Project Part 7 Universal Analysis Group - PDCO Fall 2014

Stock Analysis Project
Group Project Part #7
Universal Analysis Group
Alyssa Hofstetter
Noran Naghi
Travis Taylor

Stock Information:
Company Patterson Companies
Ticker PDCO
Recommendation Buy?
Date 11/12/2014
Valuation and Return: Comp Avg. PDCO
Forward P/E
ROA 7.2%
ROE 14.3%
P/B for utilities
Comparables:
Henry Schein Inc. (HSIC), MWI Veterinary Supply Inc. (MWIV), Zimmer Holdings Inc. (ZMH),
VCA Inc. (WOOF)
Investment Summary
We recommend … For these reasons:
 1
 2
 3
Business Description
Patterson Companies Incorporated is headquartered in St. Paul, Minnesota, and specializes in a
broad range of dental, veterinary, and medical products and services. The company was founded
in 1877 when the Patterson brothers opened a small drugstore in Milwaukee, Wisconsin. The
drugstore began selling dental equipment and quickly became known as the M.F. Patterson
Dental Supply Company, led by its first president, John F. Patterson. Over time, the company
acquired a broader product line, and expanded their customer base with the purchase of D.L.
Saslow Co., providing them with a strong position in the dental supply market.1
Today, Patterson
1Patterson Companies,Inc. Company Overview." Patterson Companies, Inc. Web. 07 Sept. 2014.
<http://www.pattersoncompanies.com/CompanyOverview>.
Current Price $45.125
Target Price
Shares Outstanding 104,259,810
Market Capitalization 4,704,723,926

Companies Incorporated sells dental, veterinary, and rehabilitation supply products and services
primarily in the US and Canada. Patterson has expanded its veterinary supplies and services
operations to the United Kingdom through the acquisition of National Veterinary Services in
August 2013.
The largest portion of the company’s revenue, 58%, comes from its dental products and services,
including consumables and dental imaging systems, used by dental practitioners. Patterson
provides supplies to 33% of North America’s dental services market. The veterinary services
division accounts for approximately 30% of total revenues, and distributes veterinary hardware
and consumables to veterinary clinics in the US, Canada, and the UK. The remaining 12% of
revenues are created by Patterson’s medical division, which focuses largely on physical therapy
products and equipment.2
Industry Analysis
Patterson Company distributes products in three main industry categories: Dental, Veterinary,
and Medical. Each of these categories is comprised of its own set of competitors and dynamics.
Patterson’s competitive position in each of these industries varies. Below we will discuss the
intricacies within the industries that Patterson competes in as well as our overall industry
expectations and advice.
The Industries: Dental, Rehabilitation, and Veterinary
Patterson sells products in three primary industries: dental supply, rehabilitation supply, and
veterinary supply. However, the competitors that they face have various industries within
themselves as well. The complex list boils down to competitors in a broad dental/medical supply
segment, and the veterinary segment. Bloomberg lists many businesses as Patterson’s peers,
but based on the business descriptions of each, we found Henry Schein (HSIC), Owens and Minor
(OMI), Cardinal Health (CAH) and McKesson (MCK) as the primary competitors in Patterson’s
Medical/Dental Supply industry. There were no veterinary businesses listed as peers in
Bloomberg, however veterinary industry reports list Patterson as a competitor in that industry.
2"Patterson Companies: Investor Relations Annual Report 2014."Page 2. Web. 1 Oct. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3419642901x0x780182/C0C4C4B2-57EC-463C-9BD5-
9D12459B9EF3/2014_Annual_Report_-_FINAL.pdf>.

