A few weeks ago, I ran a stock screener and published my August dividend stock watch list. That screener had a new entrant that seemed to check most of our boxes for investing, Cardinal Health (CAH). Headquartered in the buckeye state, I instantly had flashbacks to college recruiting events since they sponsored A LOT of events at college. The stock price continues to fall, so I wanted to perform a detailed analysis on Cardinal Health before committing to buy this healthcare company. Here it is, my dividend stock analysis over Cardinal Health!
About Cardinal Health, INC. (CAH)
From Morningstar, “Cardinal Health Inc is a healthcare services company. It provides healthcare services and products for hospital systems, pharmacies, ambulatory surgery centers, clinical laboratories and physician offices. Its segments are pharmaceutical and medical.” The Morningstar profile doesn’t tell the whole picture, as Cardinal Health is fully integrated in the healthcare services industry. Sorry for another quote, but I think this piece from Cardinal’s About Us effectively communicates how involved Cardinal Health is in every aspect of the supply chain: “The company provides clinically-proven medical products and pharmaceuticals and cost-effective solutions that enhance supply chain efficiency from hospital to home. Cardinal Health connects patients, providers, payers, pharmacists and manufacturers for integrated care coordination and better patient management.”
There were a few things that jumped out as me as I researched the company. First, the company operates in an industry with low margins. This can provide a great economic moat for Cardinal Health and its two competitors because the economy of scales allows Cardinal Health to effectively compete in the industry. Others that can’t lower their costs through this manner will have a very hard time competing with the three industry giants. A very solid barrier to entry for the industry. Second, management is committed to growing their dividend in a sustainable manner. Here is a quote from the transcript of Cardinal Health’s earnings last earnings call for the quarter in which they announced their dividend increase:
“Our proven track record of success, combined with our aspirational goals, position us to deliver meaningful, measurable value for our shareholders now and well into the future. We remain committed to a disciplined and balanced approach to capital deployment, including our dependable dividend payout ratio of 30% to 35%. We also continue to aspire to a non-GAAP EPS compound annual growth rate, over any three-year period, of 10% to 15%.”
Music to a dividend growth investors ear. Now, we must take these strong phrases about consistent dividend increases with a grain of salt. If you recall, Kinder Morgan promised double-digit dividend growth rates through 2020 before they eventually slashed their dividend. You must perform a full analysis and see if the increase is sustainable and won’t be slashed in the short-term. Experiences like Kinder Morgan suck, but the pain of the dividend cut can serve as a great lesson and make you a better investor in the long run. For us, I can definitely say that it did. Now, let’s take a look at the numbers and see how Cardinal Health performs in our stock screener.
Dividend DIplomats’ Stock Screener & Other Metrics
We have a pretty simple stock screener, the Dividend Diplomats Stock Screener, to help us identify potentially undervalued dividend growth stocks. In addition, over the years, we have written articles about other metrics that help further spot undervalued dividend growth stocks. Now, it is time to run Cardinal Health through the gauntlet and see how well the company performs after reviewing the various metrics. For some, not all, we will also compare the metrics of two competitors (AmerisourceBergan Corporation and McKesson Corporation) to see how well Cardinal Health compares others in the industry. The chart below contains the numbers behind the metrics and we will analyze the numbers in greater detail below.
Metric #1: P/E Less than the S&P 500. We all have seen this, but the market been on a tear in 2016. What do you think has catapulted Lanny’s portfolio to new highs? Due to the increase, the S&P 500’s P/E Ratio has soared to over 24X ttm earnings and 18X forward earnings (per wsj.com). The chart above shows that Cardinal Health and the two competitors are all trading at valuations below the broader market. Check for Cardinal Health.
Metric #2: Payout Ratio Less than 60% – Ah, the payout ratio. The most important dividend metric in difficult times, in our opinion. Our threshold is 60% per our stock screener. The chart above shows that all three companies are well below our threshold, which should allow the companies to continue to grow their dividend at high levels. CAH’s target payout ratio is between 30% and 35%, which is still nearly half our metric! Another pass for Cardinal Health.
Metric #3: Increasing Dividend. The chart above shows that non of the companies are Dividend Aristocrats. So darn, buying Cardinal Health or a competitor won’t help me progress toward my goal of adding 5 new Dividend Aristocrats to my portfolio in 2016. Cardinal Health has an interesting dividend history though. Looking through various dividend websites, I have seen different amounts for the number of consecutive annual dividend increases for CAH. Some are 11, 19, 20, and so on. To get to the bottom of it, I pulled up the dividend history and looked for myself. It turns out, the company has been increasing dividends for a total of 20 years; however, within the 20 years, there were a couple of periods where the company did not increase their dividend for 6-8 quarters. Thus, consecutive annual dividend increases is closer to 11 years because the periods in which the dividend spanned greater than a year. To me, this demonstrates that management is committed to increasing their dividend even though there were short-term periods where the growth was paused.
Further, remember the quote from earlier in the article about management looking to have a payout ratio between 30% and 35%? Well, as demonstrated in Metric #2, the forward payout ratio with the dividend at the current level is ~28.59%. Outside of earnings falling off a cliff, the company will need to increase their dividend to hit their target payout ratio…BOOM. Using the estimated forward earnings from Yahoo Finance, a quarterly dividend of $.471/share and $.5495/share would result in payout ratios of 30% and 35%, respectively. Pretty solid potential dividend increase if you ask me and yet another check for Cardinal Health!
Metric #4 – Comparing Current Yield to 5 Year Average Yield – Lanny broke down this metric in detail to show why comparing the current dividend yield against the five-year average yield will help us identify undervalued dividend stocks. All three companies in the chart above have current yields greater than their average. Boom. Some appreciation in price would help revert the current yield back to the historical average.
Metric #5 – Share Buyback – I also wanted to see if management has been returning capital back to shareholders in the form of share buybacks. Share buyback programs can provide a huge benefit to dividend investors by decreasing shares outstanding, increasing EPS, reducing their payout ratio, and creating more room for dividend growth. It also provides some appreciation in price as well. Typically, I prefer dividend increases because it provides a long-term return to shareholders versus the short-term benefit of buybacks; however, I will never complain when a company takes action to return capital to their shareholders. Once again, Cardinal Health passes as they announced massive buybacks in their recent 10-K. The company recently completed a $2b share buyback program and the Board approved the repurchasing of up to $1b of shares through 2019. For those keeping track at home, that means they can buyback 12.6m shares at the current share price, or just under 4% of their current shares outstanding. Woah.
Summary – Cardinal Health
What are my thoughts on Cardinal Health….I like the company a lot. Cardinal Health passed all of the metrics in our stocks screener and looks very attractive (at least as attractive) compared to their competitors. I don’t see a reason to consider one of the competitors over CAH, especially considering CAH is the only one of the companies to have a yield in line with the S&P 500. Based on this analysis, I would have no problem adding Cardinal Health to my portfolio; it is a great company, with great metrics, a double-digit dividend growth rate, and a history of increasing their dividend. While Cardinal Health is not a Dividend Aristocrat, it seems like they are working their way towards the mark. Management seems committed to increasing their dividend over the years as well, which is eased any reservations I had about the fact that they were not an Aristocrat. When the right moment prevents itself, I ma just have to initiate a position!
What are your thoughts about Cardinal Heatlh and the dividend stock analysis? Do you own them or one of their competitors? Have you considered owning them? Or do you prefer to have exposure to the healthcare sector through a foundation stock like Johnson and Johnson or a company like Abbott Laboratories?
-Bert