McKesson (MCK, Financial), the $32 billion global pharmaceutical distributor, delivered its second-quarter results on Oct. 27. McKesson had had $99.7 billion in sales for its first-half 2017 operations, 3.51% up from $96.3 billion last year. The company also had $884 million in profits, down -27.48% from last year’s $1.2 billion.
As observed, McKesson had a $290 million goodwill impairment charge for the period, which affected its overall profits as a result. Without the impairment, McKesson would have -2.28% change to $1.8 billion in its bottom line figure for the period.
“Our updated outlook for fiscal 2017 reflects McKesson’s expectation of a lower profit contribution resulting from recent customer pricing activities and lower operating profit as a result of further moderating branded pharmaceutical pricing trends compared to previous expectations.
“While we work to actively respond to these market forces, we remain focused on our long-term strategy of innovation and value-added solutions. And though we responded quickly to maintain market share and mitigate these pricing challenges, we recognize the near-term impact requires a revision to our outlook.” – John H. Hammergren, chairman and CEO
Given the lower profits outlook, McKesson’s shares traded on heavy volume, about 15 times its previous day’s volume, and closed down 23% while the broader Standard & Poor's 500 index closed -0.31%.
Valuations
McKesson had a trailing 12-month price-earnings (P/E) multiple of 17.7 times (industry median: 22), price-book (P/B) value multiple of 3.5 times (industry median: 2.28) and price-sales (P/S) ratio of 0.17 (industry median: 0.99) (4).
The company also had a trailing 12-month dividend yield of just 0.76% with a 13% payout ratio and 0.3% buyback ratio.
Market performance
McKesson had a total return of 13% for the past five years while the S&P 500 had 6.88% (5). Year-to-date figures indicated -24.47% and 8.06%.
(Slide presentation)
McKesson Corp.
McKesson is a global pharmaceutical distribution services and information technology company, ranked 11th in the Fortune 500 as per fiscal 2016. The 183-year-old pharmaceutical distributor delivers a comprehensive offering of pharmaceuticals and medical supplies.
(McKesson, annual report)
The company has two segments: McKesson Distribution Solutions and McKesson Technology Solutions.
(McKesson business segments, annual and quarterly filings)
McKesson Distribution Solutions
McKesson’s Distribution Solutions segment distributes branded and generic pharmaceutical drugs and other health care-related products worldwide (6). The segment contributed $188 billion in sales, 98% of total fiscal 2016 McKesson sales.
The distribution segment also earns most of its business, about 84.3% or $158.5 billion, in North America compared to its international operations in fiscal 2016. The segment had a 5.29% gross margin and a segment operating profit margin of 1.89% (7).
McKesson’s first-half 2017 performance entailed that it grew the segment by 3.62% to $98.3 billion compared to the same period last year. The distribution segment also delivered an operating profit margin of 1.81%, or $1.8 billion.
McKesson Technology Solutions
In its filing, the Technology Solutions segment delivers enterprisewide clinical, patient care, financial, supply chain and strategic management technology solutions as well as connectivity, outsourcing and other services, including remote hosting and managed services to health care organizations.
The segment contributed about 2%, or 2.9 billion, in total fiscal 2016 sales. It also had a 50.88% gross margin and a 17.99% segment operating profit margin.
For first-half 2017, Technology Solutions delivered a negative -3.64% sales growth to $1.4 billion and a loss of $6 million mostly secondary to the aforementioned $290 million goodwill impairment (8).
As observed, the Technology Solutions segment had the highest margin compared to the distribution solutions but has been contributing just a "small" part of McKesson’s business. The segment also has been on a sales decline in recent years.
Overall, McKesson had five-year sales and profit growth averages of 11.24% and 13.44% (5).
Cash, debt and book value
Unaudited filing as of Sept. 30 indicated that McKesson had $5.46 billion in cash and $8.1 billion in debt with a 0.86 debt-equity ratio. The pharmaceutical distributor also had 21.9%, or $12.8 billion, of its $58.3 billion assets in goodwill and intangibles.
McKesson also had a book value of $9.4 billion, up from $8.98 billion 10 quarters ago (2).
Cash flow
(McKesson cash flow, quarterly filing)
Despite its disappointing profit figures, McKesson grew its cash flow from operations by 134% to $2.9 billion for first-half 2017. The growth was mostly possible secondary to increase in receivables, inventory and payables.
