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McKesson's Q3 Earnings Up Y/Y, Guidance Lowered

Zacks Equity Research

McKesson Corporation’s (MCK) third quarter of fiscal 2014 (ended Dec 31, 2013) earnings of $1.45 per share was up only 0.7% from the year-ago quarter.

Excluding $0.52 per share of charges related to the dispute with the Canada Revenue Agency and $0.18 per share of restructuring charges in the Technology segment along with other extraordinary items, earnings came in at $2.15 per share. The Zacks Consensus Estimate was $1.83 per share.

On a reported basis, including one-time charges, earnings were down 47%.

Revenues grew 10.3% to $34.3 billion in the third quarter of fiscal 2014, surpassing the Zacks Consensus Estimate of $33.6 billion.

Quarter in Detail

McKesson operates through two segments: Distribution Solutions and Technology Solutions.

Revenues at the Distribution Solutions segment increased 10.4% year over year to $33.5 billion in the reported quarter due to strong market growth across pharmaceutical direct distribution and services. Revenues from the U.S. pharmaceutical distribution business came in at $29.3 billion, up 9.0% year over year.

Revenues from Canada were up 5.8% to $2.8 billion driven by market growth and new customer wins.

Revenues from Medical-Surgical distribution and services surged 67.3% to $1.5 billion due to the addition of PSS World Medical. We note that McKesson closed the acquisition of PSS World Medical Inc. in Feb 2013.

Revenues at the Technology Solutions segment were up 6.2% year over year to $784 million driven by growth in services (+10.0%), partially offset by a decline in software revenues (-11.0%). We remind investors that the company streamlined operations in this segment and sold its international technology and hospital automation businesses during the fiscal first quarter.

Operating expenses (on an adjusted basis) climbed 13.0% in the reported quarter to $1.2 billion.

Fiscal 2014 Outlook Lowered

McKesson now expects earnings (excluding special items) from continuing operations in the range of $8.05–$8.20 in 2014, down from the earlier estimate of $8.40–$8.70 per share.  Even though the Distribution Solutions is expected to perform well in the fourth quarter, the decline in guidance came on the back of charges related to Canadian dispute and restructuring charges in the Technology segment (related to Horizon Clinicals software platform). 

Moreover, McKesson had expected a recovery in demand in its Medical Imaging business which did not materialize. The guidance excludes the impact of Celesio acquisition.

Update on Celesio Acquisition

After a failed bid, McKesson finally managed to secure the acquisition of Celesio through the agreements signed last week. McKesson reached an agreement with Franz Haniel & Cie. GmbH, the leading shareholder of Celesio.

As per the agreement, McKesson will acquire the entire stake of Franz Haniel & Cie. GmbH in Celesio for €23.50 per share. McKesson also announced the acquisition of convertible bonds of