When AmerisourceBergen Corp. ABC announced its third-quarter results, in a year of pandemic and economic tightening, it beat analysts' expectations by announcing increases on both the top and bottom lines.
While a beat on analysts' estimates is not enough by itself to justify buying a stock for five years or more, it may be a hint of what the company might do.
AmerisourceBergen is a pharmaceutical distribution company, and pharmaceutical distribution is its main reporting segment. The only other reporting segment is simply named "Other" and does a fraction of the business that distribution does. It was described in the third-quarter 2020 earnings release as "operating segments that focus on global commercialization services and animal health and includes AmerisourceBergen Consulting Services (ABCS), World Courier and MWI Animal Health (MWI)."
The Medical Distribution industry is driven by several factors, as listed in the 10-K for 2019: aging populations, new pharmaceuticals, increasing use of generics, the growing use of drug therapies and legislative developments.
By checking AmerisourceBergen's fundamentals and dividend and buyback situation, we should find out if the outperformance in the third quarter was just a flash-in-the-pan or something more substantial.
Financial strength
The first half of the table is taken up by items related to the company's debt, so we'll check more closely by viewing its short-term and long-term debt over the past 10 years:
It has steeply reduced its short-term debt while holding its long-term debt relatively stable over the past five years. Interest coverage is nearly 11 times, so it has plenty of operating income to take care of its interest expenses.
AmerisourceBergen also receives excellent ratings from the Piotroski F-Score and the Altman Z-Score (the latter indicating the probability of bankruptcy).
Most convincingly, it has a very strong ROIC vs WACC ratio, with a return on invested capital of 25.97% versus a weighted average cost of capital of 3.8%. In words, that means AmerisourceBergen earns 6.8 times as much on its capital as it pays for it.
In summary, it possesses good financial strength.
Profitability
Profitability depends on margins, and despite the high overall rating, the orange and red bars indicate many of its competitors have better margins and that it has had stronger margins in its own history.
That's illustrated in this 10-year chart that raises questions about its net margin:
Concern increases when we check the three growth items at the bottom of the table. Revenue has grown over the past three years, but profitability (Ebitda and earnings per share) are down.
Still, it has produced return on equity of more than 48%, which is very good.
If you wonder why AmerisourceBergen scores a high 8 out of 10 rating for profitability yet has a sinking net margin, the answer is found in the criteria for the GuruFocus rating. It includes the operating margin, but not the net margin.
Overall, the company's profitability is solid, but long-term investors will want to know why the net margin has been slipping (the 10-K for 2019 provides only information about the decline experienced in fiscal 2018).
Valuation
A rating of 7 out of 10 indicates a stock with a reasonable, but not deeply undervalued, price.
This 10-year chart of share prices shows they have been what technical analysts would call "range-bound" for more than five years. Most recently, the share price went down with the market in the spring, but has since rebounded:
The price-earnings ratio is below 15, usually a good sign; its price-earnings ratio is also below a majority of its competitors and its own historical standard. This GuruFocus summary shows how its price-earnings ratio is below the median of the industry:
And this one shows how it is below its own median (it doesn't mean much, but note how high the price-earnings once rose):
The PEG ratio (not shown) gives off an undervalued signal. At 0.68, it is well below the fair value mark of 1.00.
Turning to the discounted cash flow calculator, we get an overvalued reading based on four-star predictability (which means we can take the DCF result with reasonable confidence). According to the calculator, the share price of $103.55 is well above the fair or intrinsic value of $81.12. That generates a negative margin of safety of 27.65%.
In the end, we're left with mixed messages about AmerisourceBergen's valuation. Prudent investors should stick with the pessimistic message that the stock is overvalued.
Dividends
At 1.6%, the dividend yield is slightly below the long-term S&P 500 average of 1.88%. As usual, the dividend yield inversely mirrors the share price:
The payout ratio is low at 22%, meaning AmerisourceBergen gives priority to growth rather than immediate shareholder returns.
The three-year dividend growth rate of 5.6% is reasonable for a company that wants to attract shareholders beyond the growth crowd.
The forward yield is slightly higher than the trailing 12-month yield, alerting us to a recent dividend increase. That was declared on Jan. 30, when the board raised the quarterly amount from 40 cents to 42 cents.
The five-year yield on cost at 2.64% is modest and indicates the average annual return from dividends investors might expect if they bought and held the stock for the next five years, while the company increased the dividend at the same rate as it did over the previous five years.
Shareholders might get back a bit more than 2.64% if the company continues to buy back shares. Over the previous three years, its average share buyback ratio was 2.1%.
Over the past decade, AmerisourceBergen reduced its share count by 26.5%. Assuming share repurchases were made when the price was depressed, the company will have had significant help in growing its earnings per share.
Overall, the company offers an average dividend, one that is growing slowly and helped somewhat by share buybacks.
Gurus
Twelve investing gurus had positions in AmerisourceBergen at the end of the first quarter, but nine of them had reduced their holdings.
Pioneer Investments (Trades, Portfolio) had by far the biggest stake with 1,984,512 shares, good for a 0.98% share of the company. That was after a reduction of 9.78% during the quarter.
Seth Klarman (Trades, Portfolio) of The Baupost Group held 936,299 shares after a reduction of 19.72%. Larry Robbins (Trades, Portfolio) of Glenview Capital Management was the third-largest shareholder with 738,000 shares after cutting his holding by 69.22% during the quarter.
Conclusion
The earnings beat in the third quarter was a good hint as to the health of AmerisourceBergen. It is a growing company and has prioritized its free cash flow in that direction. Despite that, investors have not seen much in the way of capital gains over the past five years. Long-term investors who see potential have had a modest dividend to help keep them keep warm at night.
Its valuation is debatable: Is it overvalued or undervalued? To some extent, that will depend on the eye of the beholder, but cautious investors will choose to believe the worst case.
Growth investors will want to see a sustained rise in the share price to justify an entry now, since the growth in earnings power has not excited the broader universe of investors. Income investors will look elsewhere for other large caps that have larger dividends or dividends that are growing more rapidly. And value investors will want a clear signal that AmerisourceBergen is undervalued before proceeding further.
Disclosure: I do not own shares in any companies named in this article.
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