(Published by Bob Ciura on March 16)
Cardinal Health (CAH, Financial) and AmerisourceBergen (ABC, Financial) are fierce competitors within the health care distribution industry.
Together Cardinal Health and AmerisourceBergen generate more than $250 billion in annual revenue and dominate their industry.
The concentration of the health care distribution industry provides Cardinal Health and AmerisourceBergen with competitive advantages and high barriers to entry.
This provides Cardinal Health and AmerisourceBergen with consistent profits and steady growth, which allow them to reward shareholders with annual dividend increases.
Cardinal Health is a Dividend Aristocrat, a group of companies in the Standard & Poor's 500 that have raised dividends for 25-plus years.
You can see the entire list of Dividend Aristocrats here.
AmerisourceBergen is not a Dividend Aristocrat, but it is a Dividend Achiever, a group of 271 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Reason No. 1: A stronger pharmaceutical business
Both companies are major players in the health care distribution industry.
Cardinal Health has a huge network, consisting of more than 25,000 pharmacies.
The company services more than 70% of U.S. hospitals and manufactures or sources 2.8 billion individual consumer health care, home medical equipment and over-the-counter products each year.
Cardinal Health is organized into two segments, Pharmaceutical and Medical.
Source: J.P. Morgan Presentation, page 6
Similarly, AmerisourceBergen is also a huge operator in the industry.
It generates $147 billion in annual revenue and sources 1.5 million products delivered from over 30 distribution centers.
Both companies rely heavily on pharmaceutical product distribution, which makes up the vast majority of their overall revenue.
Cardinal Health derives 90% of its revenue from pharmaceutical products while approximately 95% of AmerisourceBergen’s revenue comes from its pharmaceutical segment.
Cardinal Health’s pharmaceutical business is outperforming AmerisourceBergen’s. Since it generates the vast majority of its business from pharmaceutical distribution, this gives Cardinal Health a big advantage.
Cardinal Health’s pharmaceutical segment posted 20% revenue growth in fiscal 2016 along with 19% growth in profit.
This helped companywide revenue and operating earnings grow by 19% and 18% in fiscal 2016.
By contrast, AmerisourceBergen’s core pharmaceutical segment grew revenue by 7% last year. Segment profit rose 2.3%.
Because of this, AmerisourceBergen had a good year in 2016 but not quite as strong as Cardinal Health.
Source: J.P. Morgan Healthcare Conference, page 14
Overall AmerisourceBergen’s revenue and adjusted earnings per share increased 8% and 14% in fiscal 2016.
Both companies’ growth is being threatened right now by falling drug prices. Increasing demand for generics has fueled drug price deflation in the U.S., which is eroding their margins.
Even though they seem like identical counterparts, AmerisourceBergen is being impacted by macroeconomic challenges to a greater extent than Cardinal Health.
Cardinal Health’s pharmaceutical business has been more resilient over the past year, which means the present challenges are likely to continue weighing on AmerisourceBergen more than Cardinal Health moving forward.
Reason No. 2: Better growth prospects
Despite the pressures of falling drug prices, both Cardinal Health and AmerisourceBergen are benefiting from broader catalysts that should fuel future growth.
Specifically, the U.S. pharmaceutical market remains healthy.
Source: J.P. Morgan Healthcare Conference, page 6
In both cases, future growth will be due to new customer additions and cost controls. Drug pricing is not expected to improve much in fiscal 2017.
Still Cardinal Health expects fiscal 2017 to be another year of steady growth.
For example the company expects revenue to grow at a high single-digit rate for the year. Adjusted earnings per share are projected to increase 3.5% this year.
AmerisourceBergen expects 2017 revenue to increase 6.5% to 8%, but eroding margins are likely to have a big impact. The company forecasts adjusted earnings per share to be in the range of $5.63 to $5.88.
At the midpoint of its guidance, AmerisourceBergen’s 2017 adjusted earnings per share are expected to rise a more modest 2.4% from 2016.
The major growth catalysts for Cardinal Health’s higher earnings per share growth will be lower capital expenditures and better performance across its two main business segments.
In particular, Cardinal Health’s medical segment is likely to be a major source of growth in 2017.
Source: Q2 FY17 Earnings Presentation, page 12
In the fourth quarter, medical segment revenue and operating profit increased 12% and 19%, respectively. Much of this growth was due to the benefits of Cardinal Health’s $2 billion acquisition of Cordis in 2015.
For fiscal 2017, Cardinal Health expects to realize mid- to high single-digit revenue growth in its medical segment along with double-digit profit growth.
While deflation in drug pricing is likely to be a continued challenge – Cardinal Health forecasts a low single-digit decline in pharmaceutical segment operating profit this year –”‹Â the medical segment is helping offset weak drug pricing.
This provides Cardinal Health with valuable diversification from which AmerisourceBergen is not benefiting.
Reason No. 3: A higher dividend yield and dividend growth
Cardinal Health’s current dividend yield is 2.2%. This is slightly above the S&P 500 Index average dividend yield, which is around 2%.
Meanwhile, AmerisourceBergen has a 1.6% dividend yield. Its dividend yield is significantly below average.
Put differently, Cardinal Health provides investors with approximately 38% more dividend income each year than AmerisourceBergen.
Not only does Cardinal Health have a higher dividend yield than AmerisourceBergen, its dividend growth has been more impressive recently as well.
Last year, Cardinal Health raised its dividend by 16%; AmerisourceBergen’s most recent dividend increase was a 7.4% hike.
Cardinal Health’s dividend growth in 2016 was more than double AmerisourceBergen’s.
This trend could continue if Cardinal Health’s earnings growth exceeds AmerisourceBergen’s going forward.
Final thoughts
Cardinal Health has a dominant industry position, attractive growth potential and an above-average dividend yield. It is also a high dividend growth stock.
These qualities help Cardinal Health score very highly using The 8 Rules of Dividend Investing –”‹Â in fact, it ranks in the top 10 stocks on this scale.
AmerisourceBergen is a high-quality business and is a solid dividend growth stock on its own, but its pharmaceutical business is not performing quite as well as Cardinal Health’s.
Cardinal Health has an ace up its sleeve for future growth, which is its medical distribution segment.
As a result, Cardinal Health is the better pick in the health care distribution industry.
Disclosure: I am not long any of the stocks mentioned in this article.
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