Invest In AmerisourceBergen For Its Growth And Valuation - Speculate In A Potential Takeover

May 23, 2019 3:55 AM ETAmerisourceBergen Corporation (ABC)31 Comments62 Likes

Summary

  • AmerisourceBergen looks like an attractive dividend growth stock, especially for those seeking an above-average long-term total return.
  • When you invest at sound valuation, you position yourself to participate in the growth that the business generates on your behalf.
  • I believe that regardless of whatever happens to healthcare delivery politically in the future, AmerisourceBergen will still be positioned as a viable long-term business.
  • F.A.S.T. Graphs Analyze Out Loud video on AmerisourceBergen.

Introduction

This is the first in a continuing series where I identify and present dividend growth stocks for an above-average long-term total return objective. Throughout this series, I will be illustrating that there are several prudent sources of long-term return and there is also luck or chance. Personally, I suggest that investors strive to build their portfolios based on prudent fundamental realities and not simply invest with the hope that your stocks will rise.

The primary prudent sources of total return that I am alluding to are, first and foremost, sound fundamental valuation - although attractive undervaluation is even more desirable. The second primary source would be growth defined as the potential long-term rate of change of earnings and/or cash flow growth and dividend growth. When you invest at sound valuation, you position yourself to participate in the growth that the business generates on your behalf.

If you can identify attractive undervaluation, you can expect a secondary source and a potential kicker to total return that I like to call natural leverage. Simply stated, in addition to the operating growth and dividend growth that the company achieves, you are also positioned to get P/E ratio expansion. To clarify, you initially invest in a smaller level of earnings at a lower P/E ratio where the company, over time, delivers a higher level of future earnings that the market capitalizes at a higher P/E ratio. I metaphorically refer to this as a double-double. In the future, you get double the earnings that are valued at double the P/E ratio. Of course, the math does not always work out so perfectly, but I hope you get the point.

Furthermore, I will be presenting stocks that I believe offer the potential for significantly above-average total return. Stated more clearly, I will be looking for dividend growth stocks that I believe can provide double-digit total returns, including a growing dividend income stream. But perhaps most importantly, because of the focus on attractive valuation, I believe these future returns can be generated at greatly mitigated (lower) levels of long-term risk.

Moreover, it’s important to distinguish between long-term results versus short-term results. Intelligent value investors understand that investing in unpopular securities is where value is most often found. This is especially true when you are in a bull market like we have been in for the last several years.

Consequently, there are typically reasons why a stock’s valuation is low. The trick is in determining whether those reasons are valid, permanent or temporary. Nevertheless, the intelligent value investor understands that unpopular stocks can remain unpopular for some time, and therefore provide below-average short-term results. On the other hand, unpopular stocks that are erroneously valued can provide exceptional long-term returns based on the sources of long-term return described above.

AmerisourceBergen: Prudent Investment-Interesting Speculation

AmerisourceBergen (NYSE:ABC) could well be the epitome of a near-perfect dividend growth stock. It has a long history of consistent above-average earnings growth, and has increased its dividend for 14 consecutive years at an average rate exceeding 30% per annum. Therefore, even though the company's current dividend yield is slightly below market average, its growth yield (yield on cost) potential is significantly above average.

Additionally, the company has a solid investment grade A- credit rating and modest debt-to-capital of 57%. Although the company is not expected to grow at its historical double-digit rates, it is expected to continue growing at the above average rate of 7-9%. Nevertheless, trading at a blended P/E ratio below 12 makes this medical distributor a compelling long-term investment based on significant undervaluation alone. Consequently, AmerisourceBergen looks like an attractive dividend growth stock, especially for those seeking an above-average long-term total return.

On the other hand, in addition to the company’s apparent long-term attractiveness, it also appears to be a compelling short-term speculation. Walgreens Boots Alliance (WBA) already owns a 27% stake in this premier drug wholesaler and medical distributor. Moreover, according to Raymond James analyst John Ransom, it might also be a potential acquisition target. This seems plausible considering that competitor CVS Health (CVS) has recently merged (acquired) with Aetna, and the fact that Walgreens Boots Alliance has not engaged in any significant deals recently. Therefore, Walgreens Boots Alliance may have some incentive or need to catch up.

AmerisourceBergen: Compelling Valuation

The following long-term earnings- and price-correlated F.A.S.T. Graph on AmerisourceBergen clearly illustrates that the company has not been available at such a compelling valuation since the throes of the Great Recession. This is somewhat understandable considering that healthcare in general is a current political football. However, I believe that investors should also consider that the current political risk is already priced in. In other words, the current low valuations on healthcare stocks in general appear too attractive to ignore despite the political risks.

ABC FAST Graphs Historical

As I have stated many times in the past, I never consider investing in a stock before calculating a specific rate of return expectation. I call this running the numbers out to their logical conclusion. In the case of AmerisourceBergen, if the company did grow earnings at the consensus rate of 7.9% and its P/E ratio expanded from the current 12 to a more rational P/E ratio of 15, its total annualized rate of return out to fiscal year-end 2021 would be slightly over 20%. In other words, the current political risk is already baked into the valuation (price).

FAST Graphs

The Wall Street Journal published an article by Charley Grant on May 20, titled “Everyone Hates Health-Care stocks. Buy Them Anyway.” The article’s byline stated, “relatively attractive valuation and defensive properties could make this sector shine.” I consider this sound advice, especially when you understand that these healthcare stocks do not really need to grow very much to generate strong future returns. The point is that even a no-growth business is worth a reasonable multiple of earnings and cash flows, typically in the neighborhood of 14-16 times earnings. Consequently, today’s low valuations have already priced in the risk and suggest that high-quality healthcare stocks are attractive.