The top three competitors in the veterinary supply industry are MWI Veterinary Supply, Inc (MWIV),
Henry Schein (HSIC), and Patterson (PDCO). Patterson and Henry Schein are both distributors
in the medical industry as well as Veterinary. A smaller competitor in this industry is VCA Inc.
(WOOF)aveterinary producer, specializing in diagnostic technology. New products suchas more
effective flea and tick medications have been introduced into the veterinary supply market.3
These
new products could potentially allow distributors more opportunities to create strategic
partnerships with suppliers providing competitive advantages by offering the latest products.
Facing the Competition
In their Annual 2014 report, Patterson reported an “estimated 33% market share of the $7-billion
North American dental market”.4
In the dental industry, Patterson holds a competitive edge
primarily in the sale of high-tech CAD/CAM dental imaging instruments supplied by Sirona Dental
Systems Inc. The only two customers listed in Bloomberg for this company are Patterson and
Henry Schein. Because these two peers are the only suppliers of this exclusive product, we
believe that there is high potential for sales growth due to these new products. We believe that
Patterson’s competitive edge in the veterinary industry lies heavily in their position in the U.K.
market following the NVS acquisition. By having international market spread, Patterson has
competitive edge over their competitors in any industry. The profitability in this market is especially
high because NVS already held a vast majority of the U.K. market for veterinary supplies.
Market Changes
A threat to medical distribution companies is a decision by manufacturers of bypassing the
distribution channel and selling directly to the end users. Technology developments make
ordering products directly from a manufacturer much simpler for customers. Specifically,
Patterson is seeing this problem in its veterinary segment. The July 25, 2014 William Blair Article5
discusses Idexx (IDXX), a large veterinary diagnostic products manufacturer that recently decided
to bypass all distribution channels. Patterson was one of their distributors, and this information
3New Vet Products. “PiperJaffray”. (Page 1) Rep. 19 Feb. 2014. Web. 01 Oct. 2014.
<https://ucmo.blackboard.com/webapps/blackboard/execute/content/file?cmd=view&content_id=_309253
5_1&course_id=_105732_1>.
4 "Patterson Companies: Investor Relations Annual Report 2014."(Page 2) Web. 01 Oct. 2014.
5Veterinary Industry Update. Rep. WilliamBlair & Company, L.L.C., 25 July 2014. Web. 8 Oct. 2014.
<https://ucmo.blackboard.com/bbcswebdav/pid-3092533-dt-content-rid-
8618432_1/courses/201510FIN389110926/Veterinary Industry UpdateWilliamBlair 20140725.pdf>.

caused a slight decline in equity prices in the industry until investors realized the minimizedeffect.
However, the article states that distributors generally only see 5%-10% of their revenues coming
from sales in the diagnostic product market.
On October 1, 2014 Patterson announced their strategic partnership with Abaxis. 6
Under
Weaknesses and Threats we discuss the downside to relying on third party manufacturers. With
this Abaxis partnership, Patterson is effectively eliminating that threat. They have signed an
agreement with Abaxis where they will sell Abaxis’s full line of state of the art medical, research,
and veterinary products. This partnership is profitable for both businesses, and we believe that
this may offset the loss incurred by Idexx’s decision to skip distribution partners and sell directly
to end users.
Company Analysis
Patterson has expanded their product line, boosted sales and strengthened customer
relationships through acquisitions starting in the 1980s. In 2013,Patterson bought National
Veterinary Services Limited (NVS), which expanded their veterinary division to the United
Kingdom. Subsequently, they renamed their entire veterinary division, including NVS, Patterson
Veterinary to strengthen their brand. Patterson has been a financially stable company since its
foundation in 1877. Despite the numerous recessions in American industrial history since 1877,
Patterson has survived and flourished. The slow recovery from the 08-09 recessionthus far shows
that Patterson has the capability of overcoming economic downturns. The industries in which
Patterson competes are all fairly economically stable. Over half of the US population currently
holds dental insurance, providing steady demand for Patterson’s largest division: dental supplies.
Rehabilitation in the medical field is generally very important to consumers, and insurance can
help to cover costs to those with unstable financial standing. The veterinary market is currently
growing rapidly, studies show that in 2013 pet spending increased by 4.5%.7
By diversifying their
product segments, Patterson ensures stability. In having three completely separate industries, if
one segment incurs losses, there are two more to make up for it through growth.
6“Patterson Companies Announces Strategic Partnership with Abaxis” Patterson Companies: Press Releases. Web.
01 Oct. 2014.<http://investor.pattersoncompanies.com/releasedetail.cfm?ReleaseID=873989>.
7PiperJaffray. “FavorablePet Spending Trends”. Rep. Page 1. 9 Apr. 2014.Web. 1 Oct. 2014.
8652418_1/courses/201510FIN389110926/Favorabel PetSpending Trends Piper Jaffray 20140409.pdf>.

