Cardinal Health is Bargain Stock to Consider

Cardinal Health, Inc. is an Ohio corporation formed in 1979 and is a global, integrated healthcare services and products company providing customized solutions for hospitals, healthcare systems, pharmacies, ambulatory surgery centers, clinical laboratories and physician offices. It has approximately 50,000 employees, operates in 60 countries, and generates annual revenue of approximately $130 billion.

 

Cardinal Health as a business

Cardinal Health manage its business and report its financial results in two segments: Pharmaceutical and Medical.

Pharmaceutical segment (89% of revenue)

The pharmaceutical segment distributes its products to hospitals and other healthcare providers.

* Mid-to-high single digit percentage increase in revenue versus prior year

* Full-year segment profit down low-double digits versus prior year

* Generic drug price assumption of low-double digit deflation for full fiscal year

Within our Pharmaceutical segment, we expect fiscal 2018 segment profit to be less than our fiscal 2017 segment profit due primarily to generic pharmaceutical customer pricing changes.

Medical segment (11% of revenue)

The medical segment distributes its products to hospitals, surgery centers, clinical laboratories and other service centers.

* High-single digit percentage increase in revenue vs. prior year

* Double-digit segment profit growth vs. prior year

 

The company’s stock price has declined due to declining pharmaceutical costs and opioid epidemic fears. Pharmaceutical segment revenue increased, but operating profit fell. Fortunately, medical segment revenue and operating profit are increasing.

Cardinal Health’s pharmaceutical segment generics program performance, which includes the negative impact of generic pharmaceutical customer pricing changes offset by the benefits of Red Oak Sourcing. They have built a strong model in Red Oak Sourcing (joint venture with CVS Health) and it continues to contribute nicely and is a source of strength for Cardinal Health and its customers.

Acquisitions have played a major role in expanding Cardinal Health’s presence in niche and lucrative market segments. The decrease in cash and equivalents during the three months ended September 30, 2017 was driven by $6.1 billion paid for acquisitions. Cardinal Health acquired Patient Recovery Business from Medtronic for $6.1 billion in cash. The acquisition also increased amortization and other acquisition related costs due to the size and complexity of the acquisition. Also interest expense are expected to increase during the remainder of fiscal 2018.

Acquisitions strengthen company’s market position, grow their scale, add new long-term drivers of growth and improve the overall balance of integrated portfolio. When the population is aging demand for the healthcare products and services continue to grow. Cardinal Health is well placed in multiple therapeutic areas, all with firm five-year growth prospects. The strength of Company’s Specialty Solutions segment lies in its capability to focus on both upstream and downstream customers. Finally, it should be remembered that an acquisition-based growth strategy also exposes the company to significant post-merger integration risks.

Cardinal Health is taking actions to address the changes in the market including 1) employing advanced analytics in pricing strategies 2) reducing SG&A costs and 3) pursuing novel approaches to grow of consumer product offerings for its customers.

The increase in restructuring and employee severance during the three months ended September 30, 2017 was primarily due to $125 million in contract termination costs. Overall expenses rose by 8%. During the same time period, the company repurchased $150 million of its own common shares. Repurchases were funded with available cash and short-term borrowings.

Then we need to be aware that Cardinal Health is excessively dependent on its largest customers, CVS Caremark and OptumRx, which accounted for 23% and 11% of the company’s 2017 revenues, respectively. The top five largest customers of the company contributed about half of Cardinal Health’s revenues in fiscal year 2017.

Finally, Cardinal Health has announced that it has named Mike Kaufmann, its current Chief Financial Officer, as the company’s CEO effective January 1, 2018. He will succeed Cardinal Health’s current CEO, George Barrett, who has been in his role since 2009 and will continue to serve as Executive Chairman of Cardinal’s board of directors. It’s great that the new CEO comes from the company. Kaufmann is a 27-year veteran of Cardinal Health and it is to be assumed that he will continue on the path of his predecessor.

 

Valuation

Stock price is $57.51 (November 17, 2017)

Current P/E 16.5 (during the last years normally closer to 20) and industry median is 21.5. Recently earnings have been under the pressure, but when the pharmaceutical market return to normal and the medical segment will continue to grow, it is realistic to expect £5-6 EPS during the next few years. This is also supported by the company’s strong cash flow and stock repurchase program.

Dividend yield is 3.2% and the company has increased its dividend for 32 years in a row. During the past 10 years, the average dividends per share growth rate was 16.00% per year. Cardinal Health can continue to raise its dividend, because it still generates more than enough cash flow support annual increases. And its normal payout ratio is modest under 50%.

If we gauge conservative that P/E ratio will remain between 16 to 17 and earnings forecast will be true, we can wait in the next few years stock price from $80 to $90. Because the waiting time is always long and asking for patience, meanwhile we can enjoy good and growing dividends.

 

Conclusion

Cardinal Health operates in an oligopoly, which allows it to generate significant profits with relatively low amounts of competition. The biggest competitive advantage for Cardinal Health is its distribution capabilities, which make it very difficult for competitors to successfully enter the market. The company distributes its products to nearly 85% of U.S. hospitals.

And, Cardinal Health operates in a stable industry, with high demand. The company should remain steadily profitable, as there will always be a growing need for pharmaceutical products to be distributed.

Going forward, there are multiple catalysts for the pharmaceutical segment to improve and Medical segment to continue its prosperity. These include moderating price deflation, growth in specialty products and cost cuts.

Stabilization of pricing is promoted by the company’s joint venture (Red Oak Sourcing) with CVS Health. Joining forces helps the two companies negotiate better generic pharmaceutical prices. Also recently acquired the Patient Recovery business will broaden the company’s product offerings and boost earnings in the next couple of years. The company have to keep costs down and bill effectively so that receivables do not grow too much in relation to revenue. After acquisitions, it is very important to keep debt level under the control.

Often short-term problems of high-quality companies like Cardinal Health create great buying opportunity. As the company continues to focus on paying dividends and repurchasing shares, all the while investing in its core activities and maintaining robust cash flows from operations, it will prove to be a healthy investment option in the next one-year time horizon.

What is exceptional in Cardinal Health is that it can be good investment as well for bargain hunter, dividend investor or buy-and-hold investor.

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