EUR 850.00 For Business Accounts Only

Morningstar | McKesson Reports Decent Results; Our Outlook Remains Positive as Shares Remain Undervalued

Despite the tumult that has engulfed its operating environment, we believe McKesson will remain a key healthcare player and be able to produce outsize economic value. The second quarter reflected a stabilization of near-term issues as the firm reported earnings above consensus and raised the lower end of its full-year EPS guidance. After factoring in these latest results, we are reiterating our $210 fair value estimate and wide moat rating for the pharma distributor. Given the firm’s current stock price, we believe McKesson presents an opportunity for investors to own a quality asset at a deeply discounted price. While we believe there may be some material changes in how the U.S. pharmaceutical market operates over the next several years, the need to source and deliver drugs efficiently and cost-effectively will not change. We believe this fundamental factor has formed a strong foundation for McKesson, as its core drug wholesaling operations will be needed by both drug manufacturers and retail pharmacies no matter how any market dynamics shift.

McKesson’s management reported that it has moved the portion of branded contract compensation tied to a variable gross pricing component from 10% to 5%. We find this development highly positive and positions McKesson advantageously, since we expect the growth in branded gross pricing to remain well below historical norms over the foreseeable future. Most of the firm’s branded manufacturer compensation are fixed-fee arrangements, and we believe the remaining variable balance will eventually migrate to this structure. From our perspective, this dynamic will add more stability to drug distributors' results and help McKesson better manage its branded services.

Branded pricing and reformulating how manufacturers approach price-setting remain top of mind for investors. There is a fear that branded manufacturers will slow the growth or be mandated to revamp their pricing strategies, which could affect the profit profile of drug distributors. However, we believe any major overhaul will be gradual given the complexity of the pharmaceutical market. Additionally, if there were to be a set standard price, or discount for all branded buyers, the overall costs of these products would likely increase, since manufacturers would be motivated to set a higher standard initial price, or institute only a minuscule discount for all buyers, from our perspective.

McKesson’s international operations remain a major pain point, and the firm reported it is still in the process of restructuring its overseas businesses. In particular the firm’s UK operations remain challenged as the centralized government instituted greater than expected pharmacy reimbursement cuts. Accordingly, McKesson has sought to close underperforming pharmacies and revamp its overall cost structure in the region. While the firm’s international operations have been a material drag over the last several quarters, we believe the generic purchasing volume it gained through the acquisition of Celesio was necessary and gives it the ability to leverage lower generic product pricing throughout its entire business.