Drug distribution giant McKesson Corporation (NYSE:MCK) reported third-quarter earnings after the market closed on Jan. 30, 2012. The stock rallied, as earnings came in ahead of expectations and management announced additional share repurchases. The company has had a strong run of leveraging modest sales growth into double-digit annual profit gains, and there appears to be very few obstacles in its way to continuing this impressive run. A reasonable valuation and continued wave of generic drug introductions also bode well for investors.
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Third Quarter Recap
Revenues advanced 9% to $30.8 billion. The flagship distribution solutions unit, which distributes drugs, medical supplies and equipment, as well as health and beauty care products, also reported a 9% top line advance to account for the vast majority of total revenue at 97.3%. Drugstore chains CVS (NYSE:CVS) and Rite Aid (NYSE:RAD) account for a high percentage of sales at roughly a quarter of total revenues.
The remainder of sales stem from Technology Solutions, which helps hospitals such as HMA (NYSE:HMA) and Universal Health Services (NYSE:UHS) as well as related healthcare providers use technology to better manage their supply chain and financial operations. This segment saw sales rise a modest 4%.
Despite its small relative size, Technology Solutions is quite profitable and accounted for 12% of McKesson's $579 million in divisional operating profits. Backing out corporate overhead, total company operating income reached $492 million, up 60% from last year's third quarter. Both quarters contained litigation charges, but they were much larger last year at $189 million last year to dent reported profitability.
Reported net income nearly doubled to $300 million, while share buybacks helped earnings per diluted share double to $1.22. On an adjusted basis, the company estimated that recurring earnings advanced a more modest 9% to $1.40 per diluted share. (To know more about income statements, read Understanding The Income Statement.)
For the full year, analysts project revenue growth of 8.3% and total sales just north of $121.34 billion. McKesson expects to report earnings between $6.22 and $6.47 per diluted share.
The Bottom Line
Acquisitions and organic growth continue to allow McKesson to report solid revenue growth. A recent acquisition was also announced for Katz Group Canada, an integrated retail pharmacy network in Canada. Annual sales growth over the past five years has been more modest at around 5%, but management has been able to leverage that into much higher annual profit growth closer to 14%.
At a forward P/E of roughly 11, the valuation continues to be reasonable given the level of profit growth McKesson has posted in recent years. Drug distribution firms also garner higher profits on generic drugs, and with a continued wave of drugs losing patent protection, McKesson should continue to face tailwinds when it comes to profit growth. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)
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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.