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What Happened With McKesson?

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McKesson (NYSE: MCK  ) announced its results for the most recent quarter on Thursday. After beating analyst estimates for several consecutive quarters, the health care services giant announced earnings that fell far short of expectations. Shares were down 2% in after-hours trading after first dropping nearly 9%.

What happened?
McKesson reported quarterly revenue of $31.2 billion, up around 1% year-over-year. GAAP earnings came in at $1.24 per share, an increase of 3% over the same quarter in 2011. Excluding special items, earnings were $1.41 per share. The average analyst estimate was $1.63 per share.

How did McKesson miss so badly? It wasn't because of revenue woes. The company did report only flat revenue for its Technology Solutions business due partially to "revenue deferral for [its] international business." However, the segment only accounts for 3% of total revenue. Regardless, analysts were only expecting revenue of $30.8 billion for the quarter. McKesson easily beat that target.

A look at expenses, including cost of sales, tells the tale of the McKesson miss. If a company's revenue goes up by 1% but its expenses go up by 13%, earnings are headed down. That's what happened with McKesson. So where did all of that extra spending go?

McKesson attributed the increase in expenses in large part to a $40 million charge related to potential legal claims in Canada, which accounted for 4% of the 13% expense increase. Acquisition costs made up another 3%. Higher corporate expenses were also up $27 million, adding another 3% to operating expenses. The company noted that it tends to see considerable variability in corporate expenses from quarter to quarter.

On a positive note
Beating revenue estimates for the most recent quarter could bode well for next quarter, especially considering that some of the revenue anticipated for the quarter should actually be received in the current quarter. The company also has some major trends going in its favor, particularly with increased generic utilization.

McKesson tightened its full-year adjusted earnings guidance for fiscal year 2013 from $7.05 to $7.35 per share to $7.10 to $7.30 per share. That's in line with analyst expectations of $7.30 per share.

The company also announced the approval of another $500 million share buyback. That comes on top of $360 million worth of shares bought back in the last quarter.

With a forward price-to-earnings ratio less than 13, McKesson still looks to be a decent buy at current prices. My hunch is that the current setback will only be a temporary one. Controlling costs more effectively is a much easier proposition than addressing sales shortfalls. McKesson's problems should be quite solvable.

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9/30/2016 4:03 PM
MCK $166.75 Up +2.33 +1.42%
McKesson CAPS Rating: *****