Patterson Companies, Inc.: A Tale Of 2 Pandemics (NASDAQ:PDCO)

Diversify. In stocks and bonds, as in much else, there is safety in numbers. –

Diversify. In stocks and bonds, as in much else, there is safety in numbers. – Sir John Templeton

The pandemic has made both winners and losers out of companies as consumer preferences change, but Patterson Companies, Inc. (NASDAQ:PDCO) is a rare company experiencing both. Roughly two-thirds of PDCO’s sales come from the distribution and sale of animal health products. Within this segment, the Companion Animal business benefits as more Americans are becoming pet owners, and current pet owners become more attentive while at home. However, the Production Animal business experiences intermittent shutdowns from processing plant closures and lower protein exports.

The other roughly one-third of PDCO’s business is the distribution and sales of dental products. This industry is definitely better than earlier this year when many dental offices were treating only emergencies, and now, many customers are catching up on those lost visits. The animal and dental product businesses combine to give an interesting depth to PDCO’s business.

Recent financial performance

For the reasons cited above, sales in the animal health business were essentially flat year over year. In contrast, dental sales declined, resulting in total company sales of $1.25 billion, down 6.2% from the same period last year. Aggressive cost management drove operating income up year over year to $38 million.

Net income fell to $24 million from $30 million the year before as the prior year’s quarter benefited from a gain on investment. Reported earnings did surprise to the upside with reported earnings per share (EPS) of $0.33 versus expectations for $0.24. Expectations are for quarterly EPS to continue to rise, likely returning to levels similar to the prior year’s quarters, as shown below.

Cost management: temporary or continued benefit?

The company estimated the aggressive cost management saved $20 million in expenses during the quarter, but that is not expected to continue. Assuming the bulk came out of operating expenses, this equates to savings of roughly 8%. We do give credit to the company for taking swift actions in the face of uncertainty earlier this year.

The reductions included the cancellation of in-person events, travel restrictions, a headcount freeze, and eliminating discretionary spending. Temporary salary reductions and furloughs that were in place earlier this year ended on August 1. While some of the reductions may persist, especially fewer events and travel, it does not appear these cuts will result in material benefits to future quarters.

Cash flow and capitalization

Increased working capital requirements during the quarter resulted in negative cash flow of $97 million. This led to a drawdown on the revolving credit facility, which ended the quarter with a balance of $136 million. We’d keep an eye on PDCO’s ability to pay this back if working capital needs return to more normal levels in the upcoming quarters, or if PDCO needs to borrow more. PDCO has maintained a steady dividend of $0.26 per share since 2017, equating to a dividend yield of 4.35%.

Valuation

PDCO did briefly trade over $30 as the market rallied at the end of August. Even with the recent pullback, PDCO stock is now up 17% year to date and 33% over the past year.

EPS is estimated at $1.55 for the current fiscal year, equating to a PE ratio of 15.5x, which seems fairly valued. Many uncertainties remain around the strength of PDCO’s end markets, including if dental businesses will regain growth or languish as customers worry about their jobs. Meanwhile, within animal health products, things may be as good as they get in the Companion Animal business, while export uncertainty remains for the Production Animal business. I’d wait for better valuation or a clearer path for financial growth before buying PDCO.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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