Future financial success lies foremost in their innovative products, services, and strategic
partnership. The company recently built the Patterson Technology Center, a customer oriented
base designed to give technical customersupport,a huge necessityin today’s tech-forward world.
This is especially important to Patterson now that they have introduced several lines of proprietary
dental imaging products. Not only does Patterson have innovative products, they also sell a huge
number of consumable products that must be repurchased regularly. The increase in the average
population age ensures future sales in the medical/nursing home segment. At the same time,
active lifestyles are also becoming more prevalent, leading to interest in rehab services.
Patterson’s entrance into the international veterinary market has also shown growth since the
NVS acquisition, which will lead to future financial success as well. Patterson’s innovative 3-D
dental imaging product lines provide a competitive advantage in the dental services industry.
Overall, Patterson has strong brand recognition in each of their industries. Additionally, Patterson
has a reputation for reliability, innovation, and customer appreciation. Each of these factors gives
Patterson a strong competitive advantage.
Financial Analysis
The dental sector is Patterson’s largest revenue source, incurring $2.4B in sales for F2014. The
largest growth, however, is in the veterinary segment. Due to the NVS acquisition, total veterinary
segment sales had yr/yr growth in F2014 of 59%. Excluding sales in the U.K. (primarily result of
NVS), U.S. veterinary sales grew 4% in F2014 compared to 2% in F2013.8
Patterson’s main
expenses currently come from restructuring of the Medical unit, which we have included in our
forecasts.
Currently, Bloomberg reports Patterson’s P/E ratio as 19.4, and in F2014 it was reported as 19.76
which is the highest P/E since 2008.9
Bloomberg predicts the ratio to slowly fall for the next five
years. In trying to find an explanation for this downward trend, we found that Bloomberg also
expected PDCO dividends to increase slowly over the next few years. We believe that this means
that they expect earnings to increase with a relatively constant price, thus, creating a smaller P/E
multiplier. If this is true, it is not necessarily a bad sign for PDCO to have a falling forward P/E
ratio, because earnings are still increasing. However, if earnings and dividends are increasing but
8"Patterson Companies: Investor Relations Annual Report 2014."Page 3. Web. 1 Oct. 2014.
9 Bloomberg

