Nearly one 12 months in the past I printed my final article about Cardinal Well being (NYSE:CAH) and solely two months after I had printed a bullish article about Cardinal Well being in March 2022, I defined why my endurance was getting skinny with Cardinal Well being and why I bought the inventory. I additionally defined why I nonetheless noticed the inventory as undervalued however didn’t wish to maintain the inventory anymore.
In retrospective this may need been a mistake as Cardinal Well being carried out nice over the last twelve months and clearly outperformed the S&P 500 (SPY) and most different firms (Cardinal Well being was among the many high 20 greatest performing shares within the S&P 500 over the last twelve months). Within the following article we’re taking a look at Cardinal Well being as soon as once more and we begin with the quarterly outcomes.
When wanting on the third quarter, Cardinal Well being reported strong outcomes. Just like earlier years, Cardinal Well being elevated its income with a strong tempo. Income elevated from $44,836 million in Q3/22 to $50,487 million in Q3/23 – leading to 12.6% year-over-year progress. Moreover, Cardinal Well being additionally reported an working revenue of $572 million on this quarters and in comparison with an working lack of $97 million in the identical quarter final 12 months, that is an enchancment. And diluted earnings per share additionally switched from a lack of $5.05 per share in Q3/22 to $1.34 in earnings per share in Q3/23.
And we noticed not solely an enchancment in quarterly outcomes, however steerage for fiscal 2023 was additionally raised by administration. Cardinal Well being is now anticipating $5.60 to $5.80 in non-GAAP EPS (in comparison with $5.20 to $5.50 beforehand). Adjusted free money circulation is now anticipated to be between $2.0 billion to $2.3 billion (in comparison with $1.5 billion to $2.0 billion in a earlier steerage).
And administration isn’t solely optimistic for fiscal 2023, but additionally for the next years and is anticipating double-digit EPS progress for the years to come back (in accordance with the corporate’s personal long-term targets).
When taking a look at analysts’ expectations for the years to come back, we see the same optimism and earnings per share are anticipated to develop with a CAGR of 12% till fiscal 2027.
Downside: Declining Margins
And I haven’t got doubts that Cardinal Well being will be capable of develop its high line. Within the final ten years, income elevated with a CAGR of 5.36% and I stay optimistic that Cardinal Well being can proceed to extend its high line within the single digits. The issue for Cardinal Well being was not the highest line progress, however the firm’s margins. I already identified in my final article that margins have been declining for a number of many years and since final 12 months, the image didn’t enhance.
Cardinal Well being is already working in a low margin enterprise with its working margin being solely 0.83% within the final 4 quarters. And the continuously declining margins are including stress and are usually not a fantastic signal for Cardinal Well being. Declining margins – particularly a declining gross margin – are an indication for lacking pricing energy and a enterprise that’s being put beneath stress by rivals.
Dividend and Share Buybacks
In the previous few years, the most important contributor to backside line progress (or the explanation for protecting earnings per share considerably secure) have been share buybacks. And Cardinal Well being is constant to purchase again shares with a reasonably excessive tempo. Within the final twelve months the variety of excellent shares decreased from 275 million one 12 months in the past to 258 million proper now – leading to a lower of 6.2% YoY. When wanting on the final ten years, the corporate continuously decreased the variety of excellent shares.
Apart from share buybacks, Cardinal Well being can be paying a quarterly dividend to distribute money to its shareholders. And just lately, Cardinal Well being raised the dividend once more – however solely barely from $0.4957 earlier than to $0.5006 proper now – leading to 1% dividend progress. In the previous few years, the image was comparable – over the past 5 years, Cardinal Well being elevated the dividend with a CAGR of 1.4%.
I additionally talked about three different firms (and shares) in my final article about Cardinal Well being that is perhaps a greater funding than the pharmaceutical distribution firm. I personally purchased two different firms from the cash earlier invested in Cardinal Well being – considered one of them was PayPal (PYPL). When wanting on the efficiency since my final article was printed, it definitely would have been the higher concept to stay invested in Cardinal Well being as PayPal declined 26% within the meantime.
Regardless of that efficiency, I stay assured that PayPal is a a lot better long-term funding than Cardinal Well being and can clearly outperform. The identical is true for Starbucks (SBUX) – the second firm I invested in. And though Starbucks couldn’t sustain with the efficiency of Cardinal Well being within the final 12 months, an funding in Starbucks was additionally a good suggestion and the inventory gained 34%.
And eventually, I discussed McKesson (MCK) in my article and wrote that Cardinal Well being’s competitor can be a a lot better funding. And whereas McKesson gained 18% in worth over the last 12 months, it couldn’t match the good efficiency of Cardinal Well being. However in my view, all three are higher long-term investments than Cardinal Well being.
Reversion to the Imply
Though Cardinal Well being outperformed within the final 12 months (and though it was a mistake to not maintain on to Cardinal Well being in the meanwhile) I might nonetheless argue it isn’t a fantastic long-term funding. To know, we should have a look at the 2 most important drivers for any inventory value (in my view). On the one hand, inventory costs are pushed by the basic efficiency of the corporate. That is what Graham known as the long-term weighing balance. And alternatively, inventory costs are pushed by investor sentiment (and possibly information and tales). That is what Graham known as the short-term voting machine.
