In the first quarter since issuing an impressive array of long-term financial goals, did drug wholesaler and distributor Cardinal Health (NYSE:CAH) start delivering on its lofty aspirations? Judging by fourth-quarter and full-year results released today, it did, but one year does not make a trend, especially considering that the company's business model was turned upside-down not that long ago.
The drug-distribution industry, which includes peers such as McKesson (NYSE:MCK) and AmerisourceBergen (NYSE:ABC), has been undergoing some pretty significant changes. Companies used to earn profits by purchasing excess inventory from drug manufacturers such as GlaxoSmithKline (NYSE:GSK) or Bristol Meyers (NYSE:BMY). They would then sell it at a higher price to drugstores such as Walgreen (NYSE:WAG) or hospitals like HCA (NYSE:HCA). This used to be a cinch because of steady drug inflation, but a large number of protected drugs have come off patent and been replaced by cheaper generic drugs, deflating pricing in the process. The distribution industry has since begun charging a fee for its services, and it appears to be working, as witnessed by Cardinal's recently reported results.
Revenue for the full fiscal year grew 10%, while diluted earnings increased 12% -- in line with long-term goals. Management also highlighted that operating margins improved in most business segments. For the most part, fourth-quarter revenue at each segment was uneven, but full-year growth was positive across the board. The company also projects that 2007 earnings will grow approximately 20% year over year to $3.50-$3.70 per share. This excludes certain special and non-recurring items, and it represents a forward P/E of 18-19.
Operating cash flow also exceeded reported net income for the quarter and full year -- another long-term financial goal met. For the full year, I estimate free cash flow at $1.7 billion, or $1.3 billion when subtracting business acquisitions. Both figures were ahead of the $1 billion in reported net income for the year. The company spent its free cash flow repurchasing $1.5 billion of its own shares, which is quite a benefit for common shareholders, I must say.
If Cardinal can meet its long-term goals, its stock should represent a solid investment. As I've detailed before, prior to changes in the way the drug-distribution industry operates, Cardinal's performance was as strong as any company in the market, thanks to its robust free cash flow generation and subsequent juicy stock returns. But as industry dynamics changed, the company also became embroiled in an SEC accounting investigation, forcing Cardinal to restate certain financial statements going back to 2000. The restatements were not major, and Cardinal disciplined or terminated certain employees, satisfied SEC inquiries, and has worked to improve its corporate governance.
As such, the company has to regain investor confidence and rebuild a track record in a changed industry. So far, so good for 2006. Let's see if any further information can be found once Cardinal submits its 10-K filing to the SEC.
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Fool contributor Ryan Fuhrmann is long shares of Cardinal and Walgreen but has no financial interest in any other company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned further.
