McKesson Corporation Posts Solid Q1 With Drug Distribution Gains

By Markets Fool.com

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It's been an up-and-down year so far for McKesson Corporation (NYSE: MCK). Shares of the giant pharmaceutical distributor plunged over 23% by early February, only to rebound strongly in the following months. McKesson's stock price is now at roughly where it started 2016.

Investors' attention was focused on the company's fiscal 2017 first-quarter results, announced after the market closed on Wednesday. Were McKesson's numbers good enough to keep the rebound going? Here are the highlights.

McKesson results: The raw numbers

Metric

Q1 2017 Actuals

Q1 2016 Actuals

Growth (YOY)

Sales

$49.7 billion

$47.5 billion

4.6%

Net income

$542 million

$576 million

(5.9%)

Earnings per diluted share from continuing operations

$2.88

$2.50

15.2%

Data source: McKesson.

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What happened with McKesson this quarter

International pharmaceutical distribution and services emerged as the star performer for McKesson in the first quarter. Revenue for the business segment jumped 8% compared to the prior-year period to $6.3 billion. The picture looked even better on a constant currency basis, with a year-over-year increase of 9%.

As usual, the lion's share of McKesson's revenue stemmed from its North American pharmaceutical distribution and services business. This segment posted first-quarter revenue totaling $41 billion, up 5% year over year on a constant currency basis.

Medical-surgical distribution and services revenue increased 2% from the prior-year period to $1.5 billion. That growth rate isn't as sluggish as it might seem at first glance. McKesson sold its ZEE Medical business unit in the second quarter of fiscal 2016, a move that skews prior-year comparisons.

The only area where McKesson didn't report growth was with its technology solutions business segment. Technology solutions revenue fell to $724 million, down 2% from the same quarter in the previous fiscal year. Why did revenue decline? Two factors made the biggest difference: slowing hospital software sales and the sale of McKesson's nurse triage business in the first quarter of fiscal 2016.

McKesson's drop in net income stemmed primarily from a loss from discontinued operations. Earnings from continuing operations increased. The company's adjusted earnings per diluted share of $3.53 reflected an 18% year-over-year constant-currency increase.

What management had to say

John H. Hammergren, McKesson's chairman and chief executive officer, liked what he saw from the fiscal first quarter:

McKesson's first-quarter operating results represent a solid start to the fiscal year, consistent with our expectations.We operate businesses that continue to produce strong cash flow results.Our management team is focused on driving long-term value for our shareholders. We were pleased to have successfully closed several acquisitions during the quarter, further extending our strong track record of value creation through our portfolio approach to capital deployment.

Looking forward

McKesson expects GAAP earnings per diluted share for fiscal year 2017, which ends on March 31, 2017, to be between$10.70 and $11.60. The company expects adjusted non-GAAP earnings per diluted share for fiscal 2017 of$13.43 to $13.93.

What will it take for McKesson to hit these numbers? A big key will be how well its technology-solutions business performs. While the segment accounts for less than 1.5% of total revenue, technology solutions drives over 13% of gross profit.

McKesson recently announced a partnership withChange Healthcare to launch a new company combining the technology solutions from both partners. This could be a smart move for McKesson, but a new venture like this does introduce a level of risk.

Drug wholesaling, though, remains much more important to McKesson's future. The company faces some significant challenges from customer consolidation. In particular, the acquisition of Rite Aid by Walgreens Boots Alliance will hurt. McKesson currently counts Rite Aid as a customer, but that business will probably go away, since Walgreens has a distribution deal with a major rival for McKesson.

Customer consolidation cuts both ways, though. CVS Health is McKesson's largest customer and makes up over 20% of total revenue. CVS has completed several acquisition deals of its own, some of which have ended up helping McKesson.

Even this "good" kind of customer consolidation could present challenges to McKesson over the long run, however. The more important CVS Health becomes to the pharmaceutical distributor, the more likely McKesson is to be forced to give up price concessions when contract renewal time comes around.

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Keith Speights has no position in any stocks mentioned. The Motley Fool recommends CVS Health and McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.