Shares of McKesson Corporation (NYSE: MCK) crashed more than 22 percent on Friday, closing at $124.11 a piece. Intraday, the stock tumbled to as low as $114.53, extending its downtrend which began last year.
The stock is now off roughly 50 percent from its all-time high of $243.61 in May 2015, and there seem to be fewer takers.
MCK's shares tumbled massively on Friday after the company reported lower-than-expected Q2 results, and slashed its outlook for the remaining of the year. The Health Care (NYSEARCA: XLV) dropped more than 2 percent as the panic spread to other companies as well.
In such grave situations, investors often reassess their investing strategies and wonder as to what should be their next course of action. While there is little solace as of now for those who bought this stock near the top, buying near low levels can help lower the average purchase price, and may even reduce potential losses.
In this article, I will attempt to cover McKesson both from a fundamental standpoint as well as a technical perspective. My fundamental assessment reveals that in spite of the "uncertainties," the company's business is strong enough to weather the storm. The technical analysis will provide some important levels to look forward to.
The data below has been taken from MorningStar, and spans the period from 2007-to-date. There is visible improvement in all the metrics including revenue, gross margin, operating income, net income, dividends, book value per share, operating cash flow, free cash flow, etc.
Although I am looking at the historical data, my aim is to establish that the company's business is sound, formidable, and can pass through a downcycle amid competitive pricing pressures. We have also seen the company emerge stronger from the 2008 depression. The company's strengths far outweigh the weaknesses in the broader environment, and the investors should consider taking a leap of faith here, and not abandon the ship.
One way to measure the financial strength of a company is by studying its cash flows. From the green rectangle above, it is evident that the company has been increasing its free cash flow, which amply covers the dividend payout to shareholders.
Even more, while the free cash flow has grown roughly 2.5x from 2007-2016 ($1.233b-$3b), the dividend growth of >4.5x has far exceeded this rate. Recently, MCK announced a quarterly dividend of $0.28 per share; in 2007, the annual dividend was $0.24.
Now, let us consider some other aspects of this business. But this time, to draw more conclusive results, let us compare the company's fundamentals with that of the broader industry, and see if MCK is available at a discount or not.
The P/E (TTM) is 12.1, which for the industry is 13.9. The price/book is 3 while the industry average is 3.7. A very important metric to consider while doing fundamental analysis is price/sales ratio; P/S for MCK is 0.1, half of the industry's average of 0.2.
The return on assets is 3.9%, which is less than the industry's average of 4.5%. The return on equity TTM is 24.6%, lower than the industry average of 26.5%.
Overall, I am convinced that the fundamentals are intact, although I would have appreciated if the ROA was slightly better.
Looking ahead, the management has indicated that there will be a pressure on earnings, and hence, the ROA will remain depressed. This disappointment has been baked into the price, and after some further downside, I believe the stock will become attractive to long-term investors who are always on the lookout for strong businesses trading at discounts.
Another thing to consider here is that this is not simply just this company's problem, rather a broad sector-based problem in a softer pricing environment. When the fog lifts, and it will eventually, MCK and this sector will rise sharply, although it may take its time.
Technically as well, the stock looks ripe to make a strong comeback, however, near-term panic cannot be ruled out.
Here are the important technical points drawn from the Weekly MCK price chart below:
- Both 14-week MFI and 14-week RSI readings tell of grossly oversold levels. For MFI, values below 10 are considered strongly oversold and stocks often make a comeback following such extreme selling pressure. The current value of 14-week MFI is 3.4504.
For RSI, values below 20 represent dangerously oversold levels, and are often followed by strong short covering. The value of 14-week RSI is 19.4234.
- MCK has gone sharply lower than the lower range of the Bollinger Bands. Generally, the lower range acts as a cushion. Although, there is no guarantee that the stock will immediately rise, some sustenance can be observed.
- The 12-week (in black) and the 30-week (in green) SMAs have been crucial technical levels for this stock, as can be seen above. The current value of 12-week SMA is $170.2417 and the 30-week SMA is $177.0947. A reversion to these averages will be seen in the coming weeks.
Although the weekly price chart has confirmed that the stock is oversold and is a good candidate for a short-covering play, it is better to take a look at the monthly price chart as well. I have employed the Fibonacci retracements to the entire rally from the 2008 low to the 2015 peak, and found some interesting observations which are hard to deny.
Post hitting its peak in May last year, the stock slumped quickly in the new few months to pierce the 23.6% Fibonacci Retracement (FR) of $192.51 decisively and strongly rebounded from the 38.2% FR of $160.86 - marked as 1 in the chart above. The rebound saw the stock once again test the 23.6% FR, this time on the upside, but failed to sustain - marked as 2. #3 marks the moment when this failure dragged the stock down to slightly below the 38.2% FR, but once again recovered to the 23.6% FR as 4. Clearly, the stock has followed the technicals laid by the FR.
As of Friday, the stock pierced the 50% FR of $135.28 on huge volumes and slumped to $114.53, which is in close vicinity of the 61.8% FR of $109.70. The 61.8% Fibonacci retracement is an extremely strong level, and I wouldn't be surprised in the least if the stock registered a bottom near this level.
Those with a low-risk appetite can choose to adopt a broad range of $100-$110 for their purchase. One can easily expect the stock to reach at least $150-$160 in the next 6 months, based on simply the technicals.
McKesson remains a strong business from a fundamental perspective and an attractive investment from a technical viewpoint.
I am counting on the market's overreaction to drive the stock down to $105-$110, at which making fresh investments should be considered.
The company's drag on the Q2 results was a $290 million non-cash goodwill impairment charge, taken for the Enterprise Information Solutions. However, the company is exploring strategic alternatives for the EIS business within the Technology Solutions segment, and any positive news on this front, could send the stock soaring higher. With the recent debacle in stock price, the management would be pushed to achieve this sooner.
McKesson expects $12.35 to $12.85 per diluted share for the fiscal year ending March 31, 2017. Even by taking these figures as true, the stock is trading at roughly 10x, which is expensive by no means. The company has also announced a fresh $4 billion share repurchase program.
My advice to investors is simple: Never let the market's frenzy influence your investing strategies. McKesson has a good solid, honest management at the top, which actually cares about creating value for the customers as well as the shareholders. And this, in my opinion, is a lovely recipe for success.
Note: I cover several stocks in different sectors as well as S&P 500, crude oil, gold and silver, U.S. dollar, etc. So, if you liked this update, and would like to read more of such informative articles, please consider hitting the Follow button above. Thank you for reading!
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MCK over 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.