With the ever-changing pace of technology, it seems that many industries are always having to change and reinvent themselves. With this in mind, I believe it’s prudent to have a certain allocation in one’s portfolio to so-called “boring” companies that provide stability and growth. These companies don’t provide much excitement in way of being the focus of conversations at dinner parties, but there is nothing boring about the steady profits that they can generate for one’s portfolio. In addition, many of these companies have resilient business models that enable them to weather adversity.
The company that I’m focused on today, AmerisourceBergen (ABC), fits this bill for today’s article. I intend to examine the company from a fundamental perspective, and make a recommendation, so let’s get started.
A Mission-Critical Operation
AmerisourceBergen is the second largest of the “Big 3” drug distributors, sitting just behind the leader McKesson (MCK). It serves as a key link in the pharmaceutical supply chain by connecting drug manufacturers to sites of care, including healthcare systems, clinics, pharmacies, veterinary practices, and livestock producers. It has 150+ offices worldwide, 22 thousand employees, and ships over four million products per day.
As one of the leading players in its industry, AmerisourceBergen is in a position to ride the wave of expanding healthcare spend over the next decade. According to CMS, national healthcare spend is projected to grow at an average rate of 5.5% per year through 2027 and reach $6.0 trillion by 2027. This puts healthcare spend on pace to grow at 0.8 percentage point faster than the U.S. GDP, resulting in 1 in 5 dollars of the GDP being healthcare-related within a decade.
I believe that AmerisourceBergen, being a large and well-capitalized player in the industry, will be able to leverage its economy of scale to capture its fair share of this growth. In addition, I see the company’s market-leading positions in specialty distribution as being a long-term growth driver, as specialty medications provide higher margins and benefit from pharmaceutical innovation and demographic trends.
While COVID-19 has presented a unique set of risks and challenges, the company has plenty of flexibility in providing alternative ways to get medications in the hands of patients. For example, its World Courier unit has been a key asset for the company in providing direct-to-patient clinical trial services to patient homes without the need for them to step foot into a hospital or pharmacy, thereby lowering the burden on these facilities. Management has also shown operational resiliency in addressing business disruptions. An example of this is illustrated by how it responded to COVID-19 risk, as noted on the last investor call:
AmerisourceBergen has a history of investing in our businesses and capabilities, giving us significant technological and operational flexibility. Last month, we demonstrated this when we temporarily closed one of our largest distribution centers out of an abundance of caution, given its proximity to COVID-19 hot spot. We invoked our business continuity plan for the region and seamlessly transferred volume to other AmerisourceBergen distribution centers. We used the temporary closure to perform extensive sanitation measures at the location.
Digging into the financials, revenue has grown at a solid clip at an annual growth rate between 7% and 10% over the past two years. It should be noted that AmerisourceBergen, like its peers, operates with thin margins, which has held steady over the past three years. I would expect upside potential as more higher-margin specialty medications come online amidd continued improvements in generic pricing. Even in the case of flat margins, I expect continued growth in revenue to contribute to increased operating income.
(Source: Created by author based on company financials)
The company’s balance sheet is in one of the strongest positions in recent history. Management has steadily deleveraged the balance sheet in recent years, and the current 50% LT Debt to Capital ratio compares favorably to prior periods. In addition, management was able to take advantage of low interest rates by issuing $500 million of debt in May at an attractive 2.8% interest rate, allowing it to redeem 3.5% senior notes, thereby helping the company to save on interest expenses.
(Source: Created by author)
Lastly, Adjusted EPS has grown by a solid 15% since 2018. While dividends have grown just at a 4% to 5% annual rate over the last two years, the payout ratio has declined from 35% in 2018 to 32% on a trailing-12-month basis. In addition, management has taken the opportunity to reduce share count at attractive valuations at a 2% to 3% annual rate over the last couple of years.
(Source: Created by author)
As with the other drug distributors and manufacturers, opioid litigation remains an overhang for the company. While litigation costs were higher in the latest quarter at $30.8 million (compared to $13.8 million last year), it only represents 2.2% of the gross profit that the company generated in the latest quarter. In addition, as noted during the last conference call, the CEO sees merits in the global settlement framework that has been offered, which could provide predictability and clarity, and the settlement costs would be spread across a number of companies and over a number of years. This is something worth paying attention to for investors.
AmerisourceBergen operates as one of the leading drug distributors with a large economy of scale through its broad customer base and distribution channels. It is well-capitalized with a strong balance sheet as management has been timely in reducing its debt in recent years. Its recent bond offering, at an attractive interest rate, to redeem higher interest rate bonds demonstrates investor confidence from the bond community. These factors, combined with strong expected growth in healthcare spend over the next decade, put the company in a position to reward its investors over the long term.
I have a Buy rating on shares at the current price of $99.33 and a PE ratio of 13.4, as of writing. I have a one-year price target of $110, which I believe is a conservative estimate and brings shares to fair value.
(Source: F.A.S.T. Graphs)
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ABC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.