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Competition Hits McKesson's Bottom Line, but the Future Looks a Bit Brighter

By Dan Caplinger - Jul 27, 2017 at 10:16AM

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The drug wholesaler boosted its full-year earnings guidance and continues to fight hard industry conditions.

The pharmaceutical industry has been under political attack since before the 2016 elections, as lawmakers want to rein in the amount that drug companies charge for key prescription drugs. Drug distribution companies like McKesson (MCK 0.22%) have gotten caught in the middle, and the result has been increased pressure to reduce margins in favor of more affordable drugs for the general public. The threat of competition from e-commerce in drug distribution has also reared its ugly head, posing strategic challenges for McKesson and its peers.

Coming into Thursday's fiscal first-quarter financial report, McKesson investors were prepared for another hit to adjusted earnings, and they got an even bigger decline than they had expected. The company nevertheless boosted its guidance slightly for the full year, anticipating that it will be able to navigate the turbulent political waters and find a long-term solution to its competitive challenges. Let's take a closer look at McKesson and what it said about its latest quarter.

McKesson Ventures logo.

Image source: McKesson.

McKesson looks a little ill

McKesson's fiscal first-quarter results didn't live up to everything those following the stock had wanted to see. The drug distributor posted sales gains of almost 3% to $51.1 billion, which was only a bit below the consensus forecast among investors. Net income plunged by more than two-fifths to $309 million, however, and even after accounting for various extraordinary items, adjusted earnings of $2.46 per share badly missed forecasts for $2.83 per share on the bottom line.

Looking more closely at the report, McKesson once again saw healthier performance from its core distribution solutions division, where sales climbed 4%. The company saw better performance from its North American pharmaceutical distribution and services division, where growth in the addressable market and acquisitions helped pull revenue up by 4%. Current impacts hit the international pharmaceutical distribution and services business, limiting what would have been 6% sales growth in local currency terms to a 1% rise when measured in U.S. dollars. The medical-surgical distribution and services business matched the segment's overall performance, as revenue rose 4%.

McKesson continued the shift of its tiny technology solutions segment toward its Change Healthcare joint venture. Sales dropped more than 80%, as the assets contributed to the joint venture fell out of the segment's results. Only the remaining enterprise information solutions business has stayed on McKesson's direct books. The Change Healthcare investment produced a $120 million GAAP loss, but adjusted income weighed in at a profit of $70 million, and that helped produce an adjusted operating profit of $87 million for the technology solutions segment.

CEO John Hammergren put the report in context. "McKesson's first-quarter operating results were consistent with our expectations," Hammergren said, and "we're off to a solid start to the year." The CEO was pleased with the strength of the company's cash flows during the first quarter, allowing it to make good on its plans for capital deployment in the future.

Can McKesson bounce back?

McKesson also pushed its guidance higher for the 2018 fiscal year. A new call for adjusted earnings of $11.80 to $12.50 per share was $0.05 higher than the previous range announced last quarter. That's still below what the company brought in during fiscal 2017, but it's consistent with what most of those following the stock have looked for from McKesson.

The key question going forward remains whether McKesson can overcome any pressure from Washington to make moves that would result in slimmer margins. Politicians have generally demonstrated a lack of understanding about how the pharmaceutical industry's supply chain works, with drug developers often pricing drugs to produce large profits but leaving little room for distributors like McKesson to make further markups. McKesson will therefore be unlikely to make proactive moves, hoping that any negative impact from legislation will fall on drug-makers instead. If the reality turns out to be different, then it could be problematic for the distributor going forward.

McKesson investors didn't respond all that dramatically to the earnings news, and the stock posted gains of less than 1% shortly in pre-market trading following the announcement. Long-term investors will need to keep looking at how the company adapts to changing industry conditions while keeping potential competitors at bay. As long as it can stay one step ahead of its rivals, McKesson should be in a good position to see earnings growth return in time.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends McKesson. The Motley Fool has a disclosure policy.

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