Recommendation
I believe that an aging population, rising prescription drug use, and profitable expansion opportunities are positive tailwinds for McKesson Corporation (NYSE:MCK) in the long term. Even though there are still many unresolved concerns in the short term, I expect the pharmaceutical distribution business to stabilized. What’s more, after listening to the fiscal Q3 2023 earnings call transcript, I felt generally encouraged by the management’s commentary. It highlighted areas of resilience while reassuring investors of its longer-term growth potential in its oncology business and enhanced efficiency in generic sourcing.
Latest earnings highlights
McKesson Corporation’s adjusted EPS for the 3Q22 was $6.90, up 12% from 3Q21 and higher than the $6.35 consensus estimates. MCK’s strong business performance and drastically reduced operating costs led to an adjusted operating profit of $1.39 billion. The new guided range for adjusted EPS for FY23 is $25.75–$26.15, up from the previous range of $24.45–$24.95 (a 9.5% increase at the midpoint).
Underlying performance remains strong
The new guidance for adjusted operating profit growth outside of COVID-19 for the U.S. Pharmaceutical Segment is now expected to be between 7% and 9%. What this means is, over the next few years, management has confidence that this segment will grow faster than the long-term growth rate of 4% projected at the previous Investor Day. Stabilized prescription utilization, sustained strength in the oncology platform, and steady expansion of specialty providers and health systems are among the factors cited by management as the reason for the raised guidance. In my opinion, the specialty market is expanding, and MCK’s U.S. Pharma segment is well-positioned to take advantage of this trend.
As for Medical-Surgical Solutions, thanks to improved sourcing and expansion in their primary-care business, the segment operating profit ex-covid grew 25%. And, in the long-term, McKesson Corporation management believes that primary-care operations will be the primary factor in achieving the expected growth rates.
In a less encouraging move, McKesson Corporation management lowered FY23 guidance for Prescription Technology Solutions adj. operating profit growth from 17% to 14% y/y. The decline in adjusted operating profit was the result of the business’s ongoing investment, which weighed down on margins. Despite the current difficulties with Prescription Technology Solutions, I think the segment should do find as the core business appears to be healthy and is operating as expected.
More on Prescription Technology
McKesson Corporation management lowered the segment guidance for the second consecutive quarter. While I think the business has room to grow and shine, I believe management needs to be careful of communication here. Investors are paying attention to this asset because it has both higher-revenue but lower-margin 3PL operations and a number of higher-margin but smaller technology assets. Although I expect short-term fluctuations to continue due to the ongoing investments, it should incrementally show signs of success (or at least a path to achieve long-term goals).
Valuation & model
McKesson Corporation has previously guided that its long-term EPS growth will be between 12% and 14%, and its recent performance demonstrates that it will likely be able to maintain this projection. When added to MCK’s ambitious share repurchase plan, the expected 7%-11% increase in EBIT excluding-COVID this year should result in EPS growth at or above LT guidance range. In the long run, I expect MCK to be able to deliver EPS growth within its LT guidance, especially as the underlying business continues to strengthen and margin expand with mix shift.
I used a multiple of 14x P/E, which is what the market is using, but I believe there is room for multiple expansion because McKesson Corporation’s growth rate is higher than the market average (S&P 500).
Summary
I believe McKesson Corporation is a decent business given its track record of delivering EPS growth and also the undervaluation relative to its earnings growth (which I estimate to be in the low teens annually over the long term). I believe McKesson Corporation’s various efforts to grow its oncology businesses, along with the resilience of its core distribution business, will be the primary drivers that will sustain the business robust LT EPS growth.
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