the share price does not reflect this increase in value, the stock could currently be seen as
undervalued.
There have been significant financial changes in the last two years including, the NVS acquisition,
the restructuring of the rehabilitation supply segment, and the refinancing of their long-term debt.
These changes Patterson currently has the capability to remain financially stable given current
debt loads. Because of this we do not expect any significant changes to occur in the foreseeable
future. We use this concept in our forecasting, as well as the details described below.
Earnings Outlook
We began our forecasting for Patterson’s earnings by evaluating the overall conditions we
determined the economy to be in. We considered our predictions for inflation growth and
forecasted inflation to grow by 1.75% until the end of F2015, then for the next five years we
decided to forecast 2% inflation growth. These rates were determined by a consensus of each of
our analyst estimates. These rates were included in our forecasting model. Next we determined
what growth rates we would use for the segments that Patterson operates in. We expect fixed
growth in revenues for the dental segment to be between 1.5% and 4% for the foreseeable future.
We believe that Dental is in a mature stage with little expected changes to propel the industry into
any higher growth. We estimatedrevenues in the veterinary segmentto increase by a muchlarger
amount. An increase of between 4% and 7% is expected after a period of normalization following
recent acquisitions Primarily, we see many increasing trends in pet ownership due to cultural,
demographic and economic changes. A survey relating to this is quoted in the Piper Jaffray
report.10
Rehabilitation supply segment is forecasted to have negative growth for roughly the next
5 quarters, followed by slow growth thereafter. In this, we factored in the restructuring of the
segment.
The forecasts we used in our segments had direct correlation to many of the items in our income
statement, including operating income as well as net sales. Cost of sales was computed to be the
inverse of the gross margin, which was calculated as growing at a rate of 0.6%. We saw this as
appropriate for the future as well with no considerable changes. The operating expenses include
10Favorable Pet Spending Trends. “PiperJaffray”.Rep. 9 Apr. 2014. Web. 01 Oct. 2014. >.
"Investor Relations." Patterson Companies, Inc. Web. 07 Sept. 2014.
<http://investor.pattersoncompanies.com/index.cfm>.

adjustments for the rehabilitation segments restructuring. The future tax rate was estimated at
35.5%, as per management guidance. Next we used the management stock repurchasing plan
to estimate that they would repurchase 1.2M shares per year. This lead into the EPS forecasts of
considerable growth. Basic EPS for F2015 is expected to be $2.13 per share, F2016 is $2.49 per
share, and F2017 is $2.88 per share. These EPS estimates are growing considerable due to the
estimated growth rate for net income as well as the estimated share buyback decreasing overall
shares. Considering these components of EPS rising and falling in opposite directions, we
evaluated this as reasonable growth.
Recent Performance
Two major factors must be taken into account when evaluating PDCO’s recent performance. The
recent acquisition of NVS in the UK has grown the veterinary branch significantly, and the
divestiture of several product lines from PDCO’s medical branch should move the company
towards a more pro-growth strategy. Sales in the veterinary segment rose 77% year-over-year in
4Q14, largely due to the acquisition of NVS. Adjusted for currency change and the divestiture of
several product lines, Patterson reported roughly flat sales in the medical division versus the prior
year period. Dental sales declined 1.5%, largely due to the negative impacts of weather in several
key market areas. Consolidated PDCO revenues rose approximately 14% over the prior year
period, mostly due to the acquisition of NVS.11
Dental sales improved slightly in 1Q15 year-over-year on a constant currency basis. PDCO
Veterinary sales rose 94% from the prior year period, owing partly to the acquisition of NVS, and
partly due to 7% organic growth. The medical division suffered a 4.5% decrease in revenues over
the prior year period. However, due to changes in product offerings, Patterson has showed a
120bps improvement in operating margin for the medical segment. Excluding NVS, operating
profit and the operating profit margin decreased considerably over the previous year for all
divisions.12
Due to the large investing this year, PDCO expenses were relatively high, resulting in
lowered earnings.
11"Patterson Companies 4Q14 Earnings Call Transcript."Page 22. May 2014.Web. 7 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x757839/f9c467d5-4143-4813-a6f6-
7a7d7125d33f/Fourth Quarter Fiscal 2014 Earnings Transcript.pdf>.
12"Patterson Companies 1Q15 Earnings Call Transcript."Page 21. Aug. 2014. Web. 7 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x778505/4f7f755d-3040-4e96-ac9d-
135630e67012/1Q15 Earnings Call Transcript.pdf>.

