The share price of drug distribution firm McKesson Corp (NYSE:MCK) has completely missed the recent stock market rally. Yet its operating fundamentals remain strong and health care reform efforts should breathe further life into its growth prospects.

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First Quarter Review
First quarter sales ended June 30 and rose 3% to $27.5 billion. Core distribution revenue accounted for the vast majority of sales (97.2%) and reported a 3% increase. This area consists of acting as a middleman between pharmaceutical firms such as Merck (NYSE:MCK) and distributing drugs to hospitals and drugstores such as HMA (NYSE:HMA) and CVS Caremark (NYSE:CVS),

McKesson also operates a small but very profitable technology solutions segment that sells software and supply chain know-how to help its core customer base operate more efficiently. This unit only reported a 2% rise in the top line but accounted for 11.2% of total divisional operating profits.

Total company operating income was $474 million and grew 3% as gross profits improved but SG&A costs increase more rapidly than sales. Net income also improved 3% to $298 million, or $1.12 per diluted share.

Outlook
Analysts currently project full-year sales growth of 3% to a hair under $112 billion. Management expects earnings between $4.72 and $4.92 per diluted share. However, net income tends to understate McKesson's impressive cash flow generation capabilities. For example, last year earnings were $4.58 but free cash flow exceeded $7 per diluted share.

The Bottom Line
McKesson's first quarter results were respectable and its cash flow generation has allowed for a steady stream of share buybacks and dividend increases. The balance sheet is also strong, with cash on hand in excess of long-term debt for a net cash position.

Yet for some reason, the share price has traded down significantly recently and is very close to its lows over the past year. The forward P/E is now only 12.3, if the company reaches the midpoint of its guidance. The free cash flow multiple will be much lower as long as McKesson continues to efficiently manage its working capital and keep capex low.

This is a very reasonable entry level given McKesson's operations continue to grow and healthcare reform efforts will add millions of new patients into the industry over the coming few years. Rival AmerisourceBergen (NYSE:ABC) is also worth a look, though its stock price has held up as of late. (Want more on evaluating medical companies? Check out Measuring The Medicine Makers.)

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