Cardinal Health does face plant on skanky earnings guidance; even deal for some Medtronic assets raises concerns

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The News:

Cardinal Health Inc. (Dublin OH) struck a deal to buy part of Medtronic PLC’s (Dublin IRL) patient monitoring and recovery unit for $6.1 billion, bringing businesses under Cardinal’s roof that it has sought for years but also boosting its debt load.

@CardinalHealth to buy part of @Medtronic patient monitoring and recovery unit for $6.1 billion Click To Tweet

Cardinal said it will fund the acquisition with $4.5 billion in new debt plus existing cash.

The move prompted Fitch Ratings to voice concerns over Cardinal’s debt and lower its outlook on the healthcare services company. That, combined with a dimmed earnings outlook from Cardinal sent shares tumbling 13% at one point.

Fitch, which rates Cardinal’s debt at three notches above junk, said it expects leverage will remain elevated for an extended period.

Separately, Cardinal said it expects adjusted profit for this year to be at the bottom of its previous guidance range of $5.35 to $5.50 a share, and it forecast adjusted earnings in 2018 to be flat to down mid-single digits. Analysts had expected 9.2% growth for next year, according to Thomson Reuters.

Shares fell to the bottom of the S&P after the earnings guidance and Medtronic announcements, with a 12% shellacking to $72.39. Meanwhile, the S&P 500 declined 0.3% to 2,342. Shares recovered somewhat Thursday, closing at $73.31, down 10% for the week.

Steve’s Take:

The deal for a Medtronic medical supplies unit was thoroughly eclipsed by the ghastly earnings guidance Cardinal simultaneously released. Hopefully, management were outfitted with full-contact football attire.

Steve's Take: @CardinalHealth @Medtronic deal eclipsed by ghastly earnings guidance Click To Tweet

Leerink’s David Larsen and Matt Dellelo argue that a “great” deal couldn’t offset the dreary guidance:

“This morning CAH lowered FY17 expectations saying EPS is now expected to be at the low end of the guided range and the company announced an acquisition of Medtronic’s Patient Care, Deep Vein Thrombosis and Nutritional Insufficiency businesses for $6.1B. Management also gave preliminary FY18 and FY19 guidance, where EPS is expected to be flat to down mid-single digits and up high single digits, respectively, both of which are below Street expectations. While the deal looks strategically and financially sensible, it is likely not enough to offset the ongoing generic deflation headwinds in Pharmaceutical.”

Putting the surprise development into succinct context as only he can, Max Nisen of Bloomberg says, “This is not a new problem.” Pharmaceutical companies have tempered their price increases somewhat recently in response to growing political pressure in Washington, including criticisms from President Donald Trump.

But Cardinal CEO George S. Barrett said the generic pricing pressure it is experiencing is related mainly to the prices it charges its pharmacy customers, rather than unexpected price cuts by drug manufacturers.

Cardinal is still able to “work with our [drug] manufacturing partners to make sure that we’re having…an excellent cost position,” Barrett said on a conference call with analysts. The pricing pressures are on the “sell-side downstream to the customers. It’s still a little bit more than what we modeled.”

Generic drugmakers such as Teva Pharmaceutical Industries Ltd., specialty/generic hybrids including Mylan NV and Endo International PLC, and drug distributors such as Cardinal all suffered through a 2016 marked by price warnings and disappointing results, Nisen reminds.

Contributing to the problem are pharmacies and insurers looking for lower prices, along with a relative dearth of pricey drugs going generic. And drugmakers are more reluctant than ever to take price increases on older drugs, which is hurting both wholesalers and manufacturers. Drug pricing pressure made for a dismal 2016 for generic drugmakers and distributors.

Cardinal expects generic drug-price deflation for its 2017 fiscal year, which ends in July, to be in the low double digits. This marks a worse outlook than the company gave on its Feb 2 earnings call. Then, Cardinal said it saw signs of pricing improvement. Whoops.

The Ohio-based company expects mid-single-digit generic deflation in 2018. But that’s off an already eroded base, and the company’s recent guidance failures don’t produce much confidence. Some of the issues may be Cardinal-specific, but this trend has been widespread enough to be infectious.

