Dental Supplier Trades at Tempting Discount

THE NUMBER OF dentists in America has remained mostly flat since 1990, while the population has increased 22%, reports the New York Times. So while the cost of most goods rises gradually from one year to the next due to inflation, the cost of dental care rose 25% after subtracting for inflation between 1996 and 2004. Meanwhile, around one in three Americans lack dental plans, double the number that lack health plans. Half of all dental spending is out-of-pocket.

The results of that are several. Since dental fees are less constrained than medical ones by insurance companies, my dentist now makes more money than my doctor — and sounds like more of a carnival barker when pushing nonessential services like straightening and whitening. The American Dental Association, which lobbies to depress the number of new dentists, is starting to resemble an OPEC-style trade cartel more than a group "committed to the public's oral health, ethics, science and professional advancement."

It also means that more than 27% of Americans now simply live with untreated cavities, the highest percentage since the late 1980s, according to the Centers for Disease Control. Investors are perhaps betting that more will forego cleanings and fillings to afford swelling grocery bills. Sales and profits for Patterson Cos. (PDCO), among the nation's largest distributors of dental supplies and equipment, are running modestly higher than a year ago, but its stock has fallen 17%.

The selloff has compressed Patterson's forward price/earnings ratio to 16. That's a touch higher than the broad market's P/E, but half Patterson's valuation three years ago, after the stock had completed a fivefold price gain in seven years. The discount, combined with prospects for healthy profit growth despite the challenges in dental, helped earn Patterson and spot with seven other names in a screen for medium-size companies with attractive shares. Have a look at all the criteria if you like, and run the search yourself anytime using SmartMoney's stock screener.

Patterson is taking steps to rekindle its growth. Previously, when its sales force sold a digital imaging machine, commissions were split among an equipment specialist, a technology specialist and a territory rep. The company has eliminated the position of technology specialists, laying a few of them off but folding most into its regular sales force, and making some salaried trainers for dentists. With commissions now split two ways instead of three, salespeople have more incentive. Patterson has made similar moves in its consumables division. It has also launched a trade-in program to get dentists to update their equipment.

Offsetting the economic pinch in dental sales is a rise in the number of Americans age 65 and older, who need more dental care and, on average, can better afford it. Americans are also keeping their natural teeth longer, and the well-to-do are spending more on cosmetic procedures. Through recent acquisitions, Patterson has entered the distribution business for veterinary and rehabilitation therapy supplies. The two industries share similarities with dentistry. Most practices are small and many lack back-office support, creating demand for knowledgeable salespeople. And the supplier base for all three businesses is highly fragmented, which means that large distributors have an opportunity to grab more market share.

So while Patterson's growth is slowing, it's far from stalling. Over the past five years Patterson has increased its sales and earnings per share by an average of 15% and 17%, respectively. This year Wall Street expects the company to turn 8% sales growth into 15% profit growth. That makes today's stock price look modest enough.

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