EUR 850.00 For Business Accounts Only

Morningstar | Cardinal Reports Mixed Quarter as Positive Long-Term Fundamentals Remain Intact; Shares Undervalued

Cardinal reported a mixed quarter as revenue grew at a robust clip, but profits continue to be pressured. While these near-term fluctuations reflect a shifting operating environment, we believe the need to source and deliver drugs in a cost effective and efficient manner will remain a positive fundamental for the drug distributor. This dynamic forms a strong foundation for Cardinal’s long-term competitive position, in our view, as its core drug wholesaling operations will be needed by both drug manufacturers and retail pharmacies no matter how any market dynamics shift. Accordingly, we are reiterating our wide-moat rating and $82 fair value estimate.

Cardinal’s management reiterated its guidance for the year and is confident its expectations incorporate a conservative outlook. We find this an encouraging development as it points to continued stabilization in its operations as generic deflation moderates and branded inflation remains on an expected trajectory. Management stated that its guidance incorporates a scenario where branded inflation could fall by 100-200 basis points below its current expectations. However, the team stated that it feels highly confident in its inflation expectations given its conversations with various branded manufacturers.

The firm is also reorganizing its operations and management stated that “everything is on the table." Part of this reorganization includes the firm refocusing much of its managerial bandwidth and asset investment toward building more efficiency and stabilization into its core pharmaceutical wholesale segment. This is a major change from the firm’s previous strategy of expanding its business portfolio and global reach, and we applaud the new management team on this strategy. We have modeled modest profit improvements for this segment as we forecast operating margins to expand by only 20 basis points (to 2.48%) by the end of our explicit forecast period. We believe this reflects a conservative outlook and incorporates greater infrastructure efficiency, modest pricing spread, and less variability tied to branded pricing.

CEO, Mike Kaufman, stated on the earnings call that the process of revamping the firm’s business and refocusing efforts on process improvements will continue well into the fiscal year. We believe this strategy will be a positive over the long-term given the greater focus on optimizing its drug wholesaling operations and expanding its specialty pharmaceutical operations. From our perspective, these efforts will ultimately build significant shareholder value beyond fiscal 2019. Cardinal is positioned as a critical cog within the global pharmaceutical supply chain and this dynamic will provide it the opportunity to produce significant economic profits over the long-term. Thus, the current discount in the firm’s stock price presents an opportunity for investors with long-term time horizons to own a wide moat business at a significant discount.