OMI - Cardinal Health: Investable In Potential Pullback Despite Weak Medical Segment

Summary

• Cardinal Health, Inc. reported an increasing top line growth but indicated some profitability weakness due to a slowing margin.
• It continues to post improvements in the Pharma segment, which accounted for 92% of overall sales this quarter.
• Cardinal Health's bottom line suffered due to the considerable impairment charges incurred by its Medical segment.
• The short-term upside for Cardinal Health is now limited due to its declining financial performance.
• However, Cardinal Health presented a positive outlook for its Medical segment and highlighted a robust repurchase catalyst, making Cardinal Health stock appealing in a potential pullback.

Cardinal Health, Inc. ( CAH ) is one of the leading healthcare care companies that deliver pharmaceutical and medical goods to over 30 countries around the world, and it remains listed in the Fortune 500. The company hired more than 46,500 employees globally, better than 44,000 in FY '22. This led CAH to a record trailing total revenue amounting to $186,999 million as of this writing.

Despite its efforts to protect its margins, CAH's gross margin fell for the 5th consecutive quarter. Today's profitability weakness limits its short-term upside potential, making it susceptible to a significant pullback. This is why I have trimmed my position in the company. On the other hand, CAH unlocked a strong buyback outlook this quarter, making it an attractive stock in its pullback.

Q1 ‘23 Overview

CAH ended its fiscal Q1 2023 quarter with a growing top line of $49,603 million, up 12.82% YoY growth. However, it faced continued inflationary pressures, leading to its 5th consecutive declining gross margin.

A part of this decline may be attributed to its weaker Medical segment, which provides personal protective equipment ((PPE)) like gloves, whose demand has decreased due to the successful control of Covid-19. In fact, this segment still ended the quarter with $18 million in inventory charges, and according to the management, it is related to its simplification strategy. Additionally, the company incurred a $154 million impairment related to its Medical segment this quarter on top of its $2.1 billion recognized impairment in FY '22. This leaves CAH with a negative trailing net income of -$1,094 million.

CAH's simplification plan will allow the company to refocus on its medical healthcare portfolio, which is expected by the management to produce an improving segment profit to $650 million in FY '25. A part of this growth will be focused on its high-growth home solutions portfolio, where its market is estimated to reach $56.4 billion by the end of 2027 , representing a 6.1% CAGR.

Growing Pharma Segment

Cardinal Health's largest revenue generator is its Pharma segment, which reached $45,828 million and accounts for 92% of total revenue this quarter. This segment posted a positive 15% YoY growth compared to its $39,822 million recorded in Q1 '22. An exciting catalyst for CAH is its acquisition of the Bendcare group purchasing organization , expanding its capabilities in the rheumatology market. It has launched a new revenue cycle management ((RCM)) solutions through collaborations with PayrHealth and eBlu solutions , simplifying payer contracting and relationship management to boost operational efficiency. Additionally, CAH provided a positive demand outlook and new contracts, as quoted below.

With biosimilars, we remain well positioned to distribute and provide the surrounding services as they come to market, particularly in the new therapeutic areas and sites of care. We continue to expect increased contributions from biosimilars in fiscal 2023 and beyond.

Upstream and Specialty, our third-party logistics business continues its strong growth with more than double the launches in the first quarter compared to a year ago, as well as double-digit new contract wins. And our continued investment towards the digital transformation of our Sonexus access and patient support business has enabled us to realize benefits from new business wins and expansion of existing clients. Source: Q1 2023 Earnings Call Transcript .

This contributed to its Pharma segment's growing profit of $431 million, a 6% increase over the $406 posted in the same quarter the previous year.

Positive Normalized Net Income

However, looking at its normalized figure, which excludes non-recurring impairment charges related to its Medical segment, CAH has a positive normalized net income of $198.4 million. On the other hand, it is still relatively weak compared to its $257.1 million recorded in Q1 '22. This leaves CAH with a normalized EPS of $0.73, down from its $0.89 recorded in the same quarter last year. Finally, management finished the quarter with a positive non-GAAP EPS outlook of $5.22 on average, which is higher than the $5.06 reported in FY '22 but lower than the $5.57 recorded in FY '21.

Baking Another Pullback Opportunity

CAH broke its previous strong psychological resistance around $65 this past August and pulled back around the same area last September, as shown in the image above. Despite its good financial results, its price was recently rejected at roughly $80. If this bearish pressure continues, $70 to $65 is a solid support level to keep an eye on. When the anticipated pullback occurs, it will give a better entry price and boost its current dividend yield of 2.63% .

Fairly Valued

Peers: McKesson ( MCK ), AmerisourceBergen ( ABC ), Henry Schein ( HSIC ), Patterson Companies ( PDCO ), and Owens & Minor ( OMI ).

As previously stated, CAH sustained a net loss owing to non-recurring impairment charges. As a result, it has a temporary negative P/E ratio, hence, I eliminated it from the peer's average calculation, as indicated in the image above. Its market cap improved significantly compared to its $14.5B market cap in FY ‘22. Therefore, in valuing CAH, I included its larger peer, MCK. As you can see, CAH's forward P/E ratio of 17.21x is currently higher than its peer group's average of 15.53x, while its forward EV/EBITDA of 8.97x remains discounted in comparison to its 9.82x peer average.

With an implied P/E of 15.76x, an estimated EPS of $5.30 , along with an implied EV/EBITDA multiple of 9.82x, and an estimated EBITDA of $2,400 in FY '23, we can arrive at a blended fair price of $87, representing an approximately 15% upside as of this writing.

Focusing On Improving Shareholder Value

Despite the setback in its Medical segment, CAH remains committed to enhancing shareholder value, as quoted below.

We were pleased to initiate the $1 billion accelerated share repurchase program in the first quarter and continue to expect $1.5 billion to $2 billion in total share repurchases in fiscal 2023, in addition to our ongoing dividend of over $500 million annually. Source: Q1 ‘23 Earnings Call Transcript

This could bring down CAH's outstanding share to 252 million, leading to a better fair price of $90.7 instead, making it appealing despite its current poor financial performance.

Concluding Thoughts

CAH ended the quarter with a negative free cash flow ("FCF") amounting to -$47 million, considering the litigation cost of $390 million regarding its opioid settlement. On the contrary, management provided an adjusted FCF amounting to $342 million, which translates to a 0.69% FCF margin. This is still relatively low compared to its 5-year average of 1.44%.

The company posted an improving debt/EBITDA of 2.21x, better than its 5-year average of 2.66x. This is due to its declining total debt amounting to $5,267 million, down from its $5,848 million recorded in Q4 '22.

Cardinal Health remains liquid with a total cash and cash equivalent amounting to $3,492 million and no outstanding balance on its credit facility, according to the management. In summary, Cardinal Health, Inc. shows short-term weakness but still possesses long-term growth potential, making this stock attractive in a potential pullback.

Thank you for reading and good luck! Cheers!

For further details see: