McKesson’s Prognosis Looking Even Better

“McKesson out, the Street was looking out for this. Revenues in line and the CEO called the quarter a strong quarter, and the stock opened up strong so that’s great news for McKesson there.” Fox Business Network 7/29/2009

Pharmaceutical wholesaler McKesson Corp. (NYSE:MCK) reported fiscal first quarter 2010 results that easily surpassed Wall Street expectations for $.86 EPS. The company reported revenue of $26.7 billion that was flat from a year ago, and in line with estimates, but strict const management allowed the company to report EPS of $1.06 or 23% better than consensus estimates. The company also said that it expects the operating conditions present in the first quarter should remain intact for the rest of the year. This prompted McKesson management to raise guidance for the full year to $4.15 to $4.30 from its prior view of $3.90 to $4.05. The first quarter’s results and the upbeat 6% lift to full year guidance has pushed the stock higher in morning trading by about 10%.

McKesson saw improved performance in both the Distribution and Technology divisions. The overwhelming majority of McKesson’s revenue comes from the distributions side of the business, and that business benefited from stronger sales of generic drugs which carry higher profit margins for McKesson than branded medicine sales. The company also saw an up-tick in sales of medicines related to the swine flu virus scare. However, sales were not better than last year because of the loss of few key U.S. customers, but both the company and analysts are still expecting moderate or low single digit sales growth for the full year.

The report highlighted strong cash flow and the importance of cost management in this environment. At Ockham, we have viewed this stock positively since just before it made its 52-week low last November, since that point the stock has appreciated about two thirds. Based on our methodology even after the significant run up in MCK, we still have it as Undervalued compared to historical norms. For example, McKesson has normally traded between 16.7x and 26.2x multiple of cash earnings, but that figure is closer to 11x currently. McKesson may still have further to run before we consider it fairly valued, which would be in the mid-$60’s based on our analysis. This successful first quarter does nothing to dissuade us from our Undervalued stance. The boost to guidance is also an encouraging sign as management is optimistic for business prospects going forward, which is something we always prefer to observe over a defense or cautious tone.

McKesson’s Prognosis Looking Even Better

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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