By Nick McCullum
Cardinal Health (CAH) has many of the characteristics of a high-quality dividend stock.
The company operates in an oligopoly (along with large competitors AmerisourceBergen (ABC) and McKesson (MCK)), which allows it to generate significant profits with relatively low amounts of competition.
This has led to fantastic long-term dividend growth for the company’s shareholders.
In fact, with 32 years of consecutive dividend increases, Cardinal Health is a member of the exclusive Dividend Aristocrats list – which contains only companies with 25+ years of dividend increases.
Despite the company’s fantastic long-term track record, Cardinal Health is not popular in the markets right now. The stock is down more than 25% from its peak earlier this year and is currently trading down ~2% today after its first-quarter earnings release.
Anytime a stock declines after earnings, investors should investigate whether this short-term market pessimism presents a buying opportunity.
With that in mind, this article will discuss Cardinal Health’s first-quarter earnings release in detail and analyze whether the company currently holds appeal for dividend growth investors.
Financial Performance Overview
In Cardinal Health’s fourth-quarter earnings release (which is not the release that this article is focused on), the company announced new guidance for fiscal 2018 that disappointed the markets and resulted in an ~8% decline in the company’s stock price. The new guidance was for non-GAAP diluted earnings per share of $4.85-5.10, down from $5.40 in fiscal 2017.
This guidance is presented before discussing the company’s 1Q2018 results because Cardinal Health is on pace to meet this guidance. Although only one quarter has passed so far, we believe that the markets have reacted irrationally to the company’s financial performance.
Moving onto the company’s financial performance, Cardinal Health’s first-quarter earnings release saw revenues increase 2% to $32.6 billion while GAAP operating earnings decreased by 51% to $262 million and GAAP diluted earnings per share decreased by 63% to $0.36.
Importantly, Cardinal Health’s GAAP financial results were significantly impacted by the amortization of acquisition-related intangible assets as well as restructuring costs associated with a new surgeon glove direct distribution agreement. Because of this, it is far more meaningful to consider Cardinal Health’s non-GAAP financial performance. Both are shown below.
Source: Cardinal Health First-Quarter Earnings Presentation, slide 4
On a non-GAAP basis, Cardinal Health saw operating earnings decrease by 9% to $610 million while diluted earnings per share decreased by 12% to $1.09. While these declines are larger than the company’s full-year guidance (which calls for earnings per share down 7.9% at the midpoint of the guidance band), it is likely that the company’s performance will accelerate through the year as the newly-acquired Medtronic assets are integrated more fully.
Investors should also note that Cardinal Health’s performance continues to be stratified by segment. The Medical segment has been growing far faster than the Pharmaceutical segment in recent quarters, and this trend continued in the most recent quarter.
More specifically, the larger Pharmaceutical segment saw revenue increase by 1% while segment profit declined by 13%.
Source: Cardinal Health First-Quarter Earnings Presentation, slide 5
Meanwhile, the Medical segment posted 14% revenue growth and 1% growth in segment profit.
Source: Cardinal Health First-Quarter Earnings Presentation, slide 6
The Medical segment will house the $6.1 billion worth of assets that Cardinal Health acquired from Medtronic earlier this year. It is likely that this segment will continue to post relative outperformance moving forward.
As discussed, the company is on pace to achieve its fiscal 2018 financial guidance. In the company’s first-quarter earnings release, management reaffirmed guidance of mid-single-digit revenue growth and $4.85-5.10 of adjusted earnings per share.
Source: Cardinal Health First-Quarter Earnings Presentation, slide 9
To conclude, Cardinal Health’s financial performance was in line with management’s expectations. We believe that the small ~2% drawdown in this already cheap stock is yet another opportunity to acquire attractively priced exposure in this recession-resistant Dividend Aristocrat.
Moving on, the next section will discuss the new executive transition plan that was announced at the same time as Cardinal Health’s first-quarter financial performance.
Executive Transition Plan
As discussed previously, Cardinal Health also announced a new executive succession plan when it reported first-quarter earnings.
More specifically, the company announced that it has named Mike Kaufmann, its current Chief Financial Officer, as the company’s CEO effective January 1, 2018. He will succeed Cardinal Health’s current CEO, George Barrett, who has been in his role since 2009 and will continue to serve as Executive Chairman of Cardinal’s board of directors through its annual meeting in November of 2018.
Here’s what we know about Cardinal Health’s new CEO.
Mike Kaufmann is a 27-year veteran of Cardinal Health. He presently has responsibility for all of the company’s financial activities in addition to overseeing the company’s global sourcing for both of its segments (Pharmaceutical and Medical).
