EUR 850.00 For Business Accounts Only

Morningstar | Strong Growth but Pressured Profits for Henry Schein as It Initiates a Major Restructuring

We believe narrow moat Henry Schein’s efforts to restructure its operations is a major positive, but we do not think this strategy will offset all of the secular headwinds the firm is facing. Nevertheless, after factoring in these latest developments (which include the spinout of its animal health business) we plan to moderately increase our $65 fair value estimate. The restructuring includes staff rationalization, technological infrastructure improvements, and the spinout of its Animal Health segment. From our perspective, these tactics will position Schein more favorably in a rapidly changing dental market. There has been a major shift within the dental wholesaling market, in particular the consumable niche, as new entrants have dramatically undercut the pricing environment. We believe it’s incumbent upon Schein to make the necessary organizational adjustments to move its business from a cumbersome regional structure predicated upon sales experts and toward a more streamlined centralized operation based upon cost optimization.

We believe pricing within the dental market has been permanently impaired, and Schein may not be able to preserve all lost profitability as a result of this dynamic. However, management’s announced restructuring plan is a major positive step in the right direction. Additionally, we believe the firm’s spinout of the Animal Health business and the use of proceeds from the transaction to modernize the infrastructure of its core operations will be value accretive. From our perspective, these modernization plans will enable increased profit preservation above our current projections, and we plan to fully adjust for this dynamic that will likely lead to an increase of our overall fair value estimate.

Management reemphasized its decision to spinout its animal health business, merge it with privately held Vets First Choice, and create a new publicly traded veterinarian wholesale company named Vets First Corp. It expects the deal to close toward the end of this year with the possibility it could be pushed into the first quarter of 2019. Schein will receive between $1.00 billion-$1.25 billion in pretax cash from Vets First Choice, and shareholders will own around 63% of the new corporation. We applaud management in executing this deal as we believe the firm will unlock significant shareholder value by moving this operation from under the pressured dental segment. Additionally, management’s stated intention to use most of the cash for infrastructure investments will compound the shareholder value gained through this transaction.

For the quarter, top-line growth was decent from both an organic and inorganic perspective; however, operating margins again compressed as lower SG&A costs were not able to offset gross margin pressure. From our perspective, the pricing and profit variables of the dental wholesaling business still remain pressured and will remain so over the next several years. We believe a material portion of dental customers for Henry Schein are utilizing lower cost options for consumable supplies, and the firm has been forced to discount its pricing to preserve volume.