Companies (PDCO)
Hello, I’m Kevin Kedra, healthcare analyst with G.Research. For 2020, my best idea comes from the dental and animal health space with Patterson Companies – ticker PDCO. Based in St. Paul, Minnesota, Patterson is a leading distributor to dental and veterinary practices, primarily in North America.
Patterson shares have been a disappointment over the past three years, losing over half their value during that time largely due to weakness in their dental business. The company has been losing share since a disruption with a key supplier and sales force reductions in 2017, but this underperformance finally appears to be changing with signs of stability for the dental business in the past two quarters. Some of this is due to easy comps, which will continue into 2020, but management’s recent investments in the sales force are also starting to bear fruit. This year, we expect the company to return to growth for dental that is in-line with the market.
The broader end markets of dental and veterinary are both attractive with relatively stable growth and favorable demographic trends. Patterson offers investors an opportunity to gain exposure to both markets, with dental growing at 2-3% and veterinary growing a bit faster at 4-6% annually. With modest assumptions for operating margin leverage, we expect Patterson to grow its EPS by mid-single digits over the next several years, from $1.55 in 2020 to $1.80 in 2023.
Of course, this is a value play, not a growth play. Part of that value comes from the $0.26 cent per share quarterly dividend, which the company has supported over the past three years despite its challenges. The current return of nearly 5% annually from the dividend is among the highest in healthcare, especially when considering that Patterson’s net debt is only 2x EBITDA. The valuation at under 10x EBITDA and 14x EPS in 2020 also makes Patterson the cheapest name amongst both dental and veterinary companies. As operating performance improves through 2020, particularly for dental, we expect the company’s valuation to respond in kind. We calculate a Private Market Value of $29 per share for 2020 and are recommending Patterson as our Best Idea in healthcare.
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