To illustrate how an undervalued stock doesn’t have to grow in order to be a good investment, I present the following “Custom” forecasting calculator, where I have overridden the consensus estimates. The following Custom forecast calculator illustrates the return potential on AmerisourceBergen, assuming the company only grows at 1% (significantly below consensus) and trades at a rational 15 P/E ratio. Even under that draconian scenario, the company could still potentially generate double-digit returns over the next couple of years. As I often say, valuation matters, and it matters a lot. But perhaps, more importantly, low valuation can mitigate a great deal of risk.

ABC Custom Forecasting FAST Graphs

How Reliable are Consensus Estimates on AmerisourceBergen?

As I often state, as investors we can only invest in the future and not the past. However, it also logically follows that it is implicit upon us to base our decisions on a prudent and reliable forecast of what the future might bring. Consequently, I believe it makes sense to start by reviewing the consensus estimates of the leading analysts following the company. However, it is also important to realize that consensus analyst estimates are quite often derived and aligned with company guidance. The following slide from AmerisourceBergen’s recent earnings report provides the company's fiscal 2019 (ending in September) guidance for adjusted diluted earnings of $6.70-6.90. The reader should note that this guidance is consistent with the consensus estimates of 18 analysts presented in the forecasting calculator above.

Furthermore, the following Analyst Scorecard illustrates that leading analysts have an excellent track record of forecasting AmerisourceBergen’s earnings in advance. As seen in the following screenshots, analysts have been extremely accurate with their forecasts when they have been made exactly one year or two years in advance of the actual financial reports. Consequently, this provides me some confidence that consensus estimates are a reliable starting point towards providing a reasonable future earnings expectation on this blue-chip dividend growth stock. Therefore, I am enthusiastically motivated to continue conducting a comprehensive research and due diligence process on AmerisourceBergen, because I believe the potential is worth my while.

AmerisourceBergen: Thesis for Growth And Success

According to Morningstar:

“Business Strategy and Outlook, by Soo Romanoff, Updated Apr 08, 2019

AmerisourceBergen has developed a pharmaceutical platform addressing the comprehensive sourcing and distribution needs of manufacturers and providers. With 20,000 employees and an electronic inventory platform, the company is equipped to ship more than 3 million products a day worldwide. The global scale and sheer pharmaceutical volumes enable the company to negotiate competitive prices, and it can efficiently provide access to a vast portfolio of drugs. The core business, roughly 96% of revenue, is focused on pharmaceutical distribution, and the balance of revenue is attributable to acquired businesses. AmerisourceBergen handles roughly a third of the drugs sold in the United States and has created an extensive footprint into physician-administered products, with key anchor customers within communities. Further, the company operates efficiently in a highly regulated environment, which provides some insulation.”

Furthermore, I believe that regardless of whatever happens to healthcare delivery politically in the future, the company will still be positioned as a viable long-term business.

AmerisourceBergen’s confidence in its future growth was presented in its most recent earnings report as follows:

F.A.S.T. Graphs Fundamentals Analyzer Out Loud Video: AmerisourceBergen

In the following analyze out loud video, I’m going to run AmerisourceBergen by the numbers looking at numerous cash flow and earnings metrics. In addition to looking at valuation, I will also be looking at dividend coverage and safety. There is more than one way to skin a cat and certainly more than one way to value a business. However, no matter how you evaluate the company, I believe the conclusion is the same. This is an extremely high-quality dividend growth stock that is currently available at a very attractive valuation.

Summary and Conclusions

I believe that AmerisourceBergen is an extremely high-quality dividend growth stock that is currently an attractive total return investment based on low valuation and above-average potential growth of earnings and dividends. Consequently, I also believe that the political risk associated with medical companies in general and AmerisourceBergen specifically is already priced in.

Furthermore, the possibility that Walgreens Boots Alliance may make a play for the remaining shares in the company it does not already own provides an interesting and reasonable short-term speculation. AmerisourceBergen is certainly cheap enough at current levels for Walgreens to make an offer above current valuation and still purchase the shares at a sensible valuation. However, I don’t believe the acquisition needs to occur in order to make AmerisourceBergen an attractive long-term dividend growth investment.

Finally, and as always, I suggest that investors conduct their own comprehensive research and due diligence. Caveat emptor.

This article was written by

Chuck Carnevale profile picture
60.47K Followers
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Charles (Chuck) C. Carnevale is the creator of FAST Graphs. He is also Co-Founder of The Dividend Kings, along with Brad Thomas and Adam Galas (Dividend Sensei), offering a premium service on Seeking Alpha's Market Place. Chuck is also Co-Founder of an investment management firm. He has been working in the securities industry since 1970: he has been a partner with a private NYSE member firm, the President of a NASD firm, Vice President and Regional Marketing Director for a major AMEX listed company, and an Associate Vice President and Investment Consulting Services Coordinator for a major NYSE member firm. Prior to forming his own investment firm, he was a partner in a 30-year-old established registered investment advisory in Tampa, Florida. Chuck holds a Bachelor of Science in Economics and Finance from the University of Tampa. Chuck is a sought-after public speaker who is very passionate about spreading the critical message of prudence in money management. Chuck is a Veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.


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Disclosure: I am/we are long ABC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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