(By Michael Vodicka) The long-term trend in healthcare is something we have discussed on these pages before. The facts are pretty simple; the United States has an aging domestic population that continues to drive demand for healthcare products and services. But healthcare is a fairly large category, with biotechs, big pharma, generic drug makers, branded drug makers, medical devices and healthcare services filling the landscape. So even though the long-term trend is pretty apparent, finding a great stock to take advantage is another matter.
But if you are looking for an established name in a more stable segment of the industry, one of my favorite stock picks is Cardinal Health, Inc. (CAH). The company operates in two segments. The first is Pharmaceuticals, where it is a leading distributor of generic and pharmaceuticals and various over-the-counter healthcare products to retailers, hospitals and alternative care providers. Its other segment is Medical, where it distributes a range of medical, surgical and lab products to hospitals, surgery centers, labs and doctor's offices. Cardinal is a large cap stock, generally considered to be more stable and mature companies, with a value of $14.8 billion and is considered a leader in the drugs distribution space that is dominated by only a few names.
The company's share price has been pretty flat for the last year, oscillating in a fairly tight range between $40 and $44. But that belies the company's impressive earnings growth, last on display with strong Q3 results from early May that once again beat expectations.
Another Great Quarter
Revenue for the period was up 3% from last year to $27 billion. Earnings looked even better, coming in at 94 cents, up from 70 cents last year and 7% ahead of analyst expectations, where the company has an average earnings surprise of 4% over the last four quarters.
So with a strong quarter in hand and a secular trend supporting its business, there are more than a few reasons to be bullish on Cardinal.
Reason to be Bullish
The first reason is something we discussed above, where an aging and fairly affluent baby boomer population continues to demand more healthcare products and services. In fact, we are at the front end of that trend, with the Pew Research Center saying that every day over the next 19 years, 10,000 baby boomers will reach the age of 65. That will push the number of citizens in the United States over the age of 65 from 13% to 18% by the year 2030.
Another thing I love about Cardinal is its diversified business model. As a distributor and wholesaler of pharmaceuticals and medical devices, it carries a line of thousands of products from a large number of manufacturers, protecting its bottom line from changes in demand in specific products or market preferences. That also provides Cardinal with strong pricing power, where operating in the middle of the distribution channel protects it from volatility on the manufacturing and retail sides of the business.
And finally, there is another trend in healthcare that investors should be aware of, and it's what is being referred to as the "patent cliff." Over the next five years, a number of billion-dollar, branded pharmaceutical drugs will lose their patents, enabling the generic drug makers to step into the space and create lower cost knock offs. That is a big threat to big pharma, something that Cardinal is shielded from with its diversified offerings and location in the middle of the distribution channel.
Estimates and Valuation
On the estimates front, we've seen some marginal movement in estimates over the last few months, with the full-year 2012 estimate adding 2 cents and climbing to $3.20, a 20% earnings growth projection from last year. The full-year 2013 estimate of $3.57 is projecting another healthy 11% gain.
That strength in estimates against the backdrop of a stagnant share price has pushed Cardinal's valuation below historical averages, with its PEG multiple of .96X below the 10-year median of 1.1 and much closer to the low print of .66X than 1.63X
On the chart, shares have been pretty flat for the last year, trading mostly range bound between $40 and $44. In 2012, Cardinal is up about 3.5%, after rallying with the market in June. Look for a breakout from the channel in either direction as an indicator of future movement. Take a look at the chart below.
(click to enlarge)