Cardinal Health Inc Fundamental Analysis
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Cardinal Health Inc
Last Updated: 24 Mar 2023
NYSE: CAH
GICS Sector: Healthcare
Sub-Industry: Medical Distribution
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Table of Contents
You can download a summary of Cardinal Health Inc's fundamental analysis in PDF here.
Management
CEO: Jason Hollar
Tenure: 0.5 years
Cardinal Health, Inc's management team has an average tenure of 3.3 years. It is considered experienced.
Source of Revenue
Cardinal Health, Inc. is a globally integrated healthcare services and products company providing customised solutions for hospitals, healthcare systems, pharmacies, ambulatory surgery centres, clinical laboratories, physician offices and patients in the home.
The company operates in two segments: Pharmaceutical and Medical.
Pharmaceutical Segment
In the United States, the Pharmaceutical segment:
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through its Pharmaceutical Distribution division, distributes branded and generic pharmaceutical and over-the-counter healthcare and consumer products to retailers (including chain and independent drug stores and pharmacy departments of supermarkets and mass merchandisers), hospitals and other healthcare providers. This division also maintains prime vendor relationships to streamline the purchasing process, provide services to pharmaceutical manufacturers, and offer health solutions through their Outcomes service, connecting pharmacists, payers, and pharmaceutical companies.
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provides pharmacy management services to hospitals and operates a limited number of pharmacies, including in community health centres
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repackages generic pharmaceuticals and over-the-counter healthcare products
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through its Specialty Solutions division, distributes speciality pharmaceutical products and provides consulting, patient support, logistics, group purchasing, and other services to pharmaceutical manufacturers and healthcare providers. They offer speciality pharmacy services and distribute oncology, rheumatology, urology, nephrology, and other speciality pharmaceutical products to hospitals, dialysis clinics, physician offices, and other healthcare providers. The company refers to these products and services as "speciality pharmaceutical products and services," which may not be comparable to industry terminology
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through its Nuclear and Precision Health Solutions division, operates nuclear pharmacies and manufacturing facilities, which manufacture, prepare, and deliver radiopharmaceuticals for use in nuclear imaging and other procedures in hospitals and physician offices. This division also contract manufactures a radiopharmaceutical treatment (Xofigo) and holds the North American rights to manufacture and distribute Lymphoseek, a radiopharmaceutical diagnostic imaging agent
Pharmaceutical Distribution
The company's Pharmaceutical Distribution division's gross margin includes margin from its generic pharmaceutical program, distribution services agreements with branded pharmaceutical manufacturers, and over-the-counter healthcare and consumer products. The margin also includes manufacturer cash discounts. The earnings on generic pharmaceuticals are generally highest during the initial launch period and tend to decline over time. The margin from distribution services agreements with branded pharmaceutical manufacturers is derived from compensation based on a percentage of the wholesale acquisition cost and may include branded pharmaceutical price appreciation in limited cases.
Source: Cardinal Health Inc
Medical Segment
Our Medical segment manufactures and sources Cardinal Health-branded general and speciality medical, surgical and laboratory products and devices. These products include exam and surgical gloves; needle, syringe, and sharps disposal; compression; incontinence; nutritional delivery; wound care; single-use surgical drapes, gowns and apparel; fluid suction and collection systems; urology; operating room supply; and electrode product lines. Our Cardinal Health Brand products are sold directly or through third-party distributors in the United States, Canada, Europe, Asia and other markets. These products are generally higher-margin products.
The Medical segment also distributes a broad range of medical, surgical and laboratory products known as national brand products and provides supply chain services and solutions to hospitals, ambulatory surgery centres, clinical laboratories and other healthcare providers in the United States and Canada and this segment also assembles and sells sterile and non-sterile procedure kits.
Through Cardinal Health at-Home Solutions, this segment also distributes medical products to patients' homes in the United States.
The Medical segment, through its Wavemark division, also provides an automated technology platform for inventory management.
CVS Health and OptumRx were the company's largest customers in fiscal 2022, accounting for 25% and 16% of revenue, respectively. The company's five largest customers, including CVS Health and OptumRx, accounted for 49% of revenue. The company extended its pharmaceutical distribution agreements with CVS Health through June 2027. The company also has agreements with group purchasing organisations, with Vizient, Inc. and Premier, Inc. being the largest in terms of revenue, accounting for 19% of revenue in fiscal 2022.
Cardinal Health Inc Reportable Segment Revenue FY2022
Cardinal Health Inc Geographic Revenue FY2022
Cardinal Health Inc Economic Moat
Cardinal Health Inc Economic Moat
Economic Moat: Narrow
There are many ways to identify Cardinal Health Inc’s economic moat, but I focus on the above 5 types. The rating is purely subjective and based on my in-depth understanding and analysis of Cardinal Health Inc. Please check my summary to understand more about the economic moat.
