Cardinal Health Shows China Growth Engine

Jacob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Healthcare services and pharmaceuticals distributor Cardinal Health (NYSE: CAH) reported a 16 percent growth in its second quarter profits – well ahead of Street expectations.  But what caught many by surprise was the company’s revelation that it made six acquisitions in China.

This is significant, as top line growth of the company has been facing stagnation lately amid a flurry of lower-priced generic drugs. The firm's worldwide business generated $25.2 billion during the quarter, down from $27 billion in the same period last year. Profits, however, jumped to $303 million, up from $262 million a year earlier.

This financial performance, at first glance, can be dismissed as a fluke with a counterargument that a long-term trend of declining revenues will eventually squeeze profits.

To an extent this argument is true for many of Cardinal Healths’s competitors, including McKesson (NYSE: MCK) and AmerisourceBergen (NYSE: ABC).

However, beneath the surface, positives are plentiful for Cardinal Health. The firm's CFO Jeffrey Henderson announced that four acquisitions have been completed, while two are awaiting government approvals. Combined transaction size of the deals would be around $120 million. Revenues in China are growing at a strong rate – north of 35 percent– effectively compensating for the smaller base.

Cardinal Health's operations in China aren’t very old, as the company started there in November 2010 with a big acquisition of pharmaceuticals distributor Yong Yu.

What the company is currently trying to do through multiple smaller buyouts is boost its geographical coverage in China's market. Cardinal’s exploits in China indicate the growing demand for personal healthcare in Asia.

This is a market where patients still purchase around 80 percent of their medicines directly from hospitals rather than pharmacies; but with growing income levels, consumers are willing to pay for consumer medicines and are showing immense trust in foreign brands.

The icing on the cake –margins are better too, as competition for foreign brands is less. Although Henderson did not quantify profits of its Chinese operations, he indicated margins are indeed higher than in the U.S.

While Cardinal is making steady inroads in the Chinese market and its efforts are meeting with some success, the transition has almost gone unnoticed by its U.S. competitors. Instead, its competitors continue to plough resources into the United States.

A few months ago, Cardinal Health's larger peer McKesson announced its plans to acquire PSS World Medical for $1.62 billion.

It's no wonder that McKesson missed analyst expectations when it announced quarterly results earlier this month. Although McKesson's revenue grew 1% to $31.19 billion from $30.84 billion during the quarter, net income slipped to $298 million from $300 million on legal and product charges. Furthermore, the company missed on expectations even after excluding the charges. Not to suggest that the U.S. market is dead, but it is certainly stagnating, and with no exposure to growth markets such as China, McKesson is not placed very favorably.

Another competitor - AmerisourceBergen – has no presence in China. While AmerisourceBergen managed a strong showing with the latest financial performance and appears to be in a better shape than McKesson, its absence from China is somewhat baffling. AmerisourceBergen's revenue for the quarter ended Jan. 31 stood at $21.5 billion, up nearly 6% from the same period in previous year.  Earnings per share during the same period jumped 13% to $0.69. The company also benefited from a 10% reduction in average diluted shares outstanding versus the prior year. 

AmerisourceBergen also bought a number of companies in the U.S. last year, including TheraCom and World Courier. Both McKesson and AmerisourceBergen are priced steeply when compared to Cardinal – in terms of historical earnings as well as forward earnings. In addition, Cardinal’s undervaluation is also reflected in its higher dividend yield compared to other two.

valuewalk has no position in any stocks mentioned. The Motley Fool recommends 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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