Okay, raise your hand if you"re heard of Pall Corporation. Anyone? No? Well, neither had we, until we found this company in 2010 in a search for quality industrial suppliers that were number one or two in their markets.
Pall supplies filtration, separation, and purification technologies for the removal of solid, liquid, and gaseous contaminants from a variety of liquids and gases. Its products are used in thousands of industrial and clinical settings: removal of contaminants from gas reagents in every semiconductor production facility in the world, removal of bacteria and virus spores from water in hospitals and other clinical settings, and detection of bacteria in blood samples. Its products range in scale from simple in-line filters sold 100 to the carton up to entire graywater treatment systems with capacities up to 150,000 gallons/day.
Pall"s product and customers fall into two broad categories: Life Sciences (41 percent of the business) and Industrial (59 percent). The Life Sciences category breaks down further into Blood/Medical (16 percent) and Biopharma (25 percent). The company"s Life Sciences technologies facilitate the process of drug discovery, development, regulatory validation, and production. They"re used in the research laboratory, pharmaceutical, and biotechnology industries, in blood centers and in hospitals at the point of patient care. The company"s medical products improve the safety of the use of blood products in patient care and help control the spread of infections in hospitals. Pall"s separation systems and disposable filtration and purification technologies are critical to the development and commercialization of chemically synthesized and biologically derived drugs and vaccines. The company provides a range of advanced filtration solutions for each critical stage of drug development through drug production. Its filtration systems and validation services a.s.sist drug manufacturers through the regulatory process and onto the market.
Pall provides process technologies throughout the industrial marketplace, including the aeros.p.a.ce, transportation, microelectronics, consumer electronics, munic.i.p.al and industrial water, fuels, chemicals, energy, and food and beverage markets. Within the Food & Beverage market, filtration solutions are provided to the wine, beer, soft drink, bottled water, and food ingredient markets. The company sells filtration and fluid monitoring equipment to the aeros.p.a.ce industry for use on commercial and military aircraft, ships, and land-based vehicles to help protect critical systems and components. Pall also sells filtration and purification technologies for the semiconductor, data storage, fiber optic, advanced display, and materials markets.
Financial Highlights, Fiscal Year 2010
After a drop in revenues and earnings in FY2009 far more modest than we saw in other industrial suppliers, Pall got its revenue line back on track with a $2.4 billion showing in FY2010, and more importantly, came in with earnings of $2.03 per share, a 24 percent increase over FY2009. Better yet, the company has raised FY2011 guidance to a range of $2.48$2.63 per share, and raised its dividend 9 percent to an indicated 70 cents per share annually. Strength in the Life Sciences segment helped the company weather the recession, and looks to be the primary growth and margin driver going forward, while a recovery in the industrial segment will also help. The company has also been executing on share buybacks, reducing share count from 124 million in 2005 to 115 million in 2010.
Reasons to Buy
We like companies with a dominant position in their marketplaces or market niches, and we like industrials with a diversified customer base. The company sells into the medical, biopharma, energy, and water process technologies, and aeros.p.a.ce, and microelectronics s.p.a.ces, among others. These sectors will continue to show consistency and strength over time. Further, Pall"s products are consumables used consistently within the lab and manufacturing processes they sell into; they do not depend greatly on capital spending decisions and are relatively less sensitive to economic cycles. With 68 percent of sales originating overseas, the company has a strong international foothold.
Reasons for Caution
While its presence in the consumables side of the business attenuates the effects of economic cycles somewhat, the company is still sensitive to economic downturns. The recent strength in the business and business model has been noticed by others, too, and has been reflected in the strength of the stock price; new investors should look to buy on dips.
AGGRESSIVE GROWTH.
Patterson Companies, Inc.
Ticker symbol: PDCO (NASDAQ) S&P rating: NA Value Line financial strength rating: A Current yield: 123%
Company Profile
Patterson Companies is a value-added distributor operating in three segmentsDental Supply, Veterinary Supply, and Medical Supply. Dental Supply (about 70 percent of sales) provides a complete range of consumable dental products, equipment, and software; turnkey digital solutions; office design and setup; and value-added services to dentists and dental laboratories primarily for the North American market. Veterinary Supply (20 percent of sales) is the nation"s second-largest distributor of consumable veterinary supplies, equipment, diagnostic products, vaccines, and pharmaceuticals to companion-pet veterinary clinics. Medical Supply distributes medical supplies and a.s.sistive products, primarily for rehabilitation and sports medicine, globally to hospitals, long-term-care facilities, clinics, and dealers.
Patterson has one-third of the Dental Supply market. Their main compet.i.tor is HSIC (Henry Schein), which also has about a one-third share, with the remaining third fragmented among a number of smaller players, including Dentsply (XRAY) on our 100 Best list. As one of the lead dogs, Patterson has the clout to negotiate a number of exclusive distribution deals. It is sole distributor for the industry"s most popular line of dental chairs, and also has an exclusive on the CEREC 3D dental restorative system, an increasingly popular alternative to traditional dental crowns. Patterson is also the leading provider of digital radiography systems, which create instant images of dental work, superior to the images generated by traditional x-ray equipment.
Patterson"s veterinary business, Webster Veterinary, is the second largest distributor of consumable veterinary supplies to companion-pet veterinary clinics. Its line also includes equipment and software, diagnostic products, and vaccines and pharmaceuticals.
Financial Highlights, Fiscal Year 2010 (ending April 30, 2011)
The soft economy has claimed even dental services as a victim, as many patients deferred procedures and many dentists deferred purchases as a result. The company now projects FY2011 earnings between $1.89 and $1.99 per share, a slight gain from 2010, on low single-digit growth.