Stock Valuation
Intro Paragraph including beta info
Dividend Discount Model
We calculated the current intrinsic value of PDCO equity using the Dividend Discount Model to
be $31.13. We did this by using expected dividends that are in line with historical growth. We saw
that every year dividends were increasing by $.08 every year for the last five years. We continued
this trend in our estimated dividends for fiscal years 2016-2019. We then calculated a cost of
equity of 9.04% using a normal risk free rate of 4%, a market premium of 6%, and the beta
reported by Yahoo of .84.13
We used these estimates to discount the dividends, summing to a
present value of $3.21, and to predict a terminal value of $27.92. In conclusion, we estimated a
price target of $31.13 for the end of F2015 using the Dividend Discount Model.
Discounted Cash Flows
We calculated the current intrinsic value of PDCO equity using the Discounted Cash Flow Model
to be $91.17. We used estimated cash flows for years 2016 through 2019 by using a growth rate
of 3%. We believed that based on the current expected economic growth, 3% was an appropriate
estimate for the next four years. We calculated cost of equity in the same manner as in the
Dividend Discount Model, equaling 9.04%. With this, we discounted the cash flows, summing to
a present value of $1,164,834. Next, we used a terminal growth rate of 6% to calculate a terminal
cash flow of $7,927,925. By summing these present values and dividing by the common shares
outstanding we conclude with a price target of $91.17 for F2015, using the Discounted CashFlow
Model.
P/E Valuation
Our estimate for the intrinsic value of PDCO using the P/E method is $46.95. Weused the current
forward P/E estimate multiplied by one plus our expected negative growth rate of approximately
2% for F2015. Our negative growth rate stems largely from restructuring made in the medical
segment and the adjustments to net income in regards to that fact. Without the adjustments to
F2014 net income, our estimate would have been $50.47 due to what would then have been an
expected year over year growth rate of approximately 5%.
Shortcomings of Valuation Models Used
We found that the Discount Dividend Model was fairly accurate in estimating the value of PDCO
equity. It was fairly low compared to the current trading price, but was not as varied as the value
13http://finance.yahoo.com/q?s=pdco&type=2button&fr=uh3_finance_web_gs_ctrl2&uhb=uhb2

estimated by the Discounted Cash Flow Model. The DCF Model gave us an estimated $91.17
value, which is more thandouble the current market price of the stock. I do not realistically see
the price of the stock rising all the way to $91.17 at the end of F2015. Clearly, PDCO is a company
that does not use cash flows as a realistic estimate of value. The dividends gave us a much better
estimate, but were still not factoring all the intrinsic value that investors are currently seeing. The
P/E valuation method is adversely effected in part due to the adjustments made to net income
due to restructuring. Overall, even with the restructuring effects, the estimate of $46.95 is still
within the bounds of what a reasonable person might believe possible given the circumstances.
Price Target and Potential Return
The guidance we are setting for PDCO F2015 price target is $46.95. After deliberating all possible
options, it was determined that the P/E method of valuation offered the most realistic estimate of
Patterson’s value. The DCF method was considered to be so far outside the realm of likelihood
that it was discounted as a means of valuation, while the DDM method would represent a
significant decline in value for which we can find no realistic probability short of an unforeseen
financial catastrophe. We believe that our price target of $46.95 is reasonable given the current
expected economic outlook.
Investment Risks
Risks for Patterson Companies are fairly typical for a company with cross-border operations,
stemming largely from exposure to currency exchange risk, which would primarily affect the
recently acquired NVS with a large market share in the U.K.As seen in the table below, today’s
current exchange rate for dollar to euro is 79%. The table then shows the dollar amounts you
would receive if you invested $1 in a European market, then the euro increased or decreased
before you exchanged it back to the dollar. This example shows how money invested in a foreign
market can lose value due to changes the exchange rate. If Patterson has large amounts of sales
and costs coming in/out through the U.K. location, they face losing substantial amounts to
exchange risk.
Values US Dollar Euro
Current Values $1 $0.79
*Increasing Euro Value $1.21 $0.96
*Decreasing Euro Value $0.38 $0.30
*For illustrative purposes only, does not represent actual figures.

