Cardinal Health, Inc.
/ (CAH-NYSE)/ Equity Research / CAH | Page 1
Current Recommendation / NEUTRAL
Prior Recommendation / Outperform
Date of Last Change / 06/11/2014
Current Price (06/10/14) / $70.03
Target Price / $74.00
SUMMARY
Cardinal Health toppedthe Zacks Consensus Estimate by a penny despite a 15.8% fall in fiscal-2014 third quarter earningsdue to a 12.7% decline in revenues to $21,427 million. The company’s performance in thePharmaceutical segment was disappointing as its revenues ebbed 15.0% due to the expiration of the contract with Walgreens Co. However, the problem of client and supplier concentration and reliance on group purchasing organizations is partly mitigated through long-term contracts.The company’s leverage position has also improved. As such, we downgrade our recommendation to Neutral from Outperform and set a target price of $74.00./ Equity Research / CAH | Page 1
SUMMARY DATA
52-Week High / $73.5452-Week Low / $46.58
One-Year Return (%) / 50.76
Beta / 0.63
Average Daily Volume (sh) / 1,691,600
Shares Outstanding (mil) / 340
Market Capitalization ($mil) / $23,824
Short Interest Ratio (days) / 1.65
Institutional Ownership (%) / 85
Insider Ownership (%) / 1
Annual Cash Dividend / $1.21
Dividend Yield (%) / 1.73
5-Yr. Historical Growth Rates
Sales (%) / 0.2
Earnings Per Share (%) / 8.4
Dividend (%) / 14.2
P/E using TTM EPS / 18.4
P/E using 2014 Estimate / 18.4
P/E using 2015 Estimate / 16.4
Zacks Rank*: Short Term
1–3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Below Avg.,
Type of Stock / Large-Growth
Industry / Med/Dental-Supp
Zacks Industry Rank * / 186 out of 267
OVERVIEW
Cardinal Health, Inc. (CAH), headquartered in Dublin, OH, is a nation-wide drug distributor and provider of services to pharmacies, healthcare providers and manufacturers. It enables pharmacies, hospitals, and ambulatory care sites to focus on patient care while reducing costs and enhancing efficiency and quality. As one of the largest global health care companies, Cardinal Health is an important link in the health care supply chain. It provides pharmaceuticals and medical products to more than 40,000 locations daily. It is also a leading manufacturer of medical and surgical products, including gloves, surgical apparel, and fluid management products. In addition, Cardinal Health supports the growing diagnostic industry by supplying medical products to clinical labs and operating a large network of radiopharmacies that dispense products to aid in the early diagnosis of disease. Cardinal Health has two reporting segments – Pharmaceutical and Medical.
The Pharmaceutical segment (accounted for 88% of revenues in the first nine months of fiscal 2014): It is the second largest pharmaceutical distributor in the U.S. and the largest nuclear pharmacy. Its products and services include pharmaceutical distribution, manufacturer and specialty services, and nuclear and pharmacy services. In China, the segment operates as Cardinal Health China, which supplies branded, generic and specialty pharmaceuticals and provides logistics, marketing and other services. This segment also offers “specialty pharmaceutical products and services”, which supplies (1) oncology, rheumatology, urology and other pharmaceutical products to physician offices; (2) human plasma products and specialty pharmaceutical products to hospitals and other healthcare providers; (3) consulting and other services to pharmaceutical manufacturers, third party payors and healthcare providers. These apart the specialty business operates as a specialty pharmacy.
The Medical segment (12%): The segment manufactures products such as single-use surgical drapes, gowns and apparel; exam and surgical gloves; and fluid suction and collection systems and offers sterile and non-sterile procedure kits. These products are sold directly or distributed via third-party sources in the U.S., Canada, Europe, South America and the Asia/Pacific.
REASONS TO BUY
Large-cap, diversified healthcare distributors such as Cardinal Health are relatively insulated from macro economic uncertainty and a weak economy. Cardinal Health is one of the largest distributors of pharmaceuticals and medical supplies. It has a diversified product portfolio, which is a hedge against the risk of sales shortfall in testing times. Cardinal Health’s generics business showed continuing signs of strength. Growth in this business continues to surpass the market growth rate, especially the company’s Source program. Cardinal Health has rationalized the number of generic suppliers. In addition, the company has expanded relationships with generic manufacturers that include several benefits like higher service levels, greater clarity on generic cost of goods sold, and a more consistent product supply with fewer disruptions.
The performance of the Pharmaceutical segment has been facilitated by good client retention, with the loss of only a few key customers (Walgreens and Express Scripts). Cardinal Health has already renewed many of its chain customer contracts for subsequent years. For example, Cardinal Health has already signed up Kroger and K-Mart with contracts binding through 2015. The concentration of suppliers has also been well managed by the company. It is noteworthy that no supplier accounted for more than 6% of revenue. However, five suppliers generated about 20% of Cardinal’s business. Cardinal typically writes annual contracts and grants automatic renewals each year, for five years.
In April this year, Cardinal Health inked an agreement to buy privately held AccessClosure Inc. for $320 million. AccessClosure is a manufacturer and distributor of extravascular closure devices in the U.S. with $80 million in annual sales. It is popular for its Mynx suite of patient-friendly vascular closure devices. The acquisition is expected to be completed in this month. Although, it is not going to have a material impact on the company’s earnings in fiscal 2014, it would be modestly accretive to the same in fiscal 2015.
