Activist investor Elliott Management may only have allotted 2.3% of its portfolio to Cardinal Health (NYSE:CAH) but with $13.9 billion in assets under management that still amounts to a large investment.
What is it about this healthcare firm that the investment team at Elliott have spotted to give them so much conviction as to take a position worth over $310 million?
Cardinal Health Holds Aces Up Its Sleeve
You get to see what a company is made of when tough times arrive and nowhere was that more evident than during the health crisis of 2020-21 when Cardinal Health swiftly adapted to unprecedented demand for medical supplies and pharmaceuticals. Its flexibility highlighted the firm’s adaptability under stress to maintain an efficient supply chain.
Underpinning it are predictive analytics and real-time tracking systems as well as a diversified supplier network that ensures supplier-specific issues and risks are mitigated. The lessons executives learned during this turbulent period have translated to further strengthening of its supply chain through better demand forecasting.
Cardinal has also expanded its partnerships, including alliances with hospitals and health systems that enhance the company’s ability to offer integrated services from pharmaceutical distribution to medical products. Better cost-effectiveness and operational efficiency are two consequential benefits.
It’s also established partnerships in the online space, like those with technology firms, to develop digital health solutions that can drive future growth in areas spanning from telemedicine to personalized healthcare.
With its extensive collaborations, Cardinal Health enjoys more bargaining power in negotiations with manufacturers and other suppliers. It can also expand its reach into new markets and segments, fostering growth and diversification beyond its traditional business lines.
One ace up its sleeve that’s not easily spotted by ordinary investors is its private label products that offer higher margins compared to branded products, yet ultimately boost profitability.
Private label products also let the healthcare firm build brand loyalty and recognition and differentiate itself in a crowded marketplace. They also provide insights and so enable Cardinal to respond more quickly to market trends and consumer preferences resulting in an agility to capitalize on new opportunities and pharmaceutical products. They also strengthen its market position and appeal in a cost-conscious healthcare market.
Why Did Elliott Management Buy Cardinal Health Stock?
Most likely, Elliott Management bought Cardinal Health stock because it is 33.8% undervalued according to a discounted cash flow analysis.
Another strong signal that the share price is undervalued is management’s share buyback. It’s not just a small repurchase scheme either but a $3.5 billion one.
Where concerns do arise on the valuation front are in the multiples, and specifically the price-to-earnings ratio that is 167x.
In some respects, it’s quite hard to figure out what Cardinal Health is worth because the PE ratio is sky high while the price-to-sales ratio is very low at just 0.1x. Another way of saying that is the company generates $210 billion in revenue and trades at a market capitalization of just $26 billion.
On $54.7 billion of revenues last quarter it posted just $507 million of earnings before interest and tax. The comparably small profits relative to earnings is why Cardinal Health has such a high earnings multiple yet the valuation relative to revenues is low, and it’s explained by the low gross profit margin of just 3.2%.
More To Cardinal Health Than Upside Potential
Valuation isn’t the only reason to like the stock because it also offers a modest dividend of 1.89% and has raised that yield for 36 consecutive years.
It’s also got a solid balance sheet with $3.8 billion of cash and, somewhat remarkably, an almost identical amount of long-term debt.
One key metric that is likely standing out to Elliott is the cash flows figure. Levered FCF was $2.8 billion over the past twelve month period. That’s up from $1.1 billion when comparing over a similar time frame from just a couple of years ago in Q4 2021.
Another bright light on the horizon is the revenue forecast, which according to analysts, is due to rise from $226 billion in FY 2024 to $301 billion by FY 2028.
Why Buy Cardinal Health?
While Cardinal Health has a robust supply chain, it’s also pioneering to further improve it through the integration of artificial intelligence and machine learning with a view to better forecasting demand, managing inventory and optimizing logistics. The result of these technologies is ultimately to provide a more responsive and personalized customer experience.
Customization extends to the product portfolio too where Cardinal Health tailors procedure packs to specific surgeries in order to enhance efficiency for healthcare providers. Indeed the firm’s diversity of medical products ensures it has a broad revenue mix and is a key player in public health initiatives. The breadth of its product mix also means cross-selling opportunities can be leveraged to increase sales per customer and penetrate markets more deeply.
Beyond the domestic opportunities Cardinal has captured, it is also expanding into emerging markets that offer significant growth opportunities due to high demand for healthcare products.
When you put all the ingredients into the mix you end up with a compelling investment opportunities, one which Elliott Management was clearly willing to back with over $300 million of capital.
Over the past year that bet has been a winner with CAH share price rising by 38.4% versus 19.8% for the S&P 500. That level of outperformance is a strong signal that management is executing well, and the revenue and earnings trend on the income statement would suggest it will continue for some time.
So, combining the valuation argument with the dividend and upward trend in financials, the odds are Elliott will continue to reap the rewards from its stake in Cardinal Health for some time.
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