Cardinal Health (CAH) was founded in 1971. Even though it has been in business for 45 years, the stock might fly under the radar for income investors. But it is a high-quality company and has a lot to offer investors.

It is a Dividend Aristocrat, and has increased its dividend for 31 years in a row.You can see all 50 Dividend Aristocrats here.

The company operates a large and highly profitable business model. And it has a shareholder-friendly management team that is committed to returning loads of cash to shareholders.

Cardinal Health stock offers an above-average 2.7% dividend yield and high dividend growth. Cardinal Health is Sure Dividend’s favorite health care stock today – thanks to its recent price decline.

Business Overview

Cardinal Health distributes healthcare products and supplies. It has a diverse customer base made up of retailers, hospitals, and a many other healthcare providers.

Cardinal Health has a huge network, of more than 5,000 medical suppliers, as well as 20,000 pharmacies. The company has a massive footprint in the healthcare industry: in all, it services more than 70% of hospitals in the U.S.

The company is split into two main segments:

• Pharmaceutical (90% of revenue)
• Medical (10% of revenue)

Both of these segments have generated strong revenue growth in recent years.

Source: Fiscal 2016 Annual Report, page 14

The pharmaceutical business distributes branded and generic drugs and consumer products. It distributes these products to hospitals and other healthcare providers. The medical segment distributes medical, surgical, and laboratory products to hospitals, surgery centers, clinical laboratories, and other service centers.

Unfortunately, Cardinal Health’s impressive run hit a wall in 2013, when it lost its contract with Walgreens Boots Alliance (WBA).

This was a severe blow; Walgreens was one of the company’s largest individual customers. The loss caused Cardinal Health’s total revenue to decline 6% in 2013 and 10% in 2014.

The good news is that the company offset this with growth in other areas. Over the past five years, it invested $8.5 billion in acquisitions and capital expenditures to return the company to growth.

Source: Fiscal 2016 Annual Report, page 6

It is a great sign that the company had enough cash flow left over to raise its dividend and repurchase its own shares as well.

Cardinal Health’s strategic investments have placed the company back on track for growth.

Growth Prospects

Cardinal Heath has encountered many challenges over the past 10 years, including the loss of Walgreens and the Great Recession of 2007-2009. As a result, the company grew earnings-per-share by just 1.5% per year over the past decade.

But put differently, it is impressive that the company grew earnings-per-share at all, given the stiff headwinds it has fought against.

The road ahead should be smoother for Cardinal Health. It has once again eclipsed $100 billion in annual revenue. The company expects to increase non-GAAP earnings-per-share by 3%-7% this year. Over the long-term, the company aims for 10%-15% growth of adjusted earnings-per-share.

Source: First Quarter Earnings Presentation, page 13

Earnings-per-share growth can be achieved by organic growth, bolt-on growth through acquisitions, and share repurchases.

In the past three years, Cardinal Health made three acquisitions that cumulatively cost $5.1 billion. It acquired Cordis, The Harvard Drug Company, and AssuraMed. These deals significantly increased Cardinal Health’s scale in pharmaceutical and medical distribution, particularly in cardiovascular and endovascular products.

One factor that could limit Cardinal Health’s growth is weak performance in the core pharmaceutical business. Profit in this segment fell 19% in the first quarter. This was mostly due to drug pricing deflation, as Cardinal Health moved to match competitors’ pricing discounts to retain market share.

However, the company still expects growth in adjusted earnings-per-share this year and next year. The medical segment is growing at a high rate, and is helping to offset the pharmaceutical segment.

And, Cardinal Health should benefit from a structural tailwind in the U.S. The aging population should result in increasing demand for health care products and services for many years.

Competitive Advantages & Recession Performance

One huge competitive advantage for Cardinal Health is scale. The company holds a $21 billion market cap. In addition, it basically operates in an oligopoly. There are three huge medical suppliers, including Cardinal Health, that collectively control around 85% of the market.

Cardinal Health’s competitive advantage is durable and long-lasting.It basically operates a “toll road” style business model, similarly to an oil pipeline company. Cardinal Health will continue to generate growth and steady profitability as long as prescription drugs and medical supplies need to be distributed.

This is the advantage of being a player in the distribution business. That being said, Cardinal Health is not immune from recessions. Its earnings-per-share declined significantly during the Great Recession:

• 2007 earnings-per-share of $3.41
• 2008 earnings-per-share of $3.80
• 2009 earnings-per-share of $2.26
• 2010 earnings-per-share of $2.22

The good news is that the company quickly returned to growth in 2011 and beyond.

Valuation & Expected Total Return

Cardinal Health stock trades for a price-to-earnings ratio of 15. This is a significant discount to the S&P 500, which trades for a price-to-earnings ratio of 24.3.

As a result, Cardinal Health appears to be significantly undervalued. If the stock were to earn an average market price-to-earnings ratio, it would result in a 67% return. Cardinal Health’s price-to-earnings ratio averaged around 20 for much of 2014 and 2015.Even a price-to-earnings ratio of 20 is a significant boost from current levels.

Aside from an expanding price-to-earnings ratio, Cardinal Health should generate earnings growth going forward. This could fuel even greater shareholder returns

Even if the company only generates 10% earnings-per-share growth going forward, it would provide strong total returns. Adding in Cardinal Health’s 2.7% dividend yield would generate 12.7% total annual returns.

Final Thoughts

Cardinal Health has seen its share of challenges over the past few years. But the company has proven to be resilient. It has a renewed outlook for growth, based on acquisitions and internal growth.

The stock has not performed well so far this year—shares declined 25% so far in 2016.

Still, the stock could be attractive for dividend growth investors. In the past five years, dividends declared rose 11% per year. With a payout ratio near 30%, there is plenty of reason for continued dividend growth going forward.

The company has an enticing combination of a low price-to-earnings ratio, a long history of stability, a low payout ratio (for faster future dividend growth), and expected long-term 10%+ earnings-per-share growth. These factors make Cardinal Health a buy at current prices and a favorite of The 8 Rules of Dividend Investing.