Dividend Investors: Stop Overlooking Cardinal Health by Eli Inkrot, Sure Dividend
Headquartered in Dublin, Ohio you probably don’t think of Cardinal Health (CAH) as being a big enterprise.
Yet based on revenue this healthcare company is the 21st largest firm in the U.S.; ahead of names like Microsoft (MSFT), Procter & Gamble (PG), Johnson & Johnson (JNJ) and PepsiCo (PEP).
The first London Value Investor Conference was held in April 2012 and it has since grown to become the largest gathering of Value Investors in Europe, bringing together some of the best investors every year. At this year’s conference, held on May 19th, Simon Brewer, the former CIO of Morgan Stanley and Senior Adviser to Read More
Cardinal Health operates in the generic pharmaceutical and medical supply industries. There are powerful tailwinds in this industry:
- Rising population means more health care
- Aging population means more health care
- More ailments are treatable which means more health care
Cardinal Health is poised to benefit from these trends… And it has strong fundamental numbers that make the company a Top 10 stock and current buy based on The 8 Rules of Dividend Investing.
This article takes a look at the investment opportunity at Cardinal Health
Cardinal Health’s Business
Cardinal Health is one of those firms that sort of operates in the background as far as branded products go.
Consumers seek out a Coca-Cola (KO) beverage or a Gillette razor. You probably don’t go around asking for a Cardinal Health product at a hospital, but there’s a good chance that you’ve been exposed to some of the company’s products:
Or perhaps more accurately, a very good chance:
As an operating business, Cardinal Health has been reasonably profitable in the last decade or so. Yearly income has ranged $800 million to $1.4 billion over the past 10 years – highlighting both the thin margins associated with the company’s business, but also the consistency along the way.
Here’s a look at the company’s per share performance over the last five years:
Earnings-per-share and operating earnings have been growing at a double-digit rate on an adjusted basis over the past five years, while shareholders have seen exceptional gains during this time.
A $10,000 starting investment back at the beginning of fiscal year 2011 would have been worth $27,000 fiscal year 2015. This was possible due to strong underlying earnings growth, an increase in the per share valuation multiple and a solid commitment to shareholder returns.
Speaking of shareholder returns, here’s what Cardinal Health’s capital deployment has looked like from fiscal year 2011 through 2015:
Cardinal Health Capital Allocation
With regard to improving the business, Cardinal Health has spent $1.3 billion on capital expenditures and $5.7 billion for acquisitions. This is the part that helps to further grow the business down the line.
The second part is shareholder return – with $1.8 billion going toward dividends and $2.9 billion used for share buybacks.
Cardinal Health has increased its dividend for 31 straight years, making the company a Dividend Aristocrat. Despite this, I’d contend that the company still isn’t that well known among dividend investors.
Part of this can be explained by the dividend yield.
At the start of the year Cardinal Health was paying out a $0.387 quarterly dividend or $1.55 on an annual basis. With a share price near $90, that equates to a dividend yield of just 1.7% – hardly the sort of thing that jumps off your stock screen.
Since that time, the dividend has increased to an annual rate of $1.80 and the share price has declined to under $80 – leading to a “current” yield closer to 2.3%. That’s still not spectacular, but it is getting better. Moreover, the company has certainly has the ability to make further increases as earnings are anticipated to grow nicely and the payout ratio remains well below 50%.
In addition to the recent dividend increase (a 16% jump), Cardinal Health also announced that it was increasing its share repurchase program by $1 billion. As noted above, this aspect of capital allocation has been even more robust than the dividend payment.
In the last ten years the number of common shares outstanding have declined from about 425 million to under 330 million. Expressed differently, nearly one out of every four shareholders that existed in 2005 have been bought out by the company on your behalf since.
It’s clear that the propensity and ability for Cardinal Health to reward shareholders in the past has been there. Which brings us to today.
Cardinal Health’s Future Growth Potential & Total Return Analysis
To be sure challenges exist ranging from general industry uncertainty and thin margins to possible pricing pressure resulting from increased drug price transparency. Of course there are potential catalysts as well.
For one thing, the industry is well situated for growth. Some industries you can see the decline coming – I think of things like coal, landlines or physical newspapers fitting this description. That doesn’t mean that investments still can’t work out well in those areas, it’s just that you have to be more aware of the growth (or lack thereof) characteristic.
With healthcare you don’t really have that problem. The population is not only aging, but also living longer – both bode well for healthcare demand.
The second item is that Cardinal Heath is a very large firm, as detailed above. So the company stands to benefit as the industry grows. This doesn’t have to play out – Cardinal Health could lose its way, market share or both – but at the very least it gets a good shot at capturing its fair share of economic rents in this arena.
Here’s a closer look at the types of strategic priorities that Cardinal Health is looking at and has a solid advantage in capturing:
Source: Cardinal Health, At A Glance
Naturally you want to develop your own thesis – and in turn decide whether or not you personally believe in the company or industry – but the above is how you might go about generating a background on the company and security. To get a feel for the types of returns that today’s valuation could imply, it can be helpful to develop a baseline here as well.
Analysts are presenting anticipating annualized growth for the company to be around 10% over the intermediate-term. Given Cardinal Health’s past, this certainly appears reasonable. Although then again, the company is now much larger than it was and the percentage of “organic” funds available to retire shares is now subdued due to a higher dividend payout ratio.
Let’s scale it back a bit and suggest that Cardinal Health can grow by 7% annually over the next five years (keeping in mind this is merely a baseline). After five years you would anticipate that the company could be making $6.15 per share or thereabouts (which would combine “organic” company growth with reduced share count achieved through share repurchases). Given that analysts are anticipating earnings-per-share near $5.70 for fiscal year 2017, this doesn’t appear to be an outlandish assumption for three years further out into the future.
Should shares trade with the same trailing multiple in the future, you might anticipate a future share price of around $110. If the dividend were to grow by 10% annually, you’d anticipate collecting $12 or so in dividend payments (prior to thinking about reinvestment) which would represent a payout ratio of just under 50%. In total you might anticipate that a share of Cardinal Health could generate $122 worth of value in the coming half decade.
Expressed differently, you might suppose that Cardinal Health could provide annualized gains on the magnitude of 9% per annum. As a point of reference, that’s the sort of thing that would turn a $10,000 starting investment into $15,000 or so five years later. That’s how I’d start to think about an investment in Cardinal Health.
The propensity to reward shareholders through growth in the industry, strong dividend increases and share repurchases is certainly there. Naturally things could turn out much better (say double-digit earnings growth) or much worse (for instance if profit growth started to stagnant and shares traded with a much lower earnings multiple). The idea is to think about the business, come up with a baseline and then determine whether or not that is compelling as compared to your applicable alternatives.
Cardinal Health ranks as a buy and top 10 stock using The 8 Rules of Dividend Investing thanks to its:
- Low price-to-earnings ratio of 15.1
- High 10%+ expected earnings-per-share growth rate
- Low payout ratio of 35%
The company’s mix of growth, value, and safety makes it a compelling investment at current prices.
Click here to download a 1 page PDF detailing Cardinal Health’s competitive advantage, recession performance, and much more – straight from the Sure Dividend Newsletter.