AmerisourceBergen's (NYSE:ABC) stock price has been increasing for the last 10 years, and it may seem as if the current price could be the ceiling. I don't think so. In this article, I will try to justify my claim why you should consider adding ABC to your portfolio.
AmerisourceBergen is one of the world's largest pharmaceutical services companies serving the United States, Canada, and selected global markets. Servicing both healthcare providers and pharmaceutical manufacturers in the pharmaceutical supply channel, the company provides drug distribution and related services designed to reduce costs and improve patient outcomes. AmerisourceBergen's service solutions range from niche premium logistics and pharmaceutical packaging to reimbursement and pharmaceutical consulting services. With nearly $80 billion in annual revenue, AmerisourceBergen is headquartered in Valley Forge, Pa., and employs approximately 13,000 people.
Company Stock Price
Five years ago, ABC's stock price was $19.89 per share. Currently, it's about $55.56 per share. The average increase in the stock price was 35.8% annually.
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Source: Google Finance.
Increase in the stock price is not enough to say that ABC is a very good stock. It's useful to compare it to it's direct competitors and S&P 500 performance.
It can be seen that ABC outperformed both of its direct competitors as well as the S&P 500. There are two main competitors: One of them is McKesson Corp. (NYSE:MCK) and the other is Cardinal Health (NYSE:CAH). Both competitors have higher market capitalizations.
To consider a stock for a purchase I have one requirement, and it is that the company's discounted cash flow (DCF) valuation outcome and Benjamin Graham valuation model outcome should have at least a 25% margin of safety -- thus meaning the stock is undervalued. I started with the DCF calculation. To calculate it, I used ABC's weighted average cost of capital (WACC), which in this case was 8%. The DCF states that the intrinsic value for ABC share is at $107.43, which gives us a 48.3% margin of safety.
The Graham valuation model outcome was calculated using the Bloomberg U.S. Corporate Bond Index yield of 3.14%. The outcome of the Graham valuation model stated that the intrinsic value for ABC is at $99.74, which gives us a 44.3% margin of safety. Both values propose that ABC's intrinsic value is considerably higher, and the stock should cost at least $99.74. This value gives us a possible upside move with a potential profit of 79.5%.
It is no secret that the world is aging slowly, which is a result of people living longer as well as having lower birth rates in highly developed countries. At this moment, the population of U.S. has reached almost 316 million. In 2010, there were approximately 40 million people, or 13% of the population, who were 65 years old or older. In 2050, this number will grow to approximately 88 million, or 20.2% of the total population. This is good news to ABC because older people need more medicine. Also, the overall population will grow to approximately 439 million in 2010, and this is good news. To put it plainly: "More people, more drugs needed, more business for ABC."
In its 2012 annual report, President and CEO of ABC Steven H. Collis wrote to ABC's shareholders:
Since the 2001 merger that created AmerisourceBergen, we have generated $8.8 billion in free cash flow, and we have returned 82% of that to stockholders through $6.6 billion in share repurchases and $600 million in dividends.
... Our Board of Directors approved a 62% increase in our annual dividend and authorized a new $750 million share repurchase program in November 2012.
Aggressive stock repurchases can be seen from the decreasing number of shares outstanding. In 2006, there were 414.9 diluted shares outstanding, while in 2012 there were 256.9 diluted shares outstanding.
Dividends paid for share increased from $0.1 in 2006 to $0.52 in 2012. The company's dividend yield more or less has been at the same level. One more factor working in ABC's favor is its increasing net margin. It increased from 0.36% in 2008 to 0.9% in 2012.
- June 3, 2013: AmerisourceBergen announced the completion of the divestiture of its Canadian pharmaceutical distribution business, AmerisourceBergen Canada Corporation. It has been sold to Kohl & Frisch Limited, a Canadian-owned national full-line distributor. ABC estimated that losses on the sale could be $161.7 million.
- May 13, 2013: AmerisourceBergen announced that it has completed the divestiture of its contract packaging business, AndersonBrecon. It was sold to an entity formed by affiliates of an investor group led by Frazier Healthcare VI, L.P. for the purpose of acquiring AndersonBrecon for $308 million in cash.
The most important news for ABC's future is the announcement of strategic, long-term relationship with Walgreen (WAG) and Alliance Boots, which includes a 10-year comprehensive primary pharmaceutical distribution contract with Walgreen, access to generic drugs and related pharmaceutical products through the Walgreen Boots Alliance Development joint venture, and opportunities to accelerate the company's efforts to grow its specialty and manufacturer services businesses domestically and internationally. AmerisourceBergen continues to expect the new agreements to contribute an incremental $25 billion in revenues and approximately 20 cents in earnings per share in fiscal 2014.
As mentioned at the beginning of this article, ABC stock is currently trading at a great height. Nonetheless, I believe ABC still is undervalued and my target for it stands at $99.74, which could result in a potential profit of 79.5%. It is hard to predict the time frame for a potential upward movement. If ABC manages to employ its strategic relationship with Walgreen and Alliance Boots, the upward move could possibly happen during the coming two years.
Sources: AmerisourceBergen 2012 annual report; AmerisourceBergen 2012 summary annual report; and U.S. Census Bureau report "The Next Four Decades."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.