MCK - McKesson: Outlook Remains Positive I Reiterate My Buy Recommendation

2023-06-28 13:27:50 ET

Summary

• MCK is expected to benefit from factors such as an aging population, increasing prescription drug usage, and promising expansion opportunities.
• Despite concerns about changes in branded insulin pricing, I believe MCK can protect its distribution economics due to its strong position in the value chain and negotiating power with manufacturers.
• I believe MCK's current 15x NTM will become the new normal as the business continues to scale and become stronger.

Recommendation

In my opinion, McKesson Corp (MCK) will benefit in the long run from an aging population, rising prescription drug use, and profitable expansion opportunities. The recent incredible feat of beating estimates, raising FY24 guidance and LT guidance was a very strong indicator of business health, in my opinion. Therefore, I continue to hold a bullish stance on MCK as the company's healthy growth across its business lines bodes well for its ability to sustainably drive positive earnings surprises, which in turn translates to positive stock momentum. I reiterate my buy recommendation.

Updated guidance is a positive indicator

Management's updated long-term growth outlook and FY24 guidance point to the company's fundamental strength and sustainability. Compared to previous years, the FY24 guidance range is noticeably narrower, suggesting that management has increased confidence in the near-term prospects. This narrowing of the range reduces the possibility that MCK will fall short of consensus estimates. The revised long-term operating profit targets are especially noteworthy because they reveal management's confidence in the current state of the market.

Strong ecosystem

MCK's U.S. oncology network now numbers close to 2,400 doctors after a remarkable increase of 450 practitioners in FY23. The value of the MCK ecosystem grows exponentially as the hospital continues to attract medical professionals. It's important to take a step back and consider the reasons a doctor might join the network. After signing up with USON, practices use the Unity GPO and the iKnowMed EHR system from McKesson. MCK also offers a wide variety of helpful services, such as manpower guidance, property administration, and financial aid options. MCK, then, receives a portion of the practice's profits and becomes the distributor of drugs to the practice. This mutually beneficial relationship allows MCK to leverage the added services provided while capturing incremental data that can be utilized by manufacturers through Ontada. McKesson will also gain access to a larger pool of potential trial participants. Now, this is not a new strategy. However, given the substantial growth witnessed in FY23, I think it has become evident that the company is well positioned to continue benefiting from the expanding opportunities within the oncology space. As a result of this trend, I believe MCK has a great opportunity to expand its footprint in the oncology market and benefit from the expanding reach of the network.

Distribution

Following the announcements around changes in branded insulin pricing beginning at the end of 2023 and early 2024, there has been a bear case that distributors like MCK will not be able to capture the same economics. On the other hand, management is confident in their ability to protect the insulin value it provides and even sees GLP-1sv as a net positive, as was stressed in the most recent call. In my opinion, MCK's position in the value chain and its negotiating power against manufacturers are strongly indicated by its ability to renegotiate with manufacturers to protect the economics of distribution. Given the interconnected and multifaceted nature of distributors' and manufacturers' relationships, I believe they should have a strong argument for preserving the value of the services they provide. I believe that the pharmaceutical companies appreciate the close working relationship that exists between the industry's major distributors and themselves, as this ensures that their products make it to the people who need them. Maintaining the current arrangement would be the most sensible choice.

Valuation

I have revised my model to reflect the new FY24 guidance and my expectation for FY27 earnings. Compared to the previous model, I made bolder assumptions in growth and multiples given the improved outlook and continuous momentum in the business. The notable change is I believe MCK's current 15x NTM will become the new normal as the business continues to snowball its network effect to become a much stronger player.

Summary

I maintain a bullish stance on MCK due to the company's strong growth prospects, evident in their recent impressive performance and updated long-term guidance. The narrowing of the FY24 guidance range reflects increased management confidence, reducing the risk of falling short of estimates. The expanding U.S. oncology network and the value-added services provided by MCK position the company for continued growth and success in the oncology market. Despite concerns around changes in branded insulin pricing, MCK's strong position in the value chain and negotiating power with manufacturers suggest they can protect the economics of distribution.

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