Cardinal Health (NYSE:CAH) is a longstanding member of my “Healthy Dividends” portfolio thanks to the company’s market leadership, diversified portfolio, and stable revenue streams, supported by economies of scale and growth opportunities. In addition, the company has a long track record of financial performance and respectable dividend payments that have allowed that position to marinate over the years. For me, I have never doubted Cardinal’s growth outlook due to their ability to negotiate favorable terms with manufacturers, while also passing the costs onto the customers if need be. This has allowed Cardinal to become a juggernaut in the healthcare sector, and the ticker’s performance reflects that, with CAH climbing over 125% over the past five years. Although I am bullish on Cardinal’s long-term prospects, the ticker can be argued to be overvalued based on its high price-to-earnings GAAP ratio of 46.54, significantly above the sector median of 32.05, and its elevated PEG GAAP (TTM) ratio of 1.71 compared to the sector median of 0.99. Additionally, the company's negative growth in free cash flow and operating cash flow do raise concerns. However, I believe Cardinal has plenty of growth drivers to justify its current valuation despite the risks in the market.

I intend to go over Cardinal's recent performance and will discuss the ticker’s current valuation. Then, I will discuss some of the company’s growth initiatives and opportunities. In addition, I discuss some risks that investors should consider when managing their position. Finally, I reveal my game plan for CAH as we move deeper into the second half of 2024.

Cardinal Health’s Recent Performance

Cardinal Health continues to flex its position as a global leader in healthcare solutions with solid fiscal year Q3 earnings that generated a beat on EPS and a slight miss on revenue. Despite slow growth from GLP-1 drugs, Cardinal’s Pharmaceutical and Specialty Solutions segment saw a 9% increase in revenue to $50.7B, and a 4% increase in profit to $580M. The Global Medical Products Distribution segment revealed 4% revenue growth to hit $3.1B, marking its second consecutive quarter of growth. Altogether, Cardinal pulled in $54.9B for the quarter, which was up 8.7% year-over-year. Digging a bit deeper, the company’s GAAP earnings came in at $367M, while their Non-GAAP popped 10% to hit $666M. In terms of cash position, Cardinal Health ended fiscal Q3 with $3.7B in cash and equivalents.

Valuation Discussion

Cardinal Health appears overvalued based on its valuation, growth, and profitability metrics. Notably, Cardinal’s price-to-earnings ratio is ~46.54, which is a 45.22% premium to the sector’s 32.05. Into to bargain, their PEG GAAP ratio of 1.71, a whopping 72.61% higher than the sector’s median. Even the forward price-to-earnings ratio of 26.86, is slightly above the sector’s median.

Interestingly, CAH does have valuation metrics under the sector’s averages, but those numbers are noticeably higher than CAH's five-year averages. These metrics include:

• Non-GAAP Price-to-Earnings
• GAAP Price-to-Earnings
• EV-to-Sales
• EV-to-EBITDA
• Price-to-Cash Flow

Again, all of these are lower than the sector’s average but higher than the ticker’s averages. These correlations tell me that CAH is not overvalued compared to most of its peers, but it is trading at a richer valuation than the ticker is used to.

Cardinal’s growth metrics reveal a mixed bag. CAH's year-over-year revenue growth is above the sector's average, but their forward revenue growth is projected to be only 5.01%, which is below the sector's average. EBITDA and EBIT growth rates are respectable, but they are also projected to slow down. Furthermore, Cardinal's free cash flow and operating cash flow growth, are also expected to slow in the coming years.

Taking a look at Cardinal’s profitability metrics, we can see the company is struggling with a gross profit margin of 3.35%, far below the sector’s average of 57.00%. Similarly, EBIT and EBITDA margins are substantially lower than the sector’s median. Admittedly, other healthcare distributors have similar marks in terms of profitability. However, that doesn’t negate the fact that Cardinal is not posting imposing margins that can rationalize an exceptional valuation.

Using some of my favorite valuation models, we get a variegated outlook for CAH. The DCF model suggests a substantial upside, while the Peter Lynch Fair Value and Dividend Discount Model proposes the ticker is trading at a hefty premium.

Using the valuation methods above, we can synthesize Cardinal Health's intrinsic value by averaging the results.

• DCF (Growth Exit 5Y): $1,449.53
• Peter Lynch Fair Value: $24.05
• P/E Multiples: $109.65
• EV/EBITDA Multiples: $119.24
• Earnings Power Value: $141.98
• Dividend Discount Model (Stable): $54.74

Averaging these gives us an intrinsic value of $316.53, however, the DCF really skews the average to the upside. If you remove the DCF, you get a much more reasonable fair value of about $90 per share. Typically, I like using Peter Lynch’s Fair Value for companies like Cardinal, who have steady earnings but are also reporting strong growth. Unfortunately, that would mean that CAH should be trading at around $24 per share.

What Is My Point?

Cardinal has slowing growth, lower profit margins, and mixed intrinsic value appraisals, So, I think there is a valid argument to say that CAH is a bit expensive for some key valuation metrics and that bolsters the overvaluation case.

That being said, I don’t believe there should be a definitive judgment on CAH at this time. The Street expects Cardinal to maintain its growth record for the next four years for both EPS and revenue.

Admittedly, the growth rates are not expected to be “explosive”, but 5%-10% increases in revenue for a company the size of Cardinal Health means billions of dollars in additional revenue each year. Therefore, Cardinal Health has yet to max it out its growth potential despite being a stalwart name in the healthcare sector since 1979.

Growth Drivers

Cardinal Health's growth strategy is powered by key drivers within its core and emerging business segments. Central to this strategy is the Pharmaceutical Solutions and Services (PS&S) segment, which continues to show growth prospects. Additionally, Cardinal Health's aggressive expansion in specialty pharmaceuticals and the biosimilars market, along with strategic moves in emerging segments should supply sustained growth in the coming years.

Cardinal Health's Pharmaceutical Solutions and Services (PS&S) segment has been the cornerstone of the business but should continue to deliver growth. The company has highlighted strong performances across brand, generic, and specialty pharmaceuticals. The segment's operational efficiencies are expected to drive EPS growth and at least 1% profit growth, which will help them maintain market leadership in pharmaceutical distribution.

Another big driver for Cardinal Health is specialty pharmaceuticals. The company has expanded their footprint in the recent acquisition of Specialty Networks to help make inroads into urology, rheumatology, and gastroenterology. Moreover, Cardinal Health is diving into the biosimilar market with their partnership with CVS through Red Oak.

Cardinal Health is also diversifying into emerging healthcare segments, which reported a notable 14% revenue increase to $1.2B last quarter, with profits growing by 5%. This segment has some interesting growth opportunities in At-Home Solutions, Nuclear, Precision Health Solutions, and OptiFreight Logistics. These initiatives will allow Cardinal Health to be at the forefront of personalized healthcare and take advantage of the industry trends toward decentralized care models while also improving convenience, efficiency, and patient satisfaction.

Cardinal Health continues to invest in enhancing operational efficiency with their InteLogix Platform and their acquisition of Specialty Networks. The InteLogix Platform should help drive revenue growth by offering customers a value proposition from cost-saving features. Meanwhile, the Specialty Networks acquisition is expected to serve over 11.5K providers with data-driven insights. These efforts position Cardinal Health at the forefront of their industry, thus, allowing them to preserve their current customers and acquire more, ensuring revenue growth and market expansion.

Risks To Growth

Despite my bullish outlook, I must point out that Cardinal Health faces several risks that could impact CAH’s performance besides some of the overvaluation metrics.

First, Cardinal is heavily reliant on their Pharmaceutical and Specialty Solutions segment, which poses a concentration risk. Any setback or drop in performance in this segment could have significant impact on the company’s performance. Notably, drug pricing and reimbursement fluctuations, could become a big concern by impacting profitability. While Cardinal does have the ability to negotiate better terms with manufacturers or pass costs onto customers, it is not guaranteed.

Another concern is the healthcare’s regulatory atmosphere with potential alterations in regulations, compliance, or government policies that could sabotage Cardinal’s business. Moreover, there is always the lurking issue of supply chain disruptions that could derail Cardinal’s ability to deliver products and services.

Last but not least… competition. Cardinal Health has intense competition from McKesson Corporation (MCK), Henry Schein (HSIC) Cencora (Formerly AmerisourceBergen Corporation) (COR), and Express Scripts from Cigna (CI). These companies are competing to become the leaders in pharmaceutical distributors and/or pharmacy benefit managers. Consequently, Cardinal is forced to continually innovate and improve efficiency just to maintain their position against their competition.

Again, I will point out that Cardinal continues to diversify, invest in technology, and pursue M&A, which can provide new growth and strengthen the company's position. So, I am not overly concerned about these risks. However, investors need to remain vigilant.

My Plan

Overall, I remain optimistic about Cardinal’s growth prospects due to their ability to dictate their industry and execute strategic initiatives to broaden their reach into nearly every aspect of healthcare. Cardinal has a long history of being proactive in addressing the challenges of their markets and navigating the industry’s dynamic forces. So, I am confident that Cardinal will continue to grow into its market valuation and deliver shareholder value with respectable dividends and share repurchases. As a result, I am upgrading my Buy and Sell Levels for CAH.

I have elevated my CAH Buy Threshold from under $50 to $90 per share, which is the maximum share price I am willing to buy. I have also moved my Buy Target 1 to $74.43 per share and Buy Target 2 to $50 per share. In addition, I have moved my Sell Target 1 to $143, with Sell Target 2 and Sell Target 3 being $168 and $300, respectively. I will use these Buy and Sell Targets are levels where I am looking to manage my position by adding or selling to my CAH position.

At the moment, CAH is trading above my Buy Threshold of $90 per share and below my Sell Target 1 of $143 per share, so I am not looking to make a move at this time. However, I will set some alerts at these levels in order to keep a pulse on the ticker.

Long term, CAH will be a mainstay ticker in the Compounding Healthcare “Healthy Dividends” portfolio.