Cardinal Health: Undervalued Dividend Aristocrat With Upside
Total retail prescription spending in the U.S. could grow 4%-7% per year and reach as high as $610 billion by 2021.
This puts drug distributors in a prime position to increase their market share. Even with this development, drug distributor stocks, like Cardinal Health (CAH), have very low valuations and are among the cheapest stocks in the market.
The pharmaceutical distribution industry is an oligopoly. Just 3 large players dominate the market:
Of these 3, Cardinal Health stands out for its shareholder friendliness. The company is a Dividend Aristocrat thanks to its 33 consecutive years of dividend increases. And, it has a current yield of 3.8% which compares favorably to the dividend yields of AmerisourceBergen and McKesson which are both under 2%.
Cardinal Health supplies products to more than 24,000 pharmacies in the U.S. and more than 85% of the nation’s hospitals. In addition, the company has operations in more than 60 countries and generated $130 billion in sales in 2017, up 7% from 2016.
Recent Earnings Results and Threat from Amazon
Shares of Cardinal Health have lost 20% in value since the beginning of 2018. Much of this loss is due to third-quarter earnings results. Released on May 3rd, Cardinal Health’s operating earnings in the quarter was $1.39, a 9% decline from the third quarter of the previous year. Much of this year over year decline was due to a higher effective tax rate of 45.1%, up from 32.3% the same time in the previous year. Revenue actually grew 6% to $33.6 billion.
The higher tax rate was due to a decline in the Cordis business, which has been part of Cardinal Health since October of 2015. The company was unable to use operating losses to their advantage tax-wise. While Cordis has performed well in international markets, including double-digit sales gains in China, Cordis was a $0.13 drag on earnings as operating costs and inventory reserves were higher than expected.
The company is applying new technology improvements to help manage inventory and examine ways to reduce their costs. Cardinal Health expects Cordis to return to profitability by the end of FY2019, likely meaning more pain in the short term. Cardinal Health reduced the midpoint of its earnings per share guidance to $4.90 from $5.38 due to third quarter results.
In addition to results, Amazon’s (AMZN) goal of entering the prescription delivery business has weighed on Cardinal Health and the stocks of other drug distributors. Investors seem to punish stocks in any sector that Amazon appears eager to disrupt
Evidence for Bullish Thesis
Earnings and a threat from Amazon doesn’t mean that Cardinal Health should be avoided by investors. Cardinal Health, along with AmerisourceBergen (ABC) and McKesson (MCK), controls nearly all of the pharmaceutical distribution in the United States. Drug distribution is a low margin business as lower cost generic drugs make up about three-quarters of all profits. Combining low-profit margins with the long-term contracts that Cardinal Health has with manufacturers and retail pharmacies and it is very difficult for new entrants to come to the marketplace.
Cardinal Health completed its spinoff of CareFusion Corporation in 2009, which led to a significant impact on earnings. From 2009 through 2017, the company has seen earnings growth of 13.5% per year. Based off of updated earnings guidance and the July 13th closing price of $50.90, shares of Cardinal Health trade at price to earnings multiple of just 10.4. The stock has an average multiple of 15.5 since 2010, allowing for significant multiple expansion if shares of Cardinal Health were to trade near their historical valuation.
Cardinal Health is the rare investment that offers an above-average dividend yield, solid long-term growth prospects, and is undervalued. In addition, the company is very shareholder friendly as evidenced by its 3-decade streak of paying rising dividends every year.
Disclosure: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities. However, the publishers of Sure Dividend ...
more