Introduction
McKesson Corporation (NYSE:MCK) fell to a 52-week low back in February and has since surged 34%, appreciating from $148 to ~$200 per share as of mid-July. On February 16th, I published an article titled “McKesson Has Hit A 52-Week Low – Buying Opportunity” positing that McKesson has put in place a string of positive shareholder friendly maneuvers to position itself for future growth and break out of its slump. McKesson had hit a 52-week low and boasted a P/E of 16 and a PEG of 1.46 at the time. McKesson appeared very attractive considering its EPS growth, dividend payout, acquisitive mindset and share buyback program. Now that the stock has nearly breached the $200 level thus appreciating over 34%, now what?
McKesson’s Moves Starting To Bear Fruit - McKesson Acquires Vantage Oncology, Biologics Inc., and Rexall Health
McKesson has pulled many levers and has been on an acquisition spree as of late and announced layoffs of 1,600 workers or about 4% of its U.S. workforce. These collective efforts are aimed to stem any losses in revenue from a hit to its customer base while continuing to drive value for shareholders. McKesson agreed to acquire two medical firms that focus in oncology for a total of $1.2 billion and Ontario-based Rexall Health for $2.2 billion in Canada. Layoffs are underway and being proactive in aligning its cost structure in a fiscally responsible manner in order to remain competitive and add value to shareholders.
Vantage Oncology, is a national provider of radiation oncology, medical oncology and integrated cancer care services. Biologics, Inc., is the largest independent oncology-focused specialty pharmacy in the U.S. These two acquisitions of Vantage Oncology and Biologics totaled $1.2 billion. These acquisitions enhance McKesson Specialty Health’s services to patients, providers, payers and manufacturers. The combined impact of these transactions is expected to be approximately 11 cents accretive to adjusted earnings per diluted share in Fiscal 2017. Collectively, these acquisitions will increase McKesson’s specialty pharmaceutical distribution scale, oncology-focused pharmacy offerings, solutions for manufacturers and payers, and scope of community-based oncology and practice management services available to providers and patients. Vantage will broaden the company’s scale in radiation oncology management services, adding more than 50 cancer centers across 13 states. McKesson has agreed to acquire Rexall Health for $2.2 billion. Rexall Health operates approximately 470 retail pharmacies and is one of Canada’s largest privately-owned enterprises. This acquisition further strengthens McKesson’s position in Canada’s pharmaceutical supply chain. Rexall Health will help McKesson leverage its existing portfolio of assets to drive growth, particularly in two of Canada’s fastest growing regions, Ontario and Western Canada. McKesson expects the acquisition to drive meaningful accretion, on a constant currency basis, to Fiscal 2018 adjusted earnings per diluted share.
The Recommendation To Buy McKesson At Its 52-Week Lows
McKesson had been faced with a challenging healthcare landscape as political posturing, drug pricing scrutiny, overall sentiment towards pharmaceutical companies due to price gouging allegations and the overall rotation out of healthcare related stocks. This confluence of events unfairly plagued McKesson’s stock, falling from $241 to $148 or 39% in just 9 months from May of 2015 through February 2016. McKesson appeared very attractive considering its EPS growth, dividend payout, acquisitive mindset and share buyback program however concerns remain. I felt the sell-off was unjustified and looking at the most recent quarterly numbers; sustained growth was very much intact. McKesson recently reported results for Q4 2016 and revenues for the quarter were up 4%. For the fiscal year, McKesson had revenues of that were up 7%. Full-year adjusted earnings per diluted share was up 9% compared to the prior year. For the full year, McKesson generated cash from operations of $3.7 billion, repaid approximately $1.6 billion in long-term debt and ended the year with cash and cash equivalents of $4.0 billion. Since that recommendation, the stock has appreciated from the ~$150 level to the ~$200 level or ~34% (Figure 1).
Figure 1 – Google Finance graph depicting the price appreciation of McKesson from its 52-week low or ~34%
Are Concerns Lying Ahead?
In a previous article, I wrote that I had growing concerns about the middleman in the pharmaceutical drug supply chain. This is the bread and butter of many companies in this space, notably McKesson, Cardinal Health and AmerisourceBergen. Cardinal Health’s recent earnings report spooked investors as they lowered their full-year guidance albeit reporting top and bottom line beats for the quarter. The middleman model is slowly shifting away from the traditional means of delivering drugs to hospitals and pharmacies. More often than ever hospitals and pharmacies are establishing direct relationships with manufacturers thus buying direct. Manufacturers have increased their use of direct accounts when shortages arise thus disrupting the traditional distribution model long dominated by companies such as AmerisourceBergen, Cardinal Health and McKesson. Some drug makers will intermittently pull their products from distributors when manufacturing issues strain their supply. This action hits distributors particularly hard since they make their money by moving product. Drug distribution companies such as McKesson can continue to add value via consulting, analytics and knowledge surrounding providers’ purchasing habits. Additionally, the number of resources needed to build-out infrastructure in absorbing these duties would place a major constraint on many business models within hospitals and pharmacies.
I don’t think we’ll know the impact of this shift for some time however this is concerning considering McKesson just laid off 1,600 workers throughout the company. This move could be unrelated to the middleman business and more attributable to customer base losses. The company determined “reductions in our workforce would be necessary to align our cost structure with our business model.” Greater than 98% of McKesson’s revenues come from pharmaceutical distribution & services domestically and abroad. Any impact to this business model will likely have direct negative implications with regard to revenues and EPS.
Takeaway
MCK is doing what it can to be well positioned for future growth and success in the growing healthcare space assuming the middleman model remains intact. Despite concerns of the traditional distribution model being challenged, MCK has been highly acquisitive, growing dividends over time and buying back its shares to drive shareholder value. Its major acquisitions and partnerships via UDG Healthcare plc, Sainsbury's pharmacies, Vantage Oncology, Biologics, Rexall Health, Albertsons and Wal-Mart position MCK to continue its strong performance and competitiveness in the marketplace. In addition to their acquisitive mindset, MCK also offers the backdrop of dividends and an aggressive share repurchase program to add value to shareholders. Currently, McKesson’s P/E ratio sits at the top of its peer cohort and considering the stock has risen over 34% along with the potential erosion of the middle model, I’d be cautious buying at these levels despite additional upside based on its 52-week high of $240.
Kiedrowski’s Previous Post Regarding McKesson Corporation (NYSE:MCK) can found be here.
Noah Kiedrowski
INO.com Contributor - Biotech
Disclosure: The author relinquished his position in MCK and has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses.
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