McKesson Dives on Falling Earnings, Weak Guidance

By Markets Fool.com

One of the most contentious business issues in the 2016 presidential election campaign is the question of whether pharmaceuticals are too expensive. Political rhetoric has spread into the wholesale pharmaceutical business, and McKesson (NYSE: MCK) has to be concerned that increased regulation could eat into its profitability in the long run.

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Coming into Thursday's fiscal second-quarter financial report, McKesson investors were prepared for some earnings contraction, but they wanted to see solid sales gains and evidence that any future problems would be limited. Instead, McKesson posted worse results than expected, and warned that future guidance could also be at risk. Let's look more closely at what McKesson said and whether it can bounce back from its setback.


Image source: McKesson.

McKesson gives investors some pain

McKesson's fiscal second-quarter results weren't pretty. Revenue for the quarter rose just 2%, to $50.0 billion, which was far short of the $51.2 billion that investors were expecting to see. GAAP net income got cut in half due largely to a goodwill impairment charge, but even after accounting for that one-time item, adjusted earnings of $2.94 per share missed the consensus forecast among those following the stock, by $0.11.

Once again, the major businesses within McKesson moved in different directions. The distribution solutions segment saw sales rise 3%, with international pharmaceutical distribution and services taking the lead over its domestic counterpart with growth of 7% and 2%, respectively.Medical-surgical distribution and services saw its top line rise 4%.

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Overall, a combination of organic growth and acquisitions helped McKesson's segment revenue grow. However, adjusted operating profit for the segment was down 19%, to $930 million.

At the same time, the technology solutions segment performed worse. Revenue was down 6%, due, once again, to the expected decline in its hospital software business. The company posted an operating loss due to the goodwill impairment charge, although McKesson said that, after adjusting for that figure, operating profit would have been $141 million.

What's coming down the road at McKesson?

The problem that McKesson faces is that its future looks even more uncertain. As CEO John Hammergren noted, the company has an "expectation of a lower profit contribution resulting from recent customer pricing activities and lower operating profit as a result of further moderating branded pharmaceutical pricing trends compared to previous expectations." Moreover, the CEO said that, even though McKesson is trying to think long term, that doesn't change the fact that it needs to make adjustments to its near-term outlook.

In particular, McKesson cut its earnings outlook for the full 2017 fiscal year by more than $1 per share, with a new guidance range of between $12.35 and $12.85 per share. The reduction accounts for the goodwill impairment charge, as well as the implementation of McKesson's cost alignment plan. The problem, though, is that investors were already looking for the company to post earnings somewhere within its old guidance range, and so the new hit came as a shock to the system.

Of even greater concern is the fact that the reduced guidance can't take into account the potential uncertainty in the industry right now. Depending on the results of the presidential election, it's entirely possible that McKesson and its peers will be facing a whole new slate of regulations in the near future. If that happens, then McKesson might have trouble even making reduced targets for top- and bottom-line growth.

McKesson investors were stunned by the company's performance, sending the stock down more than 12% in after-hours trading following the announcement. Until the outlook for the pharmaceutical industry starts to get a little bit clearer, it's going to be extremely difficult for McKesson to figure out how best to navigate the choppy waters in the sector, and find a way to keep making as much money as its investors expect going forward.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends 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.