Published by Bob Ciura on March 16th, 2017
Cardinal Health (CAH) and AmerisourceBergen (ABC) are fierce competitors within the healthcare distribution industry.
Together, CAH and ABC generate more than $250 billion in annual revenue, and dominate their industry.
The concentration of the healthcare distribution industry provides CAH and ABC with competitive advantages, and high barriers to entry.
This provides CAH and ABC with consistent profits and steady growth, which allows them to reward shareholders with annual dividend increases.
CAH is a Dividend Aristocrat, a group of companies in the S&P 500 that have raised dividends for 25+ years.
You can see the entire list of Dividend Aristocrats here.
ABC is not a Dividend Aristocrat, but it is a Dividend Achiever, a group of 271 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Aside from a significantly longer history of raising dividends, this article will discuss three other reasons why I prefer CAH over ABC.
Reason #1: A Stronger Pharmaceutical Business
Both companies are major players in the healthcare distribution industry.
CAH has a huge network, consisting of more than 25,000 pharmacies.
The company services more than 70% of U.S. hospitals, and manufactures or sources 2.8 billion individual consumer healthcare, home medical equipment, and over-the-counter products each year.
CAH is organized into two segments, Pharmaceutical and Medical.
Source: J.P. Morgan Presentation, page 6
Similarly, ABC is also a huge operator in the industry.
It generates $147 billion in annual revenue, and sources 1.5 million products delivered from over 30 distribution centers.
Both companies rely heavily on pharmaceutical product distribution, which makes up the vast majority of their overall revenue.
CAH derives 90% of its revenue from pharmaceutical products, while approximately 95% of ABC’s revenue comes from its pharmaceutical segment.
CAH’s pharmaceutical business is outperforming ABC’s. Since they generate the vast majority of their business from pharmaceutical distribution, this gives CAH a big advantage.
CAH’s pharmaceutical segment posted 20% revenue growth in fiscal 2016, along with 19% growth in profit.
This helped company-wide revenue and operating earnings grow by 19% and 18%, respectively, in fiscal 2016.
By contrast, ABC’s core pharmaceutical segment grew revenue by 7% last year. Segment profit rose 2.3%.
Because of this, ABC had a good year in 2016, but not quite as strong as CAH.
Source: J.P. Morgan Healthcare Conference, page 14
Overall, ABC’s revenue and adjusted earnings-per-share increased 8% and 14%, respectively, in fiscal 2016.
Both companies’ growth is being threatened right now, by falling drug prices. Increasing demand for generics has fueled drug price deflation in the U.S., which is eroding their margins.
Even though they seem like identical counterparts, ABC is being impacted by macroeconomic challenges to a greater extent than CAH.
CAH’s pharmaceutical business has been more resilient over the past year, which means the present challenges are likely to continue weighing on ABC more so than CAH moving forward.
Reason #2: Better Growth Prospects
Despite the pressures of falling drug prices, both CAH and ABC are benefiting from broader catalysts that should fuel future growth.
Specifically, the U.S. pharmaceutical market remains in a healthy condition.
Source: J.P. Morgan Healthcare Conference, page 6
In both cases, future growth will be due to new customer additions, and cost controls. Drug pricing is not expected to improve much in fiscal 2017.
Still, CAH expects fiscal 2017 to be another year of steady growth.
For example, the company expects revenue to grow at a high-single digit rate for the year. Adjusted earnings-per-share are projected to increase 3.5% this year.
ABC expects 2017 revenue to increase 6.5%-8%, but eroding margins are likely to have a big impact. The company forecasts adjusted earnings-per-share to be in the range of $5.63-$5.88.
At the midpoint of its guidance, ABC’s 2017 adjusted earnings-per-share are expected to rise a more modest 2.4% from 2016.
The major growth catalysts for CAH’s higher earnings-per-share growth, will be lower capital expenditures, and better performance across its two main business segments.
In particular, CAH’s medical segment is likely to be a major source of growth in 2017.
Source: Q2 FY17 Earnings Presentation, page 12
In the fourth quarter, medical segment revenue and operating profit increased 12% and 19%, respectively. Much of this growth was due to the benefits of CAH’s $2 billion acquisition of Cordis in 2015.
For fiscal 2017, CAH expects to realize mid-to-high single digit revenue growth in its medical segment, along with double-digit profit growth.
While deflation in drug pricing is likely to be a continued challenge—CAH forecasts a low-single digit decline in pharmaceutical segment operating profit this year—the medical segment is helping offset weak drug pricing.
This provides CAH with valuable diversification, which ABC is not benefiting from.
Reason #3: A Higher Dividend Yield & Dividend Growth
CAH’s current dividend yield is 2.2%. This is slightly above the S&P 500 Index average dividend yield, which is around 2%.
Meanwhile, ABC has a 1.6% dividend yield. Its dividend yield is significantly below-average.
Put differently, CAH provides investors with approximately 38% more dividend income each year than ABC.
Not only does CAH have a higher dividend yield than ABC, its dividend growth has been more impressively recently as well.
Last year, CAH raised its dividend by 16%; ABC’s most recent dividend increase was a 7.4% hike.
CAH’s dividend growth in 2016 was more than double ABC’s.
This trend could continue, if CAH’s earnings growth exceeds ABC’s going forward.
Final Thoughts
CAH has a dominant industry position, attractive growth potential, and an above-average dividend yield. It is also a high dividend growth stock.
These qualities help CAH score very highly using The 8 Rules of Dividend Investing—in fact, it ranks in the top 10 stocks on this scale.
ABC is a high-quality business and is a solid dividend growth stock on its own, but its pharmaceutical business is not performing quite as well as CAH’s.
And, CAH has an ace up its sleeve for future growth, which is its medical distribution segment.
As a result, CAH is the better pick in the healthcare distribution industry.
