Cardinal Watching

Cardinal Health (NYSE:CAH) had its wings clipped recently. The health-care products and services outfit shared more bad news yesterday, announcing that in the midst of an investigation by the Securities and Exchange Commission, its chief financial officer resigned. Investors reacted predictably, sending the stock down 13%.

An SEC investigation is always troubling, but in this instance, the investigation and its outcome could become a buying opportunity. Fool contributor W.D. Crotty has already laid out an excellent case for Cardinal Health based on its impressive cash flow for 2004. The good news is, the firm's strategic initiatives seem likely to keep cash coming in the door.

Cardinal Health's primary business historically has been drug distribution, a field in which it competes with McKesson (NYSE:MCK) and AmerisourceBergen (NYSE:ABC). At the moment, this business is in transition. Previously, distributors such as Cardinal Health bought large quantities of medicines from manufacturers based on long-term sales projections and then reaped rewards when prices went up. Now the industry is migrating to more of a just-in-time model, meaning distributors' inventory levels will reflect current demand. The change has caused widespread disruption as distributors negotiate new pricing schemes with early adopter clients while maintaining old structures with stragglers.

Fortunately, Cardinal Health is somewhat less vulnerable to this disruption because it has been diversifying into other areas. Most recently, the company completed its tender offer for ALARIS Medical Systems (NYSE:AMI), a maker of products for intravenous drug delivery, in part using freed-up capital that in the past would have gone to buy inventory.

Cardinal Health's investments in the sterile manufacturing area, though, may be the most intriguing. Late last year, the company closed its acquisition of Intercare Group, a European sterile manufacturer. The company also recently received regulatory approval for a facility in Albuquerque, N.M., and is expecting clearance for a site in Puerto Rico soon.

Demand for sterile manufacturing is strong and likely to boom, driven primarily by the rising number of approved biotech drugs, most of which are injectable products. Cardinal Health indicates it already has signed contracts to fill at least some new capacity but is being stymied by approval delays. As new facilities come online and more biotech drugs hit the market, the sterile manufacturing unit is likely to take off.

For now, the prudent tactic is to wait for the results of the SEC investigation. The firm's shares are sure to be buffeted by more bad news. But when the dust clears, Cardinal Health may be a good bird to have in hand.

Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.