Patterson Companies estimates that the unmitigated impact of the Idexx move would be a decline
in EPS of$.04-$.05 per share.14
The long term risk associated with this move is the possibility of
similar manufacturing companies deciding to follow in Idexx’s footsteps. Should this occur, there
is risk of running out of interested customers.
Recent restructuring in Patterson Medical has refocused efforts on products with high growth
potential, including the high-tech dental and vet digital imaging CAD/CAM products. The risk
associated with acquiring new management in the medical branch is possible, since the new
management may not have the same techniques that have worked well for Patterson over the
years. There is also risk in the possibility that the realignment will not prove fruitful in the long
term.15
Finally, Patterson has long term debt that they recently refinanced that could pose as default risk
to investors. However, PDCO is stable enough to make payments on the $250M in debt that
matures in March 2015, thus eliminating default risk.16
We believe they will be able to refinance
because they regularly have more than enough positive net income to cover interest payments
on debt.
14"Patterson Companies 1Q15 Earnings Call Transcript."Page 21. Aug. 2014. Web. 07 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x778505/4f7f755d-3040-4e96-ac9d-
135630e67012/1Q15 Earnings Call Transcript.pdf>.
15"Patterson Companies: Investor Relations Annual Report 2014."Web. 01 Oct. 2014.
16"Patterson Companies 4Q14 Earnings Call Transcript."Page 22 May 2014. Web. 07 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x757839/f9c467d5-4143-4813-a6f6-
7a7d7125d33f/Fourth Quarter Fiscal 2014 Earnings Transcript.pdf>.

Works Cited
Favorable Pet Spending Trends. “PiperJaffray”. Rep. 9 Apr. 2014. Web. 01 Oct. 2014. >.
"Investor Relations." Patterson Companies, Inc. Web. 07 Sept. 2014. >.
"Minnesota Business and Lien System, Office of the Minnesota Secretary of State." Business Filing
Details. Web. 07 Sept. 2014.
<http://mblsportal.sos.state.mn.us/Business/SearchDetails?filingGuid=9f861772-9ad4-e011-
a886-001ec94ffe7f>.
New Vet Products. “PiperJaffray”. Rep. 19 Feb. 2014. Web. 01 Oct. 2014.
<https://ucmo.blackboard.com/webapps/blackboard/execute/content/file?cmd=view&content_id
=_3092535_1&course_id=_105732_1>.
"Patterson Companies 4Q14 Earnings Call Transcript." Page 22 May 2014. Web. 07 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x757839/f9c467d5-
4143-4813-a6f6-7a7d7125d33f/Fourth Quarter Fiscal 2014 Earnings Transcript.pdf>.
"Patterson Companies 1Q15 Earnings Call Transcript." Page 21. Aug. 2014. Web. 07 Sept. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3447670407x0x778505/4f7f755d-
3040-4e96-ac9d-135630e67012/1Q15 Earnings Call Transcript.pdf>.
“Patterson Companies Announces Strategic Partnership with Abaxis” Patterson Companies: Press
Releases. Web. 01 Oct. 2014.
<http://investor.pattersoncompanies.com/releasedetail.cfm?ReleaseID=873989>.
“Patterson Companies, Inc. Company Overview." Patterson Companies, Inc. Web. 07 Sept. 2014.
<http://www.pattersoncompanies.com/CompanyOverview>.
"Patterson Companies: Investor Relations Annual Report 2014."Web. 01 Oct. 2014.
<http://files.shareholder.com/downloads/AMDA-1HGAMJ/3419642901x0x780182/C0C4C4B2-
57EC-463C-9BD5-9D12459B9EF3/2014_Annual_Report_-_FINAL.pdf>.
Veterinary Industry Update. Rep. William Blair & Company, L.L.C., 25 July 2014. Web. 8 Oct. 2014.
8618432_1/courses/201510FIN389110926/Veterinary Industry Update William Blair
20140725.pdf>.
Bloomberg Files:

Project Part 7 Universal Analysis Group - PDCO Fall 2014

Project Part 7 Universal Analysis Group - PDCO Fall 2014

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