In early 2010 the company initiated its first-ever dividend with a $.10 per share quarterly payout, reflecting the company"s confidence in its growth prospects and strong current cash flows.
Reasons to Buy
Patterson Dental uses its size market leadership position to offer services that its smaller compet.i.tors cannot, such as financing, local service and support, and software services. During the recent business downturn, the company supplied all its customers with its EagleSoft practice management software at no charge and revised its commission structures.
The aforementioned CEREC 3D is an imaging and milling system that allows the dentist to take an image of the area to be restored and in less than thirty minutes produce a crown, inlay, or other device that is then fitted to the patient"s existing dental structure. It"s a compelling proposition for high-volume offices where patient throughput is at a premium and the equipment can be fully utilized. Sales of this high-ticket item have been very good and generate ongoing supplies revenue. Patterson"s exclusive license to this product is a powerful foot in the door for new accounts.
We like the company"s moves into the companion-pet veterinary and rehabilitative markets, both of which are driven by a growing and profitable demographic. Today the company is primarily focused on the North American market, with promised 2448 hour delivery for most items. They have established an international beachhead with the Patterson Medical group in the United Kingdom and France, and intend to leverage this presence to expand the dental and veterinary businesses; thus far international expansion remains more an opportunitya good onethan a reality.
The company has been using cash flow to increase shareholder returns, repurchasing about 10 percent of outstanding shares, and starting the aforementioned dividend. This plus the international growth opportunities and relatively recession-proof business are the most compelling reasons to own Patterson.
Reasons for Caution
The company is a bit more dependent on expensive equipment purchases than most of its compet.i.tors, and thus may be more vulnerable to economic swings than most. Compet.i.tion in this arena is strong, and operating and net margins have softened a bit since the middle of the last decade. With only modest growth prospects, this company is more of a steady long-term play than a quick hitter.
AGGRESSIVE GROWTH.
Paychex, Inc.
Ticker symbol: PAYX (NASDAQ) S&P rating: NA Value Line financial strength rating: A Current yield: 3.7%
Company Profile
Paychex, Inc., provides payroll, human resource, and benefits outsourcing solutions for small to medium-sized businesses. Founded in 1971, the company has more than 100 offices and serves over 536,000 clients, mostly small to medium-sized businesses with ten to 200 employees in the United States and an additional 1,400 clients in Germany. The company has two sources of revenue: service revenue, paid by clients for services; and interest income on the funds held by Paychex for clients.
Paychex offers a portfolio of services and products, which includes: Payroll processing Payroll tax administration services Employee payment services Regulatory compliance services (new-hire reporting and garnishment processing) Comprehensive human resource outsourcing services Retirement services administration Workers" compensation insurance services Health and benefits services Time and attendance solutions Medical deduction, state unemployment, and other HR services and products The company"s products are marketed primarily through its direct sales force, the bulk of which is focused on payroll products. In addition to the direct sales force, the company utilizes its relationships with existing clients, CPAs, and banks for new client referrals. Approximately two-thirds of its new clients come via these referral sources.
The company also sells a Major Market Services product for its larger clients. The MMS product is a license that allows the client to run the Paychex software on the client"s own servers and administer the payroll function with its own personnel. They can also have their own HR people manage and control PayChex-hosted payroll processes through the Internet.
In addition to traditional payroll services, Paychex offers complete "full service" HR outsourcing solutions; custom-built solutions including payroll, compliance, HR, and employee benefits sourcing and administration; outsourcing management and even professionally trained onsite HR representatives. The company also manages retirement plans and other benefits, including pretax "cafeteria" plans, and has a subsidiary insurance agency offering property and casualty, workers" comp, health and auto policies to an employer"s employee base.
Financial Highlights, Fiscal Year 2010 (ended May 31, 2010)
The Paychex business is directly affected by the number of businesses in the client base, and the number of workers that business employs. Both "bases" went into serious decline during the recession. Paychex experienced its first-ever decline in client base in FY2009, and this decline continued into FY2010. As employment trends slightly lag the recessionary trough itself, and with the Paychex 2010 fiscal calendar ending in May 2010, that year turned out to be the weakest year, with revenues of $2 billion, off about 4 percent from FY2009. 2011 is expected to recover that 4 percent dip. Earnings, in the meantime, are expected to recover to $1.40 per share; again, not stellar but a step in the right direction.
Reasons to Buy
Paychex"s primary market is firms with fewer than 100 employees. This is one of the primary reasons that Paychex has lost clientsmany small businesses are undercapitalized and simply went out of business during the recession. On the other hand, as the economy turns around, we expect that smaller firms are the first place that new jobs will appear. Additionally, we believe many larger firms with HR and payroll departments will continue to look into outsourcing these services to cut costs, which should help Paychex.
The company is very conservatively run and is well financed. It carries no debt and will have no difficulty funding the generous dividend, even at its current payout level of 8090 percent of earnings. Fragmentation in the market and Paychex"s extremely strong financial position would allow the company to grow market share through acquisition, should it decide to do so.
Finally, the company handles billions of dollars of "float" every year as it receives payrolls from clients and doles them out to employees, who don"t always cash checks right away. This float is as much as $4 billion at any one time. The net interest income from this business dried up to near zero because of low short-term interest rates on safe securities. Any uptick in short-term rates would be an added plus for the company.
Reasons for Caution
This company will always be vulnerable to economic swings. Additionally, the company has many smaller local compet.i.tors in most markets, making it hard to raise prices and fees for its services. Finally, while most a.n.a.lysts consider the dividend payout secure, it does account for a substantial fraction of the company"s cash flow, and increases may be hard to come by for the immediate future.
CONSERVATIVE GROWTH.
PepsiCo, Inc.