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Tickers in this Article: MCK, BAX, AZN, GSK, NVS
Drug distribution firm McKesson (NYSE: MCK) reported second-quarter earnings Oct. 27 that beat analyst projections. This was due primarily to strong near-term trends, but McKesson shares have appeal over the longer haul given the company's appealing business model and reasonable valuation.

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Recent Results
Q2 revenues eked out a 1.9% increase to $27.1 billion. The vast majority of revenue stems from the distribution solutions segment that distributes drugs, medical supplies and equipment, as well as health and beauty care products in North America. Total distribution solutions revenue grew 2% to account for 97.1% of total quarterly sales with particular strength in medical and surgical distribution. The technology solutions unit provides strategic and software management services primarily to hospitals and experienced a 3.6% boost in the top line on the back of strong service growth.

While technology solutions only accounted for 2.9% of sales, it is a highly lucrative unit and posted an operating profit margin of 14.7%, which made up 21.8% of total company operating profits of $531 million before subtracting out corporate overhead costs. In stark contrast, the distribution segment reported a razor thin operating margin of 1.6% to account for 78.1% of total quarterly profitability.

A higher tax rate caused reported net income to fall 8% to $301 million, but share buybacks helped offset the hit to earnings, which ended up falling 5% to $1.11 per diluted share. This came in ahead of analyst projections. (For more on analyst expectations, be sure to read Analyst Forecasts Spell Disaster For Some Stocks.)

Outlook
Better-than-expected trends and participation in distributing H1N1 flu vaccine played a part in management raising its full-year earnings guidance to between $4.45 and $4.60 per diluted share. H1N1 vaccine is currently being produced by GlaxoSmithKline (NYSE: GSK), Baxter (NYSE: BAX), Novartis (NYSE: NVS) and Medimmune, which is now owned by AstraZeneca (NYSE: AZN). McKesson plays a major role in the drug value chain as products make their way to end consumers. Analysts currently project full-year revenue growth of 0.9% to $107.6 billion.

Bottom Line
McKesson also ended the quarter in a strong financial position with no net debt as cash of $3.2 billion on the balance sheet exceeded long-term debt of $2.3 billion. Operating cash flow nearly tripled to $1.53 billion for the first two quarters of the firm's fiscal year. CAPEX (as measured by property acquisitions and software expenditures) during this period was modest at $189 million, illustrating that McKesson generates plenty of excess capital to fund acquisitions and returns to shareholders.

McKesson repurchased $299 million of stock during the quarter and has $531 million left from its current repurchase program. Throw in a modest dividend yield of 0.8% and a very reasonable forward P/E multiple of 12.6 (should it hit the high end of guidance), and McKesson is a stock that investors should keep a close watch on.

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