AmerisourceBergen Corporation: Looking Healthier (NYSE:ABC)

It has been a long time since I covered AmerisourceBergen Corporation (NYSE:ABC). In fact, it was 2015 when I reviewed the situation after the company announced a $2.6 billion deal to acquire PharMEDium.

I noted that the company had seen solid operating performance following solid operational growth, with topline sales growth being complemented by continued share buybacks. Momentum leading up to 2015 left shares reasonably valued, yet I was a bit cautious as share price gains outpaced earnings growth in the years before.

Some Background

In the autumn of 2015, AmerisourceBergen announced a $2.6 billion deal to acquire PharMEDium, a quality business at arguably a demanding price. AmerisourceBergen has seen solid growth, having grown the operations to a $135 billion revenue base (up from $55 billion a decade before) on which $2.2 billion in EBITDA was posted. Adjusted earnings came in at half that number, still working down to a $5 earnings per share number based on 220 million shares outstanding. Trading at $93 at the time, the company was awarded a $20 billion equity valuation, and $24 billion enterprise valuation if we factor in pro forma net debt.

Trading at 18 times adjusted earnings, valuations looked fair given the historical performance, yet there were some caveats. This included warrants granted to Walgreens Boots Alliance (WBA) which had the potential to dilute the share count by 20 million shares, causing potentially 10% dilution, although this comes after the business has cut the share count nearly in half in the decade before following a serial and aggressive buyback program.

Margins were slim but quite stable. Gross margins averaged between 3.0% and 3.5% at the time, with operating margins trending between 1.0% and 1.5%. Strong growth and continued buybacks made that shares rally from $20 to $100 in the ten-year time frame, gradually increasing the valuations along the way.

Given the situation and the fact that valuations were quite demanding (given the interest rates and valuations at the time), I concluded to become appealed at a 15 times multiple, or $75 per share. In fact, I snapped up a few shares around those levels in 2016.

Stagnation – Coming To Live

After pharmaceutical names, including AmerisourceBergen, did well in 2015 and the years leading up to that, shares were trading stagnant in a $75-$100 range until 2020. What followed has been renewed momentum in the shares to a high of $165 earlier this year, after which shares have now fallen to $142 at the moment of writing.

Momentum has been fueled as the business saw some de-risking last year, with Amerisource and other distributors reaching settlements regarding their role and involvement in the opioid crisis. In a settlement reached in the summer of last year, AmerisourceBergen found itself on the hook for $6.4 billion, yet that is only to be paid out in the coming 18 years.

Forwarding to November of last year, Amerisource had grown the business to $214 billion, following another year of double-digit sales growth. The company posted 3.2% gross margins and 1.1% operating margins, in line with historical ranges, with operating profits reported at $2.4 billion. After taxes and interest rates, the company posted net earnings of $1.5 billion, for earnings of $7.39 per share, up nearly 50% from 2015. Adjusted earnings were posted at $9.26 per share, nearly two dollars per share higher, with the adjustment mostly relating to litigation and employee severance costs.

Net debt inched up to $4.1 billion, a very reasonable amount given that adjusted EBITDA was posted around $3.3 billion, translating into a mere 1.2 times leverage ratio. With shares trading at $120 at the time, valuations were not too demanding, certainly not if we factor in that the company guided for 2022 earnings (adjusted that is) set to rise to $10.50-$10.80 per share, all on the back of high single digit, or low double-digit sales growth.

Following a decent set of first quarter results, the company hiked the earnings guidance by ten cents, and further to $10.80-$11.05 per share following the release of the second quarter results, while raising the midpoint to $11.00 per share following the release of the third quarter results. Net debt has been cut to $3.0 billion, following modest dilution, as the company is now starting to buy back some stock again. This results in leverage ratios below 1 times, as major settlement charges still have to be paid out of course.

With shares now trading at $142, the 212 million shares outstanding now value AmerisourceBergen at $30 billion, or $33 billion if net debt is included. Valuations remain quite modest at 13 times adjusted earnings seen this year, or about 15 times if we keep in mind a $2 per share reconciliation to GAAP earnings. That is needed as the annual payments under the settlements, an amount equal to roughly $1.50 per share, are likely to be detrimental to earnings for years to come. One could also ignore it and treat it as a one-time liability, which is actually manageable given the solid state of the business.

Some Added Growth

To ignite a bit more growth, AmerisourceBergen reached a deal by mid-September to acquire German-based PharmaLex Holding, a provider of specialized services to the life science industry. The EUR 1.28 billion deal, which is well-timed with regard to exchange rates, is equal to about 4% of the valuation of AmerisourceBergen here.

The deal indicates that the company is moving up the value chain, and thus should involve higher margins, yet not a lot of financial details were announced. The company did indicate that adjusted earnings per share would rise by $0.15 per share, a modest accretion given the relative larger size of the deal. Net debt will inch up a bit, but remains far from a worry.

And Now?

Truth is that I think that the valuation for Amerisource looks quite solid and appealing here, but the relative outperformance of the stock so far this year makes me a tiny bit cautious here. Hence, I am constructive on Amerisource, but I see no reason to initiate here, right now.