We are concerned with the declining volumes and margin pressure in the company’s UK retail and distribution business. McKesson’s UK pharmacy business continues to face headwinds related to the COVID-19 global pandemic. In the meantime, distribution volumes have improved in North America.
RECENT DEVELOPMENTS
Pharmaceutical distribution volumes improved in the U.S. as 1Q21 progressed, but remain weak in McKesson’s European operations, which is largely centered in the UK. The company said that while social distancing mandates had shutdown physician offices and surgical suites in April and part of May, prescription transactions and elective procedures began to recover in the latter half of May and into June. McKesson reported 1Q21 results on August 3. Adjusted EPS was $2.77, down 16%. GAAP net income was $445 million or $2.72 per share, compared to the $429 million or $2.27 per share it was a year ago. Revenue was $55.7 billion, virtually flat with what it was a year ago. The company reports results in three segments. In 1Q21, revenue in the Pharmaceutical segment grew 2% to $45.1 billion. The segment margin was 1.31%, down 5 basis points. The margin decline was driven by lower prescription volumes. Revenue in the European segment declined 7% (4% operational) to $6.2 billion, largely driven by lower volumes. The segment results included restructuring charges related to the UK retail and distribution business. The adjusted segment margin was 0.56%, up 4 bps. Revenue in the Medical-Surgical segment declined 5% to $1.8 billion. The segment margin was 6.89%, down 147 bps. The margin decline was driven by lower volumes of primary care patient visits.
EARNINGS & GROWTH ANALYSIS
McKesson raised its EPS guidance, reflecting the improving volumes in U.S. distribution. It now expects adjusted EPS of $14.70-$15.50, up from prior guidance of $13.95-$14.75. Based on the updated guidance, we are raising our adjusted EPS estimates to $15.10 from $14.20 for fiscal 2021 and to $16.80 from $16.50 for fiscal 2022.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on McKesson is Medium-High, the second-highest peg on our five-point scale. McKesson pays an annualized dividend of $1.68 per share, for a yield of about 1.1%. Our dividend estimates are $1.68 for FY21 and $1.74 for FY22.
RISKS
Through acquisitions, McKesson has expanded into new markets and added new revenue streams. But acquisitions also entail integration risk and market risk. In 2014, McKesson acquired a majority interest in Celesio AG, giving it control of Celesio’s pharmaceutical and retail operations in Europe and the UK. The UK retail business has faced revenue and earnings headwinds due to declining pharmacy reimbursements from the British government. McKesson’s business in Canada also faces pricing pressures.
COMPANY DESCRIPTION
With more than $230 billion in FY20 revenue, McKesson is North America’s largest pharmaceutical distributor. The company’s Distribution Solutions segment consists of U.S. and Canadian pharmaceutical distribution. The European distribution operation includes both wholesale and retail pharmacy businesses.
VALUATION
MCK shares trade at 10.0-times our FY21 EPS estimate, in line with the average multiple of 10.0 for our coverage universe of pharmaceutical distribution stocks. While the distribution business in North America is recovering, we are still concerned about the weakness in the UK.
