McKesson: Earnings Miss Could Be an Opportunity

| About: McKesson Corporation (MCK)
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As of Wednesday, almost half of the S&P 500 companies have reported earnings. Once again, despite a still floundering economy, companies are largely beating expectations – in fact, over 80 percent of those companies who have reported have done just that.
Our portfolio holdings have largely reported positive earnings thus far as well. Tuesday after the close, however, McKesson (NYSE:MCK), a position in our Growth portfolio, provided a fiscal 2011 second quarter earnings report that fell short of expectations. Despite the miss, McKesson shares are up over 5 percent today, while the broader market fell by about 1 percent.
Why? While missing analysts expectations, the underlying fundamental results were positive. The company collected $27.5 billion revenue during the quarter, just under the $27.9 billion forecast by analysts. Earnings were $1.03 per share, short of estimates at $1.09, but the company did reaffirm its full-year guidance for $4.72 to $4.92 per share.
Possibly even more importantly, the company remains optimistic about the future of its business given the strong performance of its Distribution Solutions segment which accounts for over 97 percent of revenues. McKesson, which distributes drugs and medical products from pharmaceutical companies to drug stores and pharmacy benefits managers, has seen positive trends in recent quarters – especially relating to generics (which offer higher profit margins). Operating income in the group grew to $491 million, over 18 percent improvement versus the year-earlier period as margins expanded by 25 basis points (a quarter of a percent) during the period. McKesson’s market leading generics offerings led the charge, and will continue to bring higher profits. In the coming quarters and years, a number of top-selling drugs (like Pfizer’s Lipitor and Bristol-Myer’s Plavix) will go off patent, adding to the growth of the generic drug market – and further bolstering McKesson’s offerings (and the potential for higher profits).
The company’s Technology Solutions group’s results were down versus the year-earlier period, but in line with company’s expectations. Integrating clinical and financial systems is increasingly important to McKesson’s customers as cutting costs in health care arena becomes paramount, and so management expects the segment to improve in the back half of the fiscal year. It also noted that the current performance of the segment was not in line with long-term expectations. The company took a $72 million non-cash impairment charge on the group’s revenue cycle management product, Horizon, as it continues its product development efforts. As healthcare IT spending at large continues to grow, we expect this segment to add significantly to profits. This quarter’s poor results aside, with high margins, the 3 percent of revenue stemming from this segment accounted for almost 20 percent of operating profits in FY2010.
Even with Wednesday’s nice move in the stock, shares appear attractive. The Board thinks so too, as it approved a new $1 billion stock buyback authorization, on the heels of the company already having completed $1.5 billion of share buybacks in July. The company has further rewarded its investors by increasing dividends – hiking its quarterly dividend by 50 percent to 18 cents in June to a yield of 1.1 percent. Shares trade at 12 times next year’s expected earnings with a PEG of 1, and we continue to rate them as buy.