Neutral on Patterson Companies

We retain our Neutral rating on the leading distributor of dental, companion-pet veterinarian and rehabilitation medical supplies Patterson Companies Inc (PDCO - Analyst Report). The company posted tepid first-quarter fiscal 2012 results with earnings per share of 42 cents trailing both the Zacks Consensus Estimate and the year-ago earnings.

Profit slid roughly 10% year over year on account of charges related to the company’s Employee Stock Ownership Plan (“ESOP”). Revenues fell 0.3% year over year $847.4 million, missing the Zacks Consensus Estimate. However, on a comparable basis (excluding the impact of the benefit from an additional week a year ago) sales rose 6%.

Patterson provides a wide range of consumables, equipment and software and value-added services to its customers. The company is expected to benefit from improving North American dental industry fundamentals.

Patterson’s continued investments in infrastructure should boost operational efficiencies. Moreover, the company is exploring lucrative acquisition deals to strengthen its market position and geographic reach.

Patterson should benefit from the gradual recovery in the dental market and the rebounding dental equipment business, assisted by the promotional initiatives. Revenues from new technology equipment are growing at a healthy pace as dentists continue to switch from film to digital radiography. Patterson is investing on technology upgrades to its CEREC platform, helping it to expand the associated customer base.

The company’s Rehabilitation Supply business continues to grow at a healthy quarterly run rate, despite the unfavorable impact of the austerity measures in the U.K and current regulatory uncertainties in the U.S. The division is benefiting from the synergies of acquisitions.

However, Patterson faces significant competition in the dental market, especially from Henry Schein Inc (HSIC - Snapshot Report). The company’s back-to-back acquisitions also lead to substantial integration risk. Moreover, promotional spending and charges associated with ESOP are expected to weigh on earnings in fiscal 2012 and beyond.