Cardinal Health Stock: Long term investment at 10.0 times the term P / E

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Cardinal Salute (NYSE: CAH) has had a tough time in recent years with the opioid scandal, but it still looks like a very attractive long-term investment, trading at just 10.0x P / E forward. The company took a hit last week when management cut backs due to further expectations about supply chain problems. But this attractive forward P / E of 10.0x takes into account that update and is based on management’s new midpoint of $ 5.33 EPS guidance. This article will look at Cardinal Health’s attractive cash flows and also provide investors with an estimate of the company’s current $ 71.72 valuation, which hovers around a 28% safety margin.

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The latest results are hurt by supply chain problems

In Cardinal Health’s last fiscal first quarter 2021, revenue increased 13% to $ 44.0 billion over the prior-year period. Non-GAAP operating earnings declined 15% to $ 527 million primarily due to a decline in medical segment profit due to supply chain problems. Non-GAAP Diluted EPS decreased 15% to $ 1.29. GAAP operating income was $ 415 million and GAAP diluted EPS was $ 0.94.

In the quarterly release, the company reaffirmed its guideline range for fiscal year 2022 for diluted non-GAAP EPS attributable to Cardinal Health from $ 5.60 to $ 5.90. This update reflected net incremental supply chain costs of approximately $ 100 – $ 125 million. As previously mentioned, this upfront estimate has now been updated for an increase of $ 150 – $ 175 million ($ 0.40 – $ 0.45 of EPS impact). This leaves EPS estimates for 2022 at $ 5.20 – $ 5.45.

In the last quarter, the board also approved a three-year stock repurchase plan of up to $ 3 billion. At Cardinal Health’s valuation of $ 14.7 billion, that repurchase plan, if fully executed, would represent 20.4 percent of the company’s stock. As we will explore below, the company appears to have free cash flow available to support such buybacks.

Great cash flow generation

To get an idea of ​​the sustainability of dividends and share buybacks, we can take a look at what percentage of the cash flow from the operations is available to be returned to shareholders after making the necessary capital expenditures. As can be seen below, Cardinal Health does an extraordinary job of returning cash flow to shareholders in the form of dividends and share buybacks.

Cash Flow Analysis from Cardinal Health

Source data from Morningstar

With capital expenditures and acquisitions having absorbed only 20% of the cash flow from operations on average over the past decade, this leaves around 80% to be returned to investors in the form of dividends and share buybacks. With an average cash flow from operations of $ 2,096 million over the past five years, this 63% would imply free shareholder cash flow of $ 1,677 million for a free cash flow return of approximately 11.2 % to the current market capitalization of $ 15 billion.

Notably, Cardinal Health’s 2018 acquisition of Medtronic’s patient care, deep vein thrombosis and nutritional insufficiency business for $ 6.1 billion in cash is missing from the chart above. This significant but one-time acquisition is not a regular part of Cardinal Health’s capital allocation strategy. It was funded with $ 4.5 billion worth of new senior notes plus cash in hand. This debt has already been paid off quickly in addition to regular share buybacks, as we will see below.

Debt repayment and share buyback

Cardinal Health has large free cash flows that are used to provide shareholder value not only through the current 3.76% dividend, but also significant debt repayments and share buybacks. Since 2017, the company has reduced its interest-bearing debt by 46.5% from $ 10.4 billion to $ 5.7 billion for an average repayment rate of $ 1.1 billion per year (13.3%). Over the same period, the company repurchased 8.4% of its outstanding shares for an average repurchase rate of $ 0.5 billion (2.1%) annually.

Cardinal Health - Debt and shares

Source data from Morningstar

Get a sense of evaluation

To get a further estimate of the valuation and potential returns that Cardinal Health could offer at current prices, I will use the average free cash flow over the past 5 years for both bond and equity investors in a discounted cash flow assessment. . As can be seen in the table below, the potential returns look attractive, with the shares currently trading with a safety margin of around 23% relative to the estimated intrinsic value of $ 66.86. Specifically, this valuation subtracts the discounted $ 3.5 billion liability for the opioid transaction payment (which was previously expensed but not paid in cash) for an estimated remaining period of 10 years.

Cardinal Health Discounted Cash Flow

Authors’ calculations using Morningstar data

For those readers curious about the inputs into this zero-growth discounted cash flow assessment, here are a few more details of my thought process. For a discount rate, I conservatively used a 9% gross discount rate with a 2% growth rate given Cardinal Health’s scale, trade moat and revenue growth to arrive at a 7% net discount rate. %. From calculating the present value of the free cash flows of the entire company, I have added half of the cash and cash equivalents from the last quarter balance sheet to represent the excess liquidity that is not needed to run the business and is likely to come slowly returned to shareholders through additional share buybacks and dividends. I then subtracted the last quarter liabilities owed to investors of debt, equity leases, employee pensions, debt, and substantial opioid deals to produce the net attributable shareholder value. This net worth attributable to shareholders is then divided by the number of shares outstanding in the last quarter to get one figure per share.

Risks

Cardinal Health’s size, as evidenced by its $ 167 billion in revenue over the past twelve months, and its place in the healthcare sector make the company significant to society but also exposed to further political pressure, as seen by the recent agreement. on opioids. Such significant risks are unforeseen, but they could easily recur.

In addition, Cardinal Health is a low-margin company with net margins between 0.19% and 1.28% (excluding the negative net margin -2.42% in the year in which the opioid liquidation was expensed). These low margins leave the heavily operationally indebted company to the pressures of COGS and operating expenses. These are the issues that currently affect current net profit and forward estimates and will fluctuate in subsequent years as well.

Take away

Cardinal Health is a profitable business with excellent cash flows currently trading at 10.0 times forward EPS estimates which already account for significant supply chain issues. The company is a great cash flow generator and has done a good job returning this money to shareholders through debt repayments, stock buybacks averaging 2.1% per annum and current dividend yield of 3.76. %.

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