Performance Checklist
Is Cardinal Health Inc’s revenue growing YoY for the past 5 years consistently? Yes.
Is the net income growing YoY for the past 5 years consistently? No.
Is the cash flow from operating activities growing YoY for the past 5 years consistently? Inconsistent.
Is the free cash flow positive for the past 5 years? Yes.
Is the gross margin % consistent/ growing for the past 5 years? No.
Is the EPS growing for the past 5 years? No.
Cardinal Health Inc Revenue, Net Income, Operating Cash Flow, and FCF (USD Million)
Is the free cash flow per share growing for the past 5 years? Inconclusive.
Cardinal Health Inc FCF per Share
Management Effectiveness
Is Cardinal Health Inc’s ROE consistently at 12%-15% YoY for the past 5 years? No.
Cardinal Health's liabilities exceed its assets, so it is difficult to calculate its ROE.
Is the ROIC consistently at 12%-15% YoY for the past 5 years? No.
Cardinal Health Inc Return on Invested Capital vs Weighted Average Cost of Capital
The trendline for the number of shares outstanding is declining, which is something that an investor would be pleased to see.
Cardinal Health Inc Shares Outstanding (Million Shares)
Cardinal Health Inc Financial Health
Cardinal Health Inc Financial Health (USD Million)
Current Ratio: 1.0 (pass my requirement of >1.0)
Debt-to-EBITA: 8.3 (fail my requirement of <3.0)
Interest Coverage: 12.9 (pass my requirement of >3.0)
Debt Servicing Ratio: 3.8% (pass my requirement of <30.0%)
Dividend
Current Dividend yield: 2.9%
Have the dividend payments been stable for the past 5 years? Yes.
Have the dividend payments been growing for the past 5 years? Yes.
Cardinal Health Inc, which is unprofitable, is paying a dividend that is reasonably covered by its cash flows.
Cardinal Health Inc Stock Performance
The following line graph compares the cumulative total return of Cardinal Health common shares with the cumulative total return of the Standard & Poor’s Composite—500 Stock Index (the "S&P 500 Index") and the Standard & Poor's Composite—500 Healthcare Index (the "S&P 500 Healthcare Index"). The line graph assumes, in each case, an initial investment of $100 invested at the closing price on 30 June 30 2017, and is based on the market prices at the end of each fiscal year through and including 30 June 2022, and reinvestment of dividends. The S&P 500 Index and S&P 500 Healthcare Index investments are weighted on the basis of market capitalization at the beginning of each period.
Cardinal Health Inc Stock Performance
UnitedHealth Group Inc Valuation
Estimated intrinsic value: $210.86
Value is calculated using discounted cash flow method (taking into account their cash and debt) and scenario planning.
Average free cash flow used: USD$2,400M
Projected growth rate: 7% - 9%
Beta: 0.76
Discount rate: 5.8%
Date of calculation: 24 Mar 2023
Free cash flow used is a weighted average that is rounded to the nearest tens. In some instances, I used a more realistic number to represent the free cash flow.
Total debt and cash and short-term investments are last quarter figures that are rounded to the nearest tens. In some instances, I used more realistic numbers to represent them.
Cardinal Health Inc EV-to-EBITA vs its peers
Cardinal Health Inc Price-Earnings Ratio vs its peers
Cardinal Health Inc Historical Price-Earnings Ratio
Additional Resources
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My Top Concern
The first concern that I have is that Cardinal Health’s sales and credit concentration are significant. Cardinal Health relies heavily on two major customers, CVS Health and OptumRx, for a sizeable portion of its revenue. If either of these customers ends their agreement with Cardinal Health or drastically reduces their purchases, it could negatively impact the company's financial condition.
Next is its pharmaceutical segment, which profit margin could be affected by changes in industry or market dynamics.
Cardinal Health faces uncertainties and potential risks in both its generic and branded pharmaceutical businesses. The pricing changes, purchase volumes, contract renewals, and launches of generic drugs, which make up a significant portion of the company's business, can have an uncertain impact on its profitability. Cardinal Health has also relied on branded pharmaceutical products for a substantial portion of its revenue, but its compensation from manufacturers for the purchase of these products is based on wholesale acquisition cost, which is set by the manufacturers themselves. If manufacturers change their historical approach to setting and increasing wholesale acquisition costs, it could affect Cardinal Health's margins.
Additionally, some of Cardinal Health's distribution services agreements with branded pharmaceutical manufacturers provide fees to compensate the company for services provided, but branded pharmaceutical price appreciation also serves as a part of its compensation. If manufacturers reduce prices or implement only small increases, it could also affect Cardinal Health's margins if it is unable to negotiate alternative ways to be compensated for the value of its services.
