Chapter three of A Fistful Of Valuations In The Style Of Warren Buffett & Charlie Munger by Bud Labitan
A Fistful Of Valuations - Chapter 3
With the S&P 500 falling a double-digit percentage in the first half, most equity hedge fund managers struggled to keep their heads above water. The performance of the equity hedge fund sector stands in stark contrast to macro hedge funds, which are enjoying one of the best runs of good performance since the financial crisis. Read More
An estimated valuation of MCK, McKesson Corp. was first performed on 5/6/2010.
McKesson Corporation (McKesson) provides medicines, pharmaceutical supplies, information and care management products and services across the healthcare industry. The Company operates in two segments. The McKesson Distribution Solutions segment distributes ethical and drugs, medical-surgical supplies and equipment and health and beauty care products throughout North America. This segment also provides specialty pharmaceutical solutions for biotech and pharmaceutical manufacturers, sells financial, operational and clinical solutions for pharmacies (retail, hospital, long-term care) and provides consulting, outsourcing and other services. The McKesson Technology Solutions segment delivers enterprise-wide clinical, patient care, financial, supply chain, strategic management and software solutions.
Does MCK make for an intelligent investment or intelligent speculation in 2010? The 2015 discussion starts at the end of this chapter.
Let’s do a rough estimation of intrinsic value per share for 2010. Starting with a base estimate of annual Free Cash Flow at a value of approximately $2,137,000,000 and the number of shares outstanding at 271,000,000 shares (In 2015, the current number of shares outstanding is 232,000,000.); I used an assumed FCF annual growth of 5 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here, and think about its sustainability:
The resulting estimated intrinsic value per share (discounted back to the present) is approximately $103.24. Market Price = $66.49 Intrinsic Value = $103.24 (estimated) The Debt/Equity ratio here = .3 The Price To Value (P/V) ratio = .64 and the estimated bargain = 35.6 percent.
More importantly, before we make a purchase decision, we must decide ( filter #1 ) if MCK is a high quality business with good economics. Does MCK have ( filter #2 ) enduring competitive advantages, and does MCK have ( filter #3 ) honest and able management. The current price/earnings ratio = 13.8 It ‘s current return on capital = 12.11
Using a debt to equity ratio of .3, MCK shows a 5-year average return on equity = 15.5
The biggest threat to profitability is: Competition. The main competitors are: ABC = AmerisourceBergen Corporation, CAH = Cardinal Health, Inc., OMI = Owens & Minor Inc., Industry = Drugs Wholesale.
The Main Competitive Advantage in 2010 is: McKesson (NYSE:MCK) is one of the world's largest corporations and the leading company in the $252 billion pharmaceutical distribution industry. McKesson also provides enterprise-level software solutions to hospitals and other healthcare organizations. In the past, McKesson operated on a buy/hold business model but recently shifted to a fee-for-service business model in order to eliminate the company's dependency for profit on drug price inflation. Further discussions on competitive pressures can be viewed here: http://www.wikinvest.com/stock/MCK
You the reader can insert your notes about management here:
The shift from branded to generic drugs (as branded drugs lose their patents), allows distributors to benefit from both higher profit margins and higher total sales volume. Changes in health care policy, especially Medicare, can result in a larger volume of drugs being purchased, but threaten profits with cost controlling and transparency. As the U.S. population grows older, there will be a higher demand for pharmaceuticals. There is also the longer-term threat that providers and manufactures may one day be able to cut out the middlemen distributors.
McKesson has diversified outside of pharmaceutical and medical supplies businesses through its healthcare software and information technology offerings. Although this segment accounts for only approximately 2% of McKesson's revenue currently, it is by far McKesson's most profitable business. The market for healthcare IT is large and fragmented. The top 17 firms in the healthcare IT industry hold only approximately 40% of the market. Therefore, there is potential for McKesson to build on its leading market share in this high-margin sector.
Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.
Does MCK make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?
Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In terms of Opportunity Cost, is MCK the best place to invest our money today? Or, are there better alternatives? How will MCK compete going forward? Technologies change and new technology can emerge. Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.
A May 19th report from DOW JONES NEWSWIRES states that the Moody's Investors Service placed its near-junk ratings on McKesson Corp. (MCK) on watch for upgrade, citing the distributor of pharmaceutical products' improved margins in both its distribution and information-systems segments. Moody's rating on McKesson stands at Baa3, which is one notch into investment-grade territory.
In summary, using a debt to equity ratio of .3, MCK shows a 5-year average return on equity = 15.5
Based on a holding and compounding period of 10 years, and a purchase price bargain of 35.6 percent, and a relative FCF growth of 5 percent, then the estimated effective annual yield on this investment may be greater than 9.6%.
Going forward, are there any transformational catalysts or condition indicators imaginable on the horizon? Technologies change and new technologies will appear on the scene. Would brand loyalty keep customers buying here?
SEC Filings online: http://www.sec.gov/cgi-bin/browseedgar?company=&CIK=MCK&filenum=&State=&SIC=&owner=include&action=getcompany
Now, let’s discuss MCK, McKesson Corporation results over the past five year period. As a business, the Net Profit Margin of McKesson was in the range of 1.16% in 2010. In 2015, the Net Profit Margin is 0.90% TTM. This indicates that McKesson has very slim profit margins on its product/service mix.
The Return On Equity of McKesson was in the range of 18.40% in 2010. In 2015, the Return On Equity is 18.49% TTM. This indicates that McKesson may be using more debt to produce this return. Notice that the Financial Leverage for MCK is 6.32 TTM whereas the financial leverage is 1.86% TTM for JNJ.
The main competitors of McKesson are: Cardinal Health, Inc., CAH, AmerisourceBergen Corporation, ABC, Owens & Minor Inc., OMI, and the Drugs Wholesale Drug Industry.
So, why is the net profit margin of this business so slim? In every area of healthcare distribution operations, McKesson Distribution Solutions segment faces a highly competitive global environment with strong competition, both in price and service, from international, national, regional and local full-line, short-line and specialty wholesalers, service merchandisers, self-warehousing chains, manufacturers engaged in direct distribution, third-party logistics companies and large payer organizations.
The Technology Solutions segment experiences substantial competition from many firms, including other software services firms, consulting firms, shared service vendors, certain hospitals and hospital groups, payers, care management organizations, hardware vendors and internet-based companies with technology applicable to the healthcare industry.
From this case, I have learned to appreciate the power of competition and debt levels. Competition varies in size from small to large companies, in geographical coverage and in scope and breadth of products and services offered.
So, is McKesson a business that I would invest in today? As of October 20th, 2015, Valuepro.net estimates the intrinsic value per share of MCK at: $182.92 and the market price is at: $193.37 Therefore, McKesson does not appear to be a bargain at this time.