Count yourself lucky if you were a McKesson Corporation (NYSE: MCK) investor this year. While most of the stocks have fallen steeply, McKesson has grown more than 10%, increasing from $139 to $153 (as of July 20, 2020). Why? One simple reason. McKesson distributes pharmaceuticals, medical and surgical supplies, and healthcare IT products. Covid-19 has ensured that as other non-emergency treatments take a back seat, there is enough new business to support McKesson’s growth. But is this all? There is more to this story. While McKesson Corporation’s stock has grown nearly 38% since 2018, there is a lot more upside potential left. Trefis’ price for McKesson Corporation is $245, about 60% above the market price of $153 (as of Jul 20, 2020). Below are the key triggers that could give momentum to McKesson’s stock.
Here Is What Could Trigger Further Upside
The first trigger is McKesson’s revenues. We forecast the company’s fiscal 2021 (ending Mar 2021) sales at $230 billion, which is roughly the same compared to the last year. This is significantly better compared to other industries which are expected to face a steep decline. In particular, hospitality, leisure, retail, and airlines may be looking at 20%-40% drop in revenue for the full year. Technology infrastructure companies could be looking at a 5%-10% decline. Media and internet companies have seen ad revenues drop. This could shift investor interest to stocks that are benefiting in the current situation. What’s more? We expect the revenue to jump sharply in fiscal 2022 (ending Mar 2022) to $252 billion. So what’s at play here? While Covid-19 will help sustain the volumes, McKesson will also benefit from price increases, especially as the drug supply chain comes under pressure. The company has been growing its revenue steadily in the last few years.
The second trigger is margins. Distributors such as McKesson Corporation operate on very thin margins but a large revenue base. Therefore, a slight increase in margin can have a significant impact on profits. McKesson’s operating margin increases were around 0.4% in FY 2018 and FY 2019, and jumped to 1.1% in FY 2020. This margin expansion is likely to continue as the profit spread on generics are improving. In addition, McKesson will benefit from improving revenue mix, barring the temporary impact of Covid-19.
The third trigger is expected acceleration in the settlement of litigation over opioid drugs, which has been plaguing the industry for sometime and is expected to result in significant costs.
So What Does This Mean For Share Price?
The combination of the above will imply 2020 EPS of $4.55 per share. How much should the market pay for each dollar of McKesson’s earnings? As a reference, to earn close to $4.55 per year from a bank, you’d have to deposit about $400 in a savings account today, so about 90x the desired earnings. But McKesson is a riskier business. Investors need to consider competitive risks, regulatory changes that can impact drug prices, litigations which are common in the pharmaceutical industry, as well as branded drugs going off-patent resulting in impact to average prices. And what does this mean? Each potential dollar of McKesson earnings is worth less to you. Thus the earnings multiple (P/E), which was 90x for a bank, must be significantly lower for McKesson. The question is – how much lower? To answer this we look at historic, current trailing, and forward looking P/E for McKesson. Based on this, we apply a P/E multiple of around 54 for McKesson. This figure has increased in the last two years, which is testament to the bet investors are putting on its growth.
To sum it up, McKesson is one of those companies that might actually end up benefiting from Covid in the medium term, with minimal negative impact in 2020. This can result in a meaningful EPS jump which may not be priced in the market right now, making it a stock worth considering.
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