And within the final twelve months, the inventory efficiency was largely pushed by what Graham known as his voting machine. Within the earlier years, investor sentiment drove Cardinal Well being to unjustified low valuation multiples and because the inventory was clearly undervalued a reversion to the imply was affordable (and needed to be anticipated sooner or later). Investor sentiment usually reaches extremes – on this case: excessive pessimism – however sooner or later, traders will notice that the worth for the inventory is unjustified, and the inventory will transfer in direction of a extra affordable value (or in direction of its true intrinsic worth). Such value actions are typically taking only some months or quarters and can result in a transparent outperformance of a inventory within the short-term or mid-term.
And whereas betting on deeply undervalued shares to return to its intrinsic worth can work as short-term technique, it isn’t sufficient as long-term technique. Within the quick time period, we will revenue from investor sentiment reaching excessive ranges, however in the long run, we should decide firms (and investments) rising its backside line with a wholesome tempo. It’s a deep conviction (and foundation of my funding philosophy) that inventory costs will transfer accordingly to the basic efficiency of an organization – however solely in the long run. And an organization rising its backside line solely within the low single digits will see its inventory value transfer accordingly.
In case of Cardinal Well being, we noticed an outperformance in the previous few quarters resulting from a reversion to the intrinsic worth of the inventory (because the inventory was clearly buying and selling beneath its intrinsic worth). However over the long term, I do not suppose Cardinal Well being is the most effective funding as I count on the basic efficiency to be solely mediocre and over the long term, the basic efficiency is driving the inventory value. As soon as a inventory has reached its intrinsic worth, it will probably solely achieve in worth when the basic enterprise is rising. And when anticipating Cardinal Well being to develop 5% yearly (for instance), it is just affordable to imagine the inventory to develop 5% yearly as effectively. When hoping for the inventory to develop 6% or 7% yearly, that further progress would stem from greater valuation multiples (and the inventory due to this fact transferring in direction of overvaluation) – and that could be a wager that might work out (as markets are irrational) however isn’t a wager I’m prepared to make.
Intrinsic Worth Calculation
Whereas the efficiency of the final years was largely resulting from a reversion to the imply, it doesn’t imply this impact is already over. We nonetheless could make the case for Cardinal Well being buying and selling beneath its intrinsic worth and nonetheless implying upside potential because the inventory will transfer in direction of its intrinsic worth.
We will begin by wanting on the two main easy valuation metrics – the price-earnings ratio in addition to the price-free-cash-flow ratio. However each are reasonably deceptive in case of Cardinal Well being. When wanting on the P/E ratio of 49.5, Cardinal Well being can be overvalued and when wanting on the price-free-cash-flow ratio of 5, we should assume that the inventory is an excessive discount at this level. However each conclusions can be false, and the excessive P/E ratio relies on a reasonably low EPS (GAAP numbers) and the low P/FCF ratio relies on an unreasonably excessive free money circulation within the final 4 quarters.
As a substitute, we reasonably use a reduction money circulation calculation to find out an intrinsic worth for the inventory. And as foundation for our calculation, we will use the midpoint of the corporate’s steerage for fiscal 2023. Administration is anticipating free money circulation to be round $2.15 billion, and that quantity can be kind of in keeping with free money circulation within the final ten years.
When calculating with this quantity in addition to 258 million excellent shares (and a ten% low cost price) and in addition assume that Cardinal Well being will not actually develop within the coming years (an inexpensive assumption based mostly on the efficiency in the previous few years) we get an intrinsic worth of $83.33 making Cardinal Well being pretty valued proper now.
I nonetheless do not wish to calculate with excessive progress charges as I nonetheless see no purpose for the optimism and double-digit progress charges within the years to come back. However assuming that Cardinal Well being can develop not less than 3% yearly for the years to come back isn’t unreasonable. This might already result in an intrinsic worth of $119.05 for Cardinal Well being and is implying additional upside potential for the inventory.
Whereas an intrinsic worth calculation based mostly on fundamentals continues to be indicating that the inventory may need room to run, the technical image ought to make us extra cautious. The inventory is reasonably near reaching its all-time highs round $92 once more and this degree may change into a serious resistance degree and there’s a reasonably excessive chance for the inventory bouncing off and resulting in an even bigger correction. And I do not suppose it’s a good suggestion to speculate earlier than the inventory reaches a serious resistance degree.
Though I used to be unsuitable about Cardinal Well being and mustn’t have bought the inventory final 12 months, I nonetheless do not suppose Cardinal Well being is an effective long-term funding. The inventory is constant to commerce for low valuation multiples and doubtlessly stays undervalued. That is nonetheless implying potential upside for the inventory because the reversion to the imply (and the reversion to affordable valuation multiples) may proceed. And that is leaving us with some short-to-mid-term potential upside for the inventory, however over the long term we must always count on a reasonably mediocre efficiency – or at greatest a efficiency in keeping with the general market.