Want to ride a megatrend? Baby boomers are aging, and they're going to increasingly use prescription drugs to take care of life's aches and pains. Sound good?
Before saying, "Yikes, drug giants like Merck (NYSE:MRK) and Pfizer (NYSE:PFE) have taken their shareholders on a roller coaster ride straight down," let's look at drugs differently.
How would you like to make a very small fraction of a cent on every pill shipped? Welcome to the world of drug wholesalers.
Before mining the pearls, let's give you the bad news right up front. Industry giant McKesson's (NYSE:MCK) stock has produced a really ugly one-decade chart.
But the business fundamentals that built that ugly chart have changed. By midyear, 80% of the company's pharmaceutical manufacturing compensation will have shifted from a risk-based inventory speculation model to a fee-for-service model. In simple English, the company's margins aren't subject to the timing of drug price increases and other variables. Now McKesson is paid for moving pills.
Read last night's earnings report and you might get lost in all the one-time charges and footnotes. The good news was that fourth-quarter revenue (the company's fiscal year ends in March) grew 15% to $20.6 billion compared with the year-ago period, and net income rose a strong 21% to $259 million. Diluted earnings per share of $0.85 handily beat analyst estimates of $0.73 a share.
Here is where it gets cloudy. If you exclude a $1.2 billion security litigation charge, you'd learn that the company earned $2.19 for the fiscal year -- the same as the previous year.
Looking ahead, the company expects to earn $2.25 to $2.40 a share for 2006 -- a 2.7% to 9.6% gain over net income adjusted for charges. But focus on free cash flow: Over the last year, McKesson produced roughly $1.2 billion in free cash flow. The company has the cash to repurchase shares (there is still authorization to spend $210 million) and/or increase its minimal dividend from the current $0.24 a share (or 0.65%).
McKesson and its wholesaling peers Cardinal Health (NYSE:CAH) and AmerisourceBergen (NYSE:ABC) are set to benefit from this new pricing model. If, as expected, they become steady-but-sure earnings producers, their market multiples could expand to reflect their safe position within a strong megatrend.
In today's trading, McKesson stock is up about 1%. New York Attorney General Eliot Spitzer's investigation into the industry may explain that lackluster response. But that gray cloud may be hiding an exciting shift in a business model that is set to pay off over the years to come.
Fool contributor W.D. Crotty does not own shares in any of the companies mentioned. Click here to see The Motley Fool's disclosure policy .
