Cardinal Health(CAH) - Get Report is a leading distributor of drugs and health care products, two categories that will see spending regardless of what happens to the economy. It also has the rare honor of being a Dividend Aristocrat, which means it has increased its annual dividend payment every year for at least 25 years.
Yet shares of Cardinal Health have fallen 14% so far this year while the S&P 500 index is up 4.6%. Some investors might view Cardinal Health's underperformance as a reason to avoid the stock, but there are several good reasons to buy and hold shares for the long term.
First, Cardinal Health shares are cheap. They currently trade at a forward price-to-earnings ratio of 12.
Second, Cardinal Health is very friendly to shareholders. It has increased its annual dividend for 31 consecutive years. It also offers a 2.3% dividend yield, which is slightly higher than the 2.1% average yield for S&P 500 companies.
Third, Cardinal Health has compelling growth prospects, which we'll explore in greater detail. The company is ranked as a Top 10 dividend stock according to The 8 Rules of Dividend Investing.
Cardinal Health supplies both brand-name and generic products to a wide range of end users, including retailers, hospitals, surgical centers and other health care providers. It operates in two core segments: pharmaceutical and medical.
Cardinal Health is a leader in its industry. It serves more than 1.8 million at-home patients, along with a customer network that includes more than 5,000 medical and surgical suppliers, and more than 20,000 U.S. pharmacies. It provides services to more than 75% of U.S. hospitals.
Cardinal Health's current problems -- which have pressured its stock -- go back to 2013, when major pharmacy retailer Walgreens Boots Alliance ended its contract with Cardinal Health. At the time, Walgreens represented more than 20% of Cardinal Health's total revenue. This caused Cardinal Health to take a major hit, which it spent the next three years recovering from.
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Cardinal Health's revenue declined 6% in fiscal 2013 and another 9.9% in fiscal 2014, largely due to the loss of the Walgreens deal.
But while Cardinal Health's stock has underperformed this year, the company has come a long way since the contract expiration. Cardinal Health is benefiting from two key factors: the aging U.S. population, which has led to higher spending on health care products and services; and rising demand for generic drugs.
Cardinal Health has capitalized on these two trends by diversifying its customer base. It established Red Oak Sourcing, which is a generics sourcing joint venture with CVS Health.
Separately, Cardinal Health has focused on building its business in emerging markets such as China, where health care spending is projected to grow at a higher rate than in the U.S.
Cardinal Health has generated long-term growth from these tailwinds. Last fiscal year, total revenue increased 19% to $121.55 billion. The company saw broad success across its two core businesses. Revenue in the pharmaceutical and medical segments increased 20% and 9%, respectively, in the last fiscal year.
Looking back further, Cardinal's fiscal 2016 revenue was up 33% from its fiscal 2014 revenue. And adjusted earnings per share for fiscal 2016 were $5.24, up 20% year over year.
Investors should expect continued growth. One attractive catalyst moving forward is Cardinal Health's 2015 acquisition of Cordis from Johnson & Johnson for $1.94 billion. The purchase of Cordis gives Cardinal Health an advanced position in cardiology and endovascular products, and again helps Cardinal Health benefit from the aging population.
A side benefit of the Cordis purchase is that it gives Cardinal Health even greater exposure to the emerging markets. Approximately 70% of Cordis' revenue comes from outside the U.S.
Cardinal Health expects the merger to add 20 cents to EPS this fiscal year, thanks to significant cost synergies associated with the deal. Cardinal Health management envisions more than $100 million in annual cost savings.
Cardinal Health took a major step backwards when it lost the Walgreens contract, but it soon reclaimed the $100 billion revenue mark and now generates more annual revenue than it did before the contract expiration.
Going forward, there are many reasons for invest in Cardinal Health. Not only is the company doing well with plenty of future growth potential, but it is also an attractive choice for value and income investors.
Cardinal Health has a very shareholder-friendly management team that is committed to returning cash through both dividends and share repurchases. In May, the company simultaneously raised its cash dividend by 16% and announced a new $1 billion share buyback program.
The company can return such large amounts of cash to shareholders because it generates a great deal of free cash flow. For example, last fiscal year Cardinal Health produced $2.97 billion of operating cash flow and spent just $465 million on capital expenditures. For the fiscal year, the company generated $2.5 billion of free cash flow, and it needed just $512 million to pay its dividend last year.
This means the company takes in more than enough free cash flow to pay its dividend and still have plenty left over to buy back stock, invest for future growth and pursue acquisitions.
Cardinal Health makes a compelling purchase at current prices for long-term investors thanks to its low valuation, long history of growth and future growth potential.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.