Last November, Investopedia's Stephen Simpson wrote an article entitled If CareFusion Can Execute, This Is A Major Bargain. The biggest concern investors have with CareFusion (NYSE:CFN) is its low return on invested capital. Until and unless it creates higher free cash flow, CareFusion is more than likely rangebound. Slightly more than five months later, I'll look at what progress it's made.

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After-Tax Operating Income

There are two parts when calculating return on invested capital. The numerator is after tax operating income and the denominator is invested capital. We'll deal with the numerator first. After-tax operating income tells us how much the business generates on an after-tax basis from its operations, excluding non-recurring items, interest expense, etc. Using its most recent six-month financial results ended Dec. 31, 2011, I'll annualize them for simplicity sake, comparing the current fiscal year with the previous one.

In 2011, operating income after-tax (using an average 35%) is \$326.3 million compared to \$261.3 million in 2010; a 24.9% improvement. Even more impressive, operating cash flow on an annualized basis has improved by 69.6% so far in 2011. It's exactly the positive change Simpson is talking about.

Invested Capital

To calculate how much capital a company has invested in its business, you take the total assets and subtract cash and cash equivalents along with non-interest bearing current liabilities, such as accounts payable and anything else that represents an interest-free loan. At the end of December 2011, its invested capital was \$6.85 billion. In order to calculate the same figure for 2010, I need to look in its 2010 Q2 report, which reveals that it was \$6.84 billion or virtually identical. Therefore, now that I have both the numerator and denominator for both 2011 and 2010, I'm able to determine what, if any, progress has been made.

In one word - yes. In 2011, its return on invested capital was 4.76%, 94 basis points higher than in 2010. More importantly, on a percentage basis, it's a 25% improvement. I'm not sure if it's enough of an improvement to persuade Simpson to invest, but it's enough for me to have a closer look at CareFusion's business model. You never know what I might find.

Work In Progress

CareFusion suggests the average 300-bed hospital has an opportunity to prevent 2,000 to 3,000 healthcare associated infections, annually saving that hospital anywhere from \$23 million to \$37 million in costs by reducing the number of preventable errors. CareFusion's two segments - Medical Systems and Procedural Solutions - definitely serve markets where there is a demand for its products, albeit at a relatively low growth rate. However, before it can improve its growth rate, it first needs to continue working on its profitability.

The former Cardinal Health (NYSE:CAH) subsidiary has spent the last two years making itself fully independent from its former owner. In the next three years it wants to expand its operating margins to 20% or more, grow its operating earnings by 11 to 15% annually, deliver returns on invested capital that are higher than its weighted average cost of capital, and grow revenues in the mid- to high-single-digits.

So far it seems well on its way to achieving all of its goals. In the most recent six-month period ended Dec. 31, 2011, it increased its operating margin by 250 basis points to 14.3% and its operating profit by 25% to \$251 million. As for revenues, it's increased them by 3.6% to \$1.76 billion in the first six months of fiscal 2012. A tuck-in acquisition or two and it should meet its goal for revenue growth in this fiscal year at least.

The only negative would be that its return on invested capital is still lower than its weighted average cost of capital, although my rough calculation suggests not by much.

SEE: Analyzing An Acquisition Announcement

CareFusion and Peers

 Company Enterprise Multiple CareFusion 7.41 Becton, Dickinson and Company (NYSE:BDX) 8.05 CR Bard (NYSE:BCR) 9.37 Baxter (NYSE:BAX) 8.55 Cooper Companies (NYSE:COO) 13.40

The Bottom Line

Since CareFusion became a public company in 2009, it has badly underperformed the S&P 500. Stephen Simpson rightfully has reason to be leery. There's no guarantee it will maintain the gains made in the first half of fiscal 2012. However, the fact that its enterprise value is currently at a lower multiple to EBITDA than many of its peers, combined with the fact David Einhorn of Greenlight Capital owned 12.2 million shares as of the end of December, is enough to convince me that it is indeed heading in the right direction. Get on board while it's still a deal.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.