Summary for Cardinal Health Inc
I assigned Cardinal Health a narrow economic moat due to the company’s establishment of switching costs, and entrenched relationships with its customers which inevitably create a high barrier to entry. Supported by the characteristics of the U.S. drug distribution market, Cardinal Health should be able to generate economic profits for a foreseeable future.
The U.S. drug distribution market is dominated by an oligopoly of three big pharmaceutical wholesalers, which include Cardinal Health, AmerisourceBergen, and McKesson, making up over 90% of the market. The dominance of these three players is expected to continue over the next decade with minor changes in market share.
Pharmaceutical wholesalers play a crucial role in the prescription drug supply chain. While distribution is their primary function, wholesalers also have important partnerships with their customers and can negotiate lower prices with manufacturers due to their purchasing power. They contract directly with manufacturers for branded and generic pharmaceuticals, negotiate for lower rates, and stock a vast array of SKUs associated with prescription drugs. This task is less efficiently accomplished by retail pharmacies on their own. Most of the top 15 pharmacies in the US have long-standing partnerships with one or more of the big three wholesalers.
Cardinal Health services around a quarter of the U.S. drug distribution market, with CVS being its largest customer, accounting for 28% of total distribution revenue. Other customers include OptumRx, Kroger, and Vizient. Cardinal Health has extended its pharmaceutical distribution partnership with CVS through June 2027. The partnership is seen to be mutually beneficial and difficult to replicate with a new wholesaler. Coordination and management systems between Cardinal Health and CVS have been developed over more than 20 years and are difficult to replicate, making it unlikely for CVS to get better pricing by switching to a new distributor.
Switching costs does not always refer to money. It can be the time and effort required to switch from one product, service, or supplier to another. It can include the cost of researching new distributors, the expense of implementing new processes, and the potential loss of benefits or services that were provided by the original distributors. The higher the switching cost, the more resistance a company has to switch to a new distributor.
In addition to pharmaceutical distribution, Cardinal Health offers consulting, logistics, data, and analytics services to its customers. Cardinal Health provides such customised services to its big retailer customers to maximise efficiency and effectiveness, making the relationship between the distributor and customers stronger. Switching to a new distributor would result in the loss of operational expertise achieved over the years of working with the original distributor, which is why major retailers have not switched their distributors in the last 10 years, and the trend is expected to continue.
The reasons outlined above, such as the significant switching costs, customised services, and long-standing partnerships, have helped create a high barrier to entry for new competitors trying to enter the pharmaceutical distribution market. Moreover, the market is dominated by the three established distributors. This makes it difficult for new players to break into the market and gain a foothold, as they would need to build the same level of expertise and trust that Cardinal Health and other big distributors have built with their customers over many years.
Over the past five years, Cardinal Health has experienced revenue growth year on year. However, its net income has not been performing well, with negative results in 2020 and 2022. Furthermore, the company's operating cash flow has been inconsistent over the past five years, indicating potential challenges with managing its day-to-day operations. Despite the revenue growth, both gross and net margins have been declining over the years to a point where they are now below the industry average.
The decline in margins may be a concern for investors as it may indicate that Cardinal Health is facing increased competition or challenges with cost management. Additionally, negative net income in 2020 and 2022 may raise concerns about the company's ability to generate sustainable profits.
Cardinal Health's management effectiveness has been questionable based on some key performance indicators. Over the past five years, the company has not been able to meet my minimum requirement of 12% for ROE. Furthermore, in the recent year, the company's liabilities exceeded its assets, making it difficult to calculate its ROE accurately. This is a red flag for investors.
Similarly, the company's ROIC has not passed my minimum requirement of 12% over the past five years. Although the recent ROIC is more than 17 times its WACC, this metric is calculated based on assumptions and accounting rules, which may not accurately reflect the company's true performance.
Even though there are positive aspects of Cardinal Health's balance sheet, I do not think that its financial health is good overall. While both the company's debt servicing ratio and interest coverage ratio indicate that its interest payments are well covered by operating cash flow and EBIT, respectively, there are several concerning indicators to note.
First, the company's current ratio of 1.0 barely passes my minimum requirement, indicating that the company may be facing challenges with managing its short-term liquidity. Moreover, the current ratio is performing worse than both the company's historical past and industry benchmarks.
Additionally, the company's negative shareholder equity is a more serious concern than a high debt level. Negative shareholder equity indicates that the company's liabilities exceed its assets, which could lead to insolvency if not addressed promptly. Furthermore, the company's debt-to-EBITDA ratio fails to meet my minimum requirement, indicating that it may be carrying a high level of debt relative to its EBITDA.
There is a lot of uncertainty in investing in Cardinal Health due to its narrow moat, poor performance, ineffective capital allocation and weak balance sheet. As such, I would assign a higher margin of safety of 50%. The estimated intrinsic value of Cardinal Health is $210.86, and after factoring in the margin of safety, the investment range would be around $105.
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