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McKesson Sees Sales Pressure But Delivers on the Bottom Line

By Dan Caplinger - Jan 27, 2016 at 7:12PM

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The drug wholesaler reaped the rewards of its long-term strategies.

Image: McKesson.

Drug-wholesale specialist McKesson (MCK -1.73%) has discovered a lucrative niche in distributing pharmaceuticals to clients such as CVS Health (CVS -1.42%), and it has tried to take full advantage of advances in the healthcare industry to try to maximize its profits. Coming into Wednesday's fiscal third-quarter financial report, McKesson investors had high hopes that the company would be able to keep growing and that controversies about drug distribution that politicians have raised recently wouldn't translate into additional financial pressure for the company. McKesson's results didn't give investors as much sales growth as they wanted to see, but the company's profit gains topped expectations. Let's look more closely at how McKesson did and what lies ahead for the drug wholesaler going forward.

McKesson looks fairly healthy
McKesson's fiscal third-quarter results gave investors both top- and bottom-line growth, but growth rates didn't match up to past quarters. Revenue climbed just 3% to $47.9 billion, falling short of the nearly 4% growth that most investors were expecting from McKesson. However, net income jumped by a third to $634 million, and after taking into account various extraordinary items, adjusted earnings of $3.18 per share were a nickel higher than the consensus forecast among those following the stock.

As we've seen in past quarters, McKesson's key segments had disparate performance. The Distribution Solutions business reported revenue rising 3% on a dollar basis and 6% on a constant-currency basis, showing the impact of the strong dollar on the company's top line. North American distribution and services revenue climbed 6%, while on the international front, revenue fell 1% in constant-currency terms and 11% as reported. The loss of key contract in Norway hurt the international business. Meanwhile, medical-surgical distribution and services showed flat sales results. Overall, the segment posted flat adjusted operating profit of about $1.1 billion.

McKesson's Technology Solutions business continued to lag behind. Revenue declined 8% to $694 million, with the company blaming the sale of its nurse-triage business and poor performance in its hospital software business. Still, the segment remained profitable, bringing in $133 million in adjusted operating earnings for the quarter.

CEO John Hammergren showed his pleasure at the progress McKesson has made. "I am pleased with the excellent progress we have made in expanding our global pharmaceutical sourcing scale, delivering operating margin improvements in the Technology Solutions segment, and successfully executing on the Celesio acquisition synergies," Hammergren said.

Can McKesson satisfy investors?
McKesson's results didn't come as a major shock, mostly because the company gave investors guidance on its expected 2016 and 2017 outlook just a couple of weeks earlier. McKesson's preannouncement had already revealed the company's new guidance for earnings of $12.60 to $12.90 per share, narrowing its previous range and sending the stock down 10% in its wake. More importantly, expected long-term growth of 3% to 8% in earnings for fiscal 2017 would be particularly disappointing to those looking for faster bottom-line growth.

The primary challenge that McKesson faces is pressure on pricing for both generic and branded drugs. CVS Health and other major retailers are working hard to force their suppliers to reduce their costs. By doing so, CVS Health hopes to widen its own margins and pass at least some of the savings on to customers to relieve some of the political pressure on the industry for what many see as price-gouging for certain pharmaceuticals. McKesson has a lot riding on its relationship with CVS Health, with a recent announcement that it will supply drugs to the drugstore retailer's newly acquired pharmacies.

Looking forward, McKesson has established its success in generating profits and sharing them with shareholders through dividends and sizable stock repurchases. What McKesson now needs to do is to build on that past success by looking for new ways to keep growing. Through partnerships with CVS Health and other clients, McKesson has an opportunity to be an even more important player in the key drug distribution business in 2016 and beyond.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends CVS Health and McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

McKesson Corporation Stock Quote
McKesson Corporation
$367.37 (-1.73%) $-6.47
CVS Health Corporation Stock Quote
CVS Health Corporation
$104.92 (-1.42%) $-1.51

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