But long-term investors shouldn’t lose sight of the fact that the low end of the earnings range provided in management’s guidance for the current year is still ahead of performance achieved in fiscal year 2016 (non-GAAP EPS of $5.24), and well ahead of that achieved in fiscal year 2015 (non-GAAP EPS of $4.38). Despite pressure from generic drug prices, Cardinal most likely will continue to grow and is positioned for vigorous long-term performance.

Management highlighted three factors affecting its approach to crafting guidance for fiscal year 2018, according to Motley Fool.

First, the medical segment will immediately feel the impact from the Medtronic portfolio acquisition. It included the patient care, deep vein thrombosis, and nutritional insufficiency products and businesses. If the deal closes in the first quarter, Cardinal should realize a non-GAAP EPS lift of $0.21. That includes $100 million in inventory expenses following the acquisition, which suggests that the new product offerings will prove even more beneficial down the road.

Second, Cardinal expects company-specific discrete items will have a negative impact on non-GAAP EPS of $0.50 in fiscal year 2018. Half of that is expected to come from the pharmaceutical segment, which demonstrates that pricing headwinds will persist at least another year.

Third, management expects drug pricing headwinds to become less fierce over time. When combined with the company-specific items mentioned above, the pharmaceutical segment could see profits fall next year compared to fiscal year 2017.

And finally, Cardinal expects fiscal 2019 non-GAAP EPS to grow by at least high-single-digits compared to fiscal 2018. Per usual, however, investors are more concerned about the near-term developments.

Bottom Line:

Cardinal’s fall from grace was influenced by two things: The expectation for current-year earnings to come in at the low end of guidance, and the expectation that the pharmaceutical segment will continue to ward off headwinds from generic drug pricing for at least another year.

That’s what makes the product portfolio acquisition from Medtronic intriguing for long-term investors, Fool asserts. It will have an immediate beneficial impact and help to diversify the company’s business for the long haul.

At the moment, however, investors aren’t content to bide their time waiting for a potentially mitigating, possibly positive update during next month’s earnings announcement.

Here’s a brief summary of Wall Street’s responses to the Cardinal news, courtesy of Bloomberg:

Mizuho (Ann Hynes)

Weaker forecast raises concerns for drug distributors; expects generic deflation also will be headwind for McKesson and AmerisourceBergen heading into their earnings.

CAH sees FY18 EPS growth flat to down mid-single digits, implying range of $5.03-$5.35; at the midpoint, that’s 12% below average analyst estimates and includes 21c of gains from purchase of MDT businesses.

Says CAH-MDT deal was largely expected.

Rates CAH neutral, Price Target (PT) $79


Baird (Eric Coldwell)

CAH trimmed FY17 forecast for third consecutive quarter as generic deflation now seen down low-double digits vs. previously down high-single digits.

Initial FY18 outlook is ~18% below Street on apples-to-apples basis excluding gains from purchase of Medtronic businesses.

Rates CAH neutral, PT $80


Evercore ISI (Ross Muken)

Initial FY18 outlook is major surprise; says it’s a shame that solid MDT deal is being completely overshadowed by guidance.

Modestly more confident about CAH conf. call; appears that majority of revisions in generic deflation expectations is due to handful of highly profitable products.

While slope of decline doesn’t seem to have gotten worse, recovery will probably take much longer than projected when CAH was upgraded to outperform on April 6.

Rates outperform, cuts PT to $77.50 from $91.50


Cowen (Charles Rhyee)

Near-term challenges to pharma segment remain as fewer branded drugs go generic.

CAH’s outlook for FY18 generic deflation to improve y/y suggests macro environment is starting to stabilize but will take longer than expected.

Rates market perform, PT $89


Prior to the haircut dealt to its share price this week, Cardinal was up 14% year-to-date vs. the S&P 500 Health Care Index–up just 7.6%.

If there ever was a buy the dip equity, this is perhaps it. By its earnings announcement next month, it will probably be too late.

Steve Walker has no position in any stocks mentioned. MedContent Inc. has no position in any stocks mentioned. has a disclosure policy.

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