Kaufmann originally joined Cardinal Health in 1990 and has served as CFO since 2014. Prior to assuming the CFO role, Kaufmann served in a wide range of leadership positions across operations, sales, and finance in all areas of the company. He played an important strategic role in organizing partnerships like Red Oak Sourcing with CVS (NYSE:CVS) and the creation of Fuse, Cardinal’s technology innovation center.
As someone who is significantly younger than the current CEO (54 compared to 62) as well as being well-tenured at the organization (27 years), Mr. Kaufmann seems like a solid fit for the top role at this healthcare giant.
We’re not the only ones who like the decision. Here’s what Cardinal Health’s current CEO had to say about his successor in the press release:
“As I approach a decade with Cardinal Health, it feels very natural to hand the baton to Mike, who has been a close and trusted partner to me and an integral part of driving our strategy. Mike brings tremendous knowledge of our business, a passion for excellence, and a commitment to the values and mission of our organization, and he has the respect of our entire organization. The steps we’ve taken to expand our reach and enhance our critical role within the healthcare industry, including our recent acquisition of Medtronic’s Patient Recovery business, position Cardinal Health well for the future. Mike is a superb leader and operator, well-prepared to take the reins and guide us forward to leverage the full potential of Cardinal Health.”
Moreover, here’s what Mr. Kaufmann himself had to say about his leadership appointment:
“I am honored to be selected as Cardinal Health’s next chief executive. George and I have worked side by side for years, and I look forward to continuing our partnership over the next year in ensuring a successful transition. George has built a powerful legacy and strategy that I am proud to have helped craft. I look forward to working with him and our incredibly talented and dedicated team to build on the strong foundation we have in place and further enhance the value we provide to all of our stakeholders, while never losing sight of our ultimate goal of supporting our partners in the critical work they do serving patients and their families.”
Unsurprisingly, the company has not provided any insight into why its current CEO is retiring. Given his age (62) and tenure with the company (nearly a decade as CEO), it is likely he is ready to retire from the workforce permanently, and we believe this to be the most likely impetus for this leadership change. Moreover, we believe that the company’s current CFO is a logical choice to assume the helm at Cardinal Health.
Valuation Expected Total Returns
Cardinal Health continues to have a very attractive total return profile based on its valuation, dividend yield, and our expectations for its earnings per share growth.
As mentioned, Cardinal Health’s fiscal 2018 financial guidance calls for adjusted earnings per share of $4.85-5.10. The midpoint of this guidance band ($4.975) combined with the company’s current stock price of $60.55 implies a price-to-earnings ratio of just 12.1.
A 12.1x earnings multiple is less than half the average valuation within the SP 500. Moreover, it is a significant discount to Cardinal Health’s long-term average valuation, as shown below.
Source: Value Line
Cardinal Health’s current price-to-earnings ratio is 12.1 and its long-term average price-to-earnings ratio is 16.8. To understand how compelling this value opportunity can be for future shareholder returns, consider this: if the company’s valuation reverts to its long-term average over a period of five years, this would add 6.8% per year to its annualized total returns.
Fortunately, valuation is not the only factor that will add to Cardinal Health’s future returns. The company’s current dividend yield of 3.1% is noticeably elevated from its normal levels.
Source: YCharts
Cardinal Health also has significant opportunities to grow its adjusted earnings per share, particularly once the current pricing war among wholesale drug distributors slows down. Investors can gain a sense of how quickly Cardinal Health is likely to grow by considering the company’s historical growth rate (shown below).
Source: Value Line
Since 2009 (when Cardinal executed the transformative spinoff of CareFusion which resulted in its 42% decline in adjusted earnings), the company has compounded its bottom line at 7.5% per year. While Value Line is expecting 13% earnings growth for Cardinal over the next several years, we believe that a more historically similar 6-8% growth is feasible moving forward.
Altogether, Cardinal Health has a very attractive total return profile comprised of:
- 3.1% dividend yield
- 6-8% adjusted earnings per share growth
- Significant valuation expansion opportunities
We believe that Cardinal Health provides a recession-resistant investment opportunity with double-digit total return potential.
Final Thoughts
While the markets seem disappointed with Cardinal Health’s earnings release (the stock is down about 1.5% as I write this), the company is actually performing in line with its communicated expectations.
Moreover, the stock continues to trade at a persistent discount to its long-term average valuation multiple.
We continue to like Cardinal Health for the long-term, buy-and-hold total return investor. The company earns a buy recommendation from us and has definite potential for market-beating performance moving forward.
Disclosure: I am/we are long CAH.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Article source: https://seekingalpha.com/article/4121432-cardinal-health-still-buy-first-quarter-earnings