Cardinal Health Is A Tempting Healthcare Income Play (CAH)

Introductory Remarks

In my previous article, I discussed how McKesson Corporation (MCK)’s share price has bucked the broader market’s downward trend by climbing nearly 55% in 2022. As I looked into McKesson to see how it might potentially fit into my dividend growth portfolio, I could not resist evaluating it in comparison with Cardinal Health (NYSE:CAH), which has enjoyed a similarly upward trajectory during this year’s bear market. Like McKesson, Cardinal Health has outperformed both the broader stock market and the health care sector (using the SPDR S&P 500 Trust (SPY) and the Health Care Select Sector SPDR (XLV) ETFs as benchmarks) by fairly large margins. In fact, Cardinal Health’s share price actually outperformed McKesson’s over the past year with dividends reinvested. As one can see in the chart below, Cardinal Health’s 2022 performance surpasses even McKesson’s stout 60% total return:

While a climbing share price is certainly not the sole (or even most important) consideration in determining whether or not to add a company to my portfolio, it does provide me with a solid reason to take a closer look.

The Dividend

As an income-oriented investor, I focus on dividend-paying stocks with a proven track record of paying shareholders, raising payouts, and maintaining a reasonable payout ratio. Thus, the first thing about Cardinal Health that I looked into was its dividend.

As a Dividend Aristocrat, Cardinal Health has demonstrated a commitment both to returning capital to shareholders in the form of regular dividends as well as to raising those payouts annually, which Cardinal Health has done for the past 27 years:

Of course, not all dividend growth is equal. Despite Cardinal Health’s decades-long streak of annual dividend hikes, the company’s dividend growth rate has been an anemic 1% for the past three years and a marginally stronger 1.6% for the past five. While the dividend grew at a rapid clip from 2005 to 2016, it appears to have stalled for the past six, lagging even the rate of inflation.

That said, Cardinal Health’s current yield of 2.46% is nearly one full percentage point higher than the health care sector average, its trailing twelve month payout ratio of 16.23% is half that of the sector average, and its long history of dividends places it among only such venerable names in the healthcare sector as Johnson and Johnson (JNJ), Abbott Laboratories (ABT), and Becton Dickinson & Company (BDX) on the list of Dividend Aristocrats.

Perhaps most importantly, the dividend appears to be comfortably covered. The 3.4 billion dollars Cardinal Health generated in the last year amounts to more than six times the amount the company has paid out to shareholders during that time. It is no surprise, then, that CAH has earned a “safe” score from Simply Safe Dividends and a safety grade of A- from Seeking Alpha.

A Recession-Resistant Business

As any seasoned investor will explain, buying companies tied to human needs during a recessionary environment is one of the more tried-and-true ways to stay invested during a bear market. After all, while people will likely cut back on luxuries and other non-essential expenses, we still need food, shelter, and medical care, which is precisely why Cardinal Health is worth looking into during this year’s bear market.

Like McKesson, Cardinal Health is a major player in American healthcare, enjoying distribution relationships with 90% of hospitals in the United States. One key difference between the two distributors, however, is that while McKesson focuses primarily on the distribution of pharmaceuticals to clients, Cardinal Health also distributes medical devices to hospitals around the country. Thanks to the company’s comfortable position as a middleman, Cardinal Health does not need to invest in the research, development, and testing of medical products, which has helped the company maintain a steady revenue stream even in the most difficult of financial environments. Thus, while global supply chain delays have adversely impacted Cardinal Health this year, the company has continued to generate strong profits. In the quarter ending in September, Cardinal Health reported just over 49.6 billion dollars in revenue, up 13% to 47.1 billion dollars year over year.

In fact, Cardinal Health has leveraged its expertise in supply chain logistics to build Velocare, which the company describes as “a supply chain network and last-mile fulfillment solution that the company says is capable of reaching patients in one to two hours with the critical products and services that are required for hospital-level care at home.” Combined with Cardinal Health’s competitive advantages in bringing critical medicines and medical devices to hospitals, Velocare positions the company to benefit from the expansion of in-home care.

A Catalyst for Growth…

While Cardinal Health maintains operations in both pharmaceuticals and medical devices, the former is substantially more valuable than the latter. In fact, the company’s pharmaceutical segment generated more than 90% of Cardinal Health’s total revenue for the first quarter of the 2023 fiscal year, which ended on September 30. In the company’s Q1 2023 earnings call, Cardinal Health announced that it anticipates the revenue generated by its pharmaceutical operations to grow between 10%-14% over the next year.

The company is also committed to acquisitions that will accelerate the revenues generated by its pharmaceutical segment. In July, for instance, Cardinal Health acquired the Bendcare Group Purchasing Organization and made a minority investment in the Bendcare Management Services Organization as a way to bolster what Dan Duran, Senior Vice President and General Manager, Provider Solutions, Cardinal Health Specialty Solutions describes as the company’s “best-in-class distribution to support rheumatology providers so they can ultimately focus on achieving cost-effective patient outcomes and care.”

… And a Cautionary Note

While Cardinal Health did report the aforementioned 13% year over year jump in revenue to 49.6 billion dollars, the company also reported a 67% decline in income from operations and a 57% drop in earnings per share. While some of these declines can be attributed to supply chain difficulties that impacted virtually every industry over the past couple of years, the numbers should still give one pause. It is important to note that while Cardinal Health reported that its pharmaceutical segment accounted for 46 billion dollars of the company’s 49.6 billion dollars in revenue for the most recent quarter, the medical device segment experienced a 9% drop in revenue. Given the decreased demand for personal protective equipment such as medical gowns, gloves, and masks in the past year as hospitals recalibrate their pandemic protocols, it is perhaps not surprising to see a drop in revenues in this segment. Indeed, the Q1 2023 earnings call presentation anticipates another 3%-6% decline in revenue generated by the medical segment in the upcoming fiscal year.

Fortunately, Cardinal Health’s management is acutely aware of the impact the company’s medical segment has had on the bottom line and has outlined a plan for “returning to a normalized environment”:

(Source: Cardinal Health Q1 2023 Earnings Call Presentation)

If the company can execute its plan to mitigate inflation, ease its supply chain woes, and simplify its portfolio, Cardinal Health projects to generate “at least $650 million in segment profit by FY25.”

Parting Thoughts

Cardinal Health has earned its reputation as a reliable payer of dividends and it deserves the consideration of any income investor hoping to add exposure to the health care sector to his or her portfolio. The dividend yield is a respectable 2.5%, though its recent growth rate leaves much to be desired. As a major player in a recession-resistant industry, Cardinal Health offers investors an intriguing opportunity for regular income and the potential for significant capital appreciation. While I believe there are better healthcare stocks out there such as Johnson and Johnson and McKesson, I do think Cardinal Health is worth considering.