Switching to a "fee for service" business model has helped wholesale pharmaceuticals distributor and industry giant McKesson (NYSE:MCK) pump up notoriously low operating margins. The stock has fattened itself up, too, doubling from the low that it set roughly a year ago.
On Tuesday, the company reported second-quarter results that were very pleasing indeed. While revenue rose 8% over the year-ago quarter, net income from continuing operations increased by a whopping 79%. Even more impressive, year-to-date cash from operations has increased more than fivefold to $2 billion.
Accounting for the big earnings increase is a half-percentage-point increase in operating margins to 1.12%. With quarterly sales at $21.6 billion, that seemingly small increase translates into 79 million greenbacks from continuing operations. Also to its merit, McKesson sports a nice-looking balance sheet: It ended the latest quarter with net cash (cash minus total debt) of $2 billion.
So let's take a little look into the future. While analysts expect the drug wholesale industry to grow earnings 12% annually for the next five years, they also expect McKesson to chip in 13.5% annual growth. I expect that expanding margins, as McKesson's hones its new business model, will certainly help produce those results.
McKesson's updated guidance for fiscal 2006 (which ends in March) is $2.25 to $2.40 -- within the $2.30 range that analysts are expecting. The stock is priced at 19.8 times analysts' 2006 expectations.
The story at McKesson is cash flow. Year to date, the company has used $575 million for acquisitions, $290 million for share repurchases, and $36 million for dividends. There is plenty of cash lying around for the company to substantially boost its paltry 0.5% dividend. But for now, acquisitions and share repurchases are the order of the day.
Because McKesson is a broadly based supplier, it avoids the roller-coaster impact that specific drug successes and failures have on drug-developer stocks. If you're looking for a conservative ride on the American demographic shift of an aging population that needs more medications, this company may be for you.
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Fool contributor W.D. Crotty does not own any shares of the companies mentioned. Click here to see The Motley Fool's disclosure policy.
