Introduction
McKesson Corporation (NYSE:MCK) has been faced with a challenging healthcare landscape as political posturing, drug pricing scrutiny, overall sentiment towards pharmaceutical companies due to price gouging allegations and the overall rotation out of healthcare related stocks. This confluence of events has plagued McKesson’s stock, falling from $241 to $148 or 39% in just 9 months from May of 2015 through February 2016. MCK has been on an acquisition spree as of late and announced layoffs of 1,600 workers or about 4% of its U.S. workforce. These collective efforts are aimed to stem any losses in revenue from a hit to its customer base while continuing to drive value for shareholders. McKesson has acquired two medical firms that focus in oncology for a total of $1.2 billion and Ontario-based Rexall Health for $2.2 billion. McKesson is being proactive and aligning its cost structure in a fiscally responsible manner in order to remain competitive and add value to shareholders. At the writing of my previous article covering McKesson, it had hit a 52-week low of ~$150 in March. Since then, the stock has been on an uptick to current levels at $182 or 20% rise in its stock price. McKesson appears very attractive considering its EPS growth, dividend payout, acquisitive mindset and share buyback program however concerns remain.
McKesson Announces Fiscal Q4 2016 Results
McKesson recently reported results for Q4 2016 and revenues for the quarter ending March 31, 2016, were $46.7 billion, up 4% compared to $44.9 billion a year ago. Q4 earnings per diluted share was $1.97 compared to $1.69 a year ago. Fourth-quarter Adjusted Earnings per diluted share was $2.44, down 17% compared to the prior year. For the fiscal year, McKesson had revenues of $190.9 billion, up 7% compared to $179.0 billion a year ago. Full-year Adjusted Earnings per diluted share was $12.08, up 9% compared to the prior year (Figure 1).
“I am pleased with our fourth-quarter results, driven by solid execution across both our Distribution Solutions and Technology Solutions segments,” “Fiscal 2016 was a year of growth at McKesson, and I am encouraged by the many new and expanded customer relationships throughout our businesses. McKesson’s focus on driving value and innovation in our daily interactions with our customers, built on a deep foundation of operational excellence, will continue to propel our company going forward as we look to Fiscal 2017 and beyond.”
- John H. Hammergren
For the full year, McKesson generated cash from operations of $3.7 billion, repaid approximately $1.6 billion in long-term debt and ended the year with cash and cash equivalents of $4.0 billion. During the year, McKesson had internal capital spending of $677 million, spent $40 million on acquisitions, repurchased approximately $1.5 billion of its common stock and paid $244 million in dividends. It’s noteworthy to point out that although profit for the fiscal year increased, on a Q4 to Q4 comparison, profit was down 2%. When comparing the fiscal year 2015 to the fiscal year 2015, gross profit was unchanged. On a quarterly and fiscal year basis, net income was up by 208% and 50%, respectively.
Figure 1 – Fiscal Q4 earnings highlights
Middleman concerns in the pharmaceutical drug supply chain
Are Cardinal Health’s earnings a prelude for future growth concerns? Cardinal Health’s recent earnings report spooked investors as they lowered their full-year guidance albeit reporting top and bottom line beats for the quarter. The middleman model is slowly shifting away from the traditional means of delivering drugs to hospitals and pharmacies. More often than ever hospitals and pharmacies are establishing direct relationships with manufacturers thus buying direct. Manufacturers have increased their use of direct accounts when shortages arise thus disrupting the traditional distribution model long dominated by companies such as AmerisourceBergen, Cardinal Health and McKesson. Some drug makers will intermittently pull their products from distributors when manufacturing issues strain their supply. This action hits distributors particularly hard since they make their money by moving product. Drug distribution companies such as McKesson will continue to add value via consulting, analytics and knowledge surrounding providers’ purchasing habits. Additionally, the number of resources needed to build-out infrastructure in absorbing these duties would place a major constraint on many business models within hospitals and pharmacies.
This is concerning considering McKesson just laid off 1,600 workers throughout the company. This would loosely translate into removing $160 million from the overall cost structure. The company determined “reductions in our workforce would be necessary to align our cost structure with our business model.” Greater than 98% of McKesson’s revenues come from pharmaceutical distribution & services domestically and abroad. Any impact to this business model will likely have negative implications with regard to revenues and EPS (Figure 2).
Figure 2 – Revenues broken out per segment highlighting the reliance on pharmaceutical & distribution services
McKesson’s Recent Acquisitions
Vantage Oncology is a national provider of radiation oncology, medical oncology and integrated cancer care services. Biologics, Inc., is the largest independent oncology-focused specialty pharmacy in the U.S. These acquisitions, totaling $1.2 billion, enhance McKesson Specialty Health’s services to patients, providers, payers and manufacturers. The combined impact of these transactions is expected to be approximately 11 cents accretive to adjusted earnings per diluted share in Fiscal 2017. Collectively, these acquisitions will increase McKesson’s specialty pharmaceutical distribution scale, oncology-focused pharmacy offerings, solutions for manufacturers and payers, and scope of community-based oncology and practice management services available to providers and patients. Vantage will broaden the company’s scale in radiation oncology management services, adding more than 50 cancer centers across 13 states. McKesson acquired Rexall Health, valued at $2.2 billion, which operates approximately 470 retail pharmacies throughout Canada. This acquisition further strengthens McKesson’s position in Canada’s pharmaceutical space. Rexall Health will help McKesson leverage its existing portfolio of assets to drive growth, particularly in two of Canada’s fastest growing regions, Ontario and Western Canada. McKesson expects the acquisition to drive meaningful accretion, on a constant currency basis, to Fiscal 2018 adjusted earnings per diluted share.
Summary
MCK is ostensibly well positioned for future growth and success in the growing healthcare space so long as the middleman model remains intact. Despite concerns of the traditional distribution model being challenged, MCK has been highly acquisitive, growing dividends over time and buying back its shares to drive shareholder value. Its major acquisitions and partnerships via UDG Healthcare plc, Sainsbury's pharmacies, Vantage Oncology, Biologics, Rexall Health and Albertsons position MCK to continue its strong performance and competitiveness in the marketplace. In addition to their acquisitive mindset, MCK also offers the backdrop of dividends and an aggressive share repurchase program to add value to shareholders. Considering the stock has risen 20% from its lows in March, any significant downtick may present a great buying opportunity despite the potential risks outlined.
Noah Kiedrowski
INO.com Contributor - Biotech
Disclosure: The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses.