Despite a rise in total debt, Cardinal Health’s debt-to-capitalization ratio fell 170 bps to 37.5% as of Mar 31, 2014 from 39.2% as of Jun 30, 2013 due to increase in shareholder’s equity.In the first nine months of fiscal 2014, Cardinal Health’s operating net cash flow rose 26.7% to $1,808 million from $1,427 million in the prior-year period due to increases in net earnings and depreciation and amortization, and decreases in trade receivables and inventories.
REASONS TO SELL
Loss of contracts with Walgreens and Express Scripts Holding Company has negatively impacted revenues. However, these largely bulk volume clients carried a lower margin than other customers of Cardinal Health. Walgreen was largely a purchaser of generics from Cardinal Health. In the third quarter of fiscal 2014, revenues from Cardinal Health’s mainstay Pharmaceutical segment ebbed 15.0% to $18,762 million, owing to the expiration of the contract with Walgreens.
Cardinal Health derives a significant quantum of revenues through agreements with group purchasing organizations (GPOs). These organizations act as agents that negotiate vendor contracts on behalf of their members. The company’s two largest GPO agents are Novation, LLC and Premier Purchasing Partners, L.P., who together account for about 15% of Cardinal’s revenues. Loss of relationship with either of these agents will severely affect the company’s sales. In addition, some GPOs sell products that compete with distributors.
Cardinal Health faces tough competition in each of its business segments. For example, its pharmaceutical supply chain business faces competition from McKesson Corporation (MCK) and AmerisourceBergen Corporation (ABC) as well as several smaller medical-surgical distributors such as Henry Schein (HSIC) and Owens & Minor (OMI).
RECENT NEWS
Cardinal Health Earnings Fall but Beat by a Penny – May 1, 2014
Cardinal Health Inc. posted adjusted earnings per share $1.01 for the third quarter of fiscal 2014 that fell 15.8% from $1.20 in the comparable quarter of fiscal 2013 but surpassed the Zacks Consensus Estimate by a penny.
Adjusted net earnings dipped 15.3% to $349 million from $412 million in the third quarter of fiscal 2013. The fall in earnings was attributable to lower revenues during the quarter.
On a reported basis, net earnings decreased to $315 million or $0.91 per share in the quarter from $346 million or $1.00 per share in the year-ago quarter.
Revenues in the quarter went down 12.7% to $21,427 million, due to lower revenues from the Pharmaceutical segment. The top line was almost in line with the Zacks Consensus Estimate of $21,491 million.
Adjusted operating earnings slid 3.1% to $561 million from $579 million in the year-ago quarter. However, adjusted operating margin upped 20 basis points (bps) to 2.6% from 2.4% a year ago.
Segment Results
Revenues from Cardinal Health’s mainstay Pharmaceutical segment ebbed 15.0% to $18,762 million, owing to the expiration of the contractwith Walgreens Co., partially offset by sales growth from new and existing customers. Segment earnings fell 9.2% to $452 million owing to lower revenues, partially offset by strong performance from generic programs.
Revenues from the smaller Medical segment grew 7.0% to $2,657 million in the quarter, due to the home health platform, reflecting the acquisition of AssuraMed. Segment earnings rose 11.0% to $111 million, driven by home health, which was partially offset by the effect of overall procedural volume softness and reductions in Presource kitting volumes.
Financial Status
Cardinal Health exited the fiscal third quarter with cash and cash equivalents of about $3,041 million, up significantly by 60.0% from $1,901 million as of Jun 30, 2013. Total debt stood at $3,920 million as of Mar 31, 2014, up 1.7% from $3,854 million as of Jun 30, 2013. However, debt-to-capitalization ratio fell 170 bps to 37.5% as of Mar 31, 2014 from 39.2% as of Jun 30, 2013 due to increase in shareholder’s equity.
In the first nine months of fiscal 2014, operating net cash flow rose 26.7% to $1,808 million from $1,427 million in the prior-year period due to increases in net earnings and depreciation and amortization, and decreases in trade receivables and inventories. Capital expenditure increased 40.0% to $138 million from $103 million in the first nine months of fiscal 2013.
EPS Guidance Reiterated
For fiscal 2014, Cardinal Health retained its forecast for adjusted earnings per share in the band of $3.75 to $3.85. The current Zacks Consensus Estimate of $3.81 for the year lies within the guided range.
VALUATION
Currently, shares of Cardinal Health are trading at 18.4x our 2014 EPS estimate of $3.81. The company’s current trailing 12-month earnings multiple is 18.6, compared with the 36.6 average for the peer group and 18.2 for the S&P 500. Over the last five years, Cardinal Health’s shares have traded in a range of 8.1x to 18.6x trailing 12-month earnings. The stock is also trading at a discount to the peer group, based on forward earnings estimates. The current P/E, which is close to the upper end of the historical range, is at a 25.0% discount to the peer group for 2014. Our long-term $74.00 target price, 19.4x 2014 EPS, reflects this view.
Key Indicators
Earnings Surprise and Estimate Revision History
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of CAH. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1083companies covered: Outperform- 16.1%, Neutral- 77.7%, Underperform – 5.4%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
Analyst / Souvik GuhaLead Analyst / Souvik Guha
QCA / Souvik Guha
Reason for Update / Earnings
/ Equity Research / CAH | Page 1