Cardinal Health (CAH - Get Report) reported a generally upbeat outlook for 2018 and 2019 despite deflation in generics and reimbursement pressures, that caused third-quarter earnings to fall at the lower end of the company's guidance and below analysts' expectations.
The formal results announced Monday were not a surprise--the company had provided preliminary results on April 18 that let the market know how the quarter was likely to turn out. The disclosure coincided with Cardinal's announcement of its agreement to acquire the patient recovery business of Medtronic (MDT - Get Report) for $6.1 billion and caused Cardinal's shares to fall more than $9 to $72.39 that day.
Although that news had already been incorporated into Cardinal's price, the shares fell again Monday. Through mid-day Cardinal stock was down 50 cents to $72.19.
"We are experiencing pricing deflation in generics, some heightened reimbursement pressures, which affect our customers and scarcity of new generic launches in the near term," Cardinal Chairman and CEO George Barrett told analysts on a conference call Monday morning.
Third quarter earnings were $381 million, or $1.53 per share on an adjusted basis, ahead of analysts' $1.46 per share expectations for the period. Revenue of $31.82 billion rose 3.8% year over year, but missed analysts' expectations of $32.30 billion in revenue.
Leerink analyst David Larson cautioned that although Cardinal's adjusted EPS was ahead of consensus, that was mainly due to a lower tax rate, "other income" and a lower share count.
The quality of Cardinal's earnings was actually "modest," he said, noting that adjusted operating income "missed both our estimate and consensus, and the Medical Division in particular was behind our estimate."
Cardinal CFO Michael Kaufman said that the company now expects full year 2017 revenue percentage growth to be in the mid-to high single-digits, versus the high single digit growth originally predicted. However, he said the generic deflation is improving and should level off. "Generic market pricing . . . while less deflationary than what we saw earlier this year, is still lower than we modeled for the second half of the year," he said.
Kaufman blamed the deflation on pricing declines in "a very small subset of items that have deflated significantly this year, items you probably might be aware of over the last couple of years at launch that had limited competition either because they were hard to make or there was raw material issues or those types of things that were relatively high priced toward the beginning of the year or higher-priced in terms of generics go and then they deflated significantly during the year." Those items "have really reached probably near the bottom of where they will be. And so the impact of those items we don't see reoccurring next year.
Additional the company has taken steps "in terms of pricing, sourcing, working with our customers on penetration" to stem the impact of deflation.
Kaufmann also conceded that the company has faced challenges building the infrastructure to integrate its 2015 purchase of Johnson & Johnson's (JNJ - Get Report) Cordis business, a maker of cardiology and endovascular devices, for $1.94 billion. The hardest part of the Cordis deal has been "ramping up the international infrastructure," he said.
"Building up that infrastructure has been one that has taken a little more time than we expected but we want to get it right," he said.
Nevertheless, the company has said U.S. customers have shown a strong interest in Cardinal's expansion of its product bundle beyond pharmaceutical distribution has had "particular resonance among our strategic accounts."
The benefits of expansion into new, higher value products will continue with the Medtronic deal, he said. "We're very optimistic that the foundation we built for Cordis is going to pay dividends as we bring the [Medtronic] patient recovery business on top of that when we're able to close the business, hopefully, sometime in the first quarter," said Casey. The Medtronic assets being acquired cover patient care, deep vein thrombosis and nutritional insufficiency.
Barrett, however, emphasized that the acquisitions are intended to bolster Cardinal's core business and don't indicate a shift away from pharmaceutical distribution. "We've had our eye on [Medtronic] for a long time, and we believe that adding these product lines to our existing portfolio will provide additional value to our customers and our shareholders," he said. "Let me be clear on this: our pharmaceutical distribution business is an important and value part of an integrated portfolio. While market conditions came from time to time affect any business, we are confident in the value that our best-in-class distribution business provides today and into the future."