The management of Patterson Companies (NASDAQ:PDCO) had to address a tough quarter: "The results we report today clearly do not meet our expectations," said Mr. Mark Walchirk, boss of PDCO. "They fall short of what we know the business is capable of achieving." Here are a few disappointing facts:

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Noam Ganel is the Managing Director of Pen & Paper, a value-oriented stock research publication. Subscriptions are now available. He also serves as  Vice President in Capital Markets at Silvergate Bank and holds the Chartered Financial Analyst (CFA) credential. Click here for frequently asked questions.

Patterson Companies

The one advantage of short term thinking? a cheap stock price

May 4, 2018

The management of Patterson Companies (NASDAQ:PDCO) had to address a tough quarter: "The results we report today clearly do not meet our expectations," said Mr. Mark Walchirk, boss of PDCO. "They fall short of what we know the business is capable of achieving." Here are a few disappointing facts: sales are down 2.7% compared to the prior year; gross profit margin declined by 2.20%; adjusted operating profit declined to 36.2%; and the company reported a loss of $49 million in free cash flow.

Capital markets must have paid close attention to the March 1, 2018 earnings call, because PDCO's stock price declined by about 20% shorty after. The stock closed for that day at price of $25 a share, compared to $32 a share the week prior.

Based on the question raised by the analysts, I am guessing Wall Street is concerned with three issues.  First, management is planning to sell private label products. This is a new, unchartered territory for the firm that may prove to be more expensive than expected. Second, there is a concern that the decline in operating margin will continue for a long time (Management explained that this was the result of "a change in the sales division and a disruption related to our ERP implementation and sale of digital equipment."). Third, future earnings will be lower compared to past earnings. Management lowered the earnings per share guidance to $1.65 from $1.70. A faux pas on Wall Street.      

Five-year comparison

Yet on a five-year basis, PDCO shows different results. For the first nine months, PDCO reported on $180 million, or $1.94 earnings per share. Compare that to 2013 operations, where the company earned $210 million, or $2.03 per share, in 12 months. Put differently, in nine months, the company earned 85% of what it had earned five years prior. Also, in terms of revenue, Patterson sales were slightly over $4 billion, compared to $3.6 billion for the 12 months in 2013. And for the is-management-shareholder-friendly-minded reader, total outstanding shares declined to $92.6 million from $103.8 million, a decline of about 10% in outstanding shares.

Let us go back a decade in time and compare the operating results between 2008 and 2013. In 2008, PDCO earned $225 million, or $1.69 per share, compared to $119 million, or $1.75 per share, in 2003. Total sales in 2008 were $2.99 billion, compared to $1.7 billion in 2003. And reported outstanding common shares in 2008 were $132 million, compared to $86 million in 2003. In short, the company had done substantially better in terms of revenue and profit, but because it had issued a large amount of outstanding shares, on a per share basis, it showed unimpressive results.    

Let us now summarize 15 years of operations:  revenue increased to $5.6 billion from $1.7 billion, an increase of 229%. Earnings increased to $171 million, or $1.79 per share, compared to $119 million, or $1.75, an increase of 43%. And the number of outstanding shares only grew by 10%, to $92.6 million from $86 million. And a few more praiseworthy notes: the company did not report a single year of loss in earnings; since 2010, it had returned $615 million in dividends (at purchase price of $23 per share, the dividend yield is over 4%), and PDCO operates in an industry where time is your friend. Read: the need for dental and veterinary products is likely to increase with time. 

The earnings multiple 2017 - 2008

Should the reader need a classic example of the difference between a short term view and a long term view of a business, I believe PDCO serves as one of the best illustrations out there. Over the past month, the stock traded hands at a price between $23 to $22. That translates to an earnings multiple of about 11 times the reported earnings of $1.94 as of January 27, 2018 (which again only represented nine months of operating financials!).

Compare that to period between 2017 and 2013, when the stock traded as low as $32 and as high as $53. During this five-year period, investors happily paid an earnings multiple between 28 times and 12 times the earnings per share.

Or we can go back even further in time and see that between 2012 and 2008, the stock traded as low as $16 and as high as $37. And during the five-year period, investors were paying an earnings multiple between 19 and 9 times the earnings per share. If one were to exclude the Great Recession years, the stocked traded between $37 to $28 and the earnings multiple ranged from 13 to 19 times the earnings per share.

A personal note

This week ends my relationship with Paulina, a woman I thought - no, I was sure – I would be with for a very long time. And I think "short-termism" is to blame here too, just as it is in penalizing the stock price of PDCO. While I emphatically apologized for my behavior that can only be described as insecure and mixed with an inferiority complex, my attempt to apologize was unpardoned and our relationship abruptly ended as a result. My faulty behavior in the short term outweighed any long term prospects she had for me.

 It is a fact of life that the present dominates our thoughts and feelings. But to become a successful investor - or a partner in a relationship - to see the long, distant horizon is key.