Capital expenditures were $151 million, leaving the company with $2.78 billion in free cash flow*. McKesson spent $2.04 billion in acquisitions for the period (3). McKesson also spent $187 million in dividends and buybacks, about 6.7% of free cash flow, excluding the $2 billion acquisition cost for the period.
In the past three years, McKesson gave out 33.7% of its free cash flow for shareholder payouts.
Conclusion
(McKesson Corp. share price, Google Finance)
Earlier company statements and supporting figures in the quarterly results drove McKesson shares down post-earnings announcement. Almost a couple of weeks later, Donald Trump wins the presidency, and the pharmaceutical industry (among other industries) bounced back up in a snap. It appears that the market already assumed that the new administration would alleviate the recent immediate concerns that surround McKesson’s business.
As The New York Times put it, drugmakers can profit more by raising drug prices and wholesalers (McKesson) can improve the bottom line by buying drugs ahead of the anticipated price increases Fewer drug price increase regulations should probably help McKesson continue to have double-digit growth figures. Meanwhile, it is just too early to tell if this will happen.
Analysts at Mizuho thought McKesson was a buy Thursday and indicated a price target of $147 per share. Historical earnings multiple with estimated earnings per share (EPS) figure of $9.38 (GAAP EPS outlook between $8.95 and $9.8) a share accompanied by a 20% margin, gave a figure of $174 a share.
In conclusion, McKesson would be a speculative buy with a target price of $150 a share.
*capital expenditures instead of free cash flow was incorrectly written earlier.
Notes
(1) Quarterly filing. The goodwill impairment was related to McKesson’s Technology Solutions segment.
(2) Morningstar data.
(3) Quarterly filing. In 1H 2017, McKesson completed acquisitions of Vantage Oncology Holdings LLC, Biologics Inc., UDG Healthcare PLC (LSE:UDG, Financial) and J Sainsbury PLC.
April 1: Acquisition of California-based Vantage & Biologics for $515 million.
Vantage provides comprehensive oncology management services, including radiation oncology, medical oncology, and other integrated cancer care services, through over 51 cancer treatment facilities in 13 states.
April 1: Acquisition of North Carolina-based Biologics Inc. for $692 million.
Biologics is one of the largest independent oncology-focused specialty pharmacy.
April 1: Acquisition of Europe-based UDG’s pharmaceutical distribution business in Ireland and the U.K. for $431 million.
The acquired UDG businesses primarily provide pharmaceutical and other health care products to retail and hospital pharmacies.
March: Major asset acquisition from Canada-based Rexall Health from Katz Group for $3 billion.
Rexall Health operates approximately 470 retail pharmacies in Canada, particularly in Ontario and Western Canada. The acquisition will enhance McKesson’s Canadian pharmaceutical supply chain business.
Rexall Health asset acquisition is still subject for regulatory approval but is expected to close in second-half 2016.
Aug. 31: Acquisition of U.K.-based Sainsbury’s pharmacy business for $164 million.
Vantage & Biologics; Biologics; Sainsbury’s; Rexall Health and UDG business operations are and to be included in McKesson’s distribution solutions segment.
(4) GuruFocus data.
(5) Morningstar data.
(6) Annual filing. McKesson’s Distribution Solutions segment offers wide numerous businesses to its customers.
In addition to what was briefly mentioned above, the segment also provides practice management, technology, clinical support and business solutions to community-based oncology and other specialty practices.
This segment also provides specialty pharmaceutical solutions for pharmaceutical manufacturers including offering multiple distribution channels and clinical trial access to our network of oncology physicians.
It also provides medical-surgical supply distribution, equipment, logistics and other services to healthcare providers within the U.S.
Additionally, this segment operates retail pharmacies in Europe and supports independent pharmacy networks within North America.
It also sells financial, operational and clinical solutions to pharmacies (retail, hospital, alternate site) and provides consulting, outsourcing and other services.
(7) Annual filing: Segment operating profit includes gross profit, net of operating expenses, plus other income, net, for McKesson’s two operating segments.
(8) Quarterly filing. The $290 million goodwill impairment is concerning McKesson’s EIS business under the technology solutions segment.
Disclosure: I do not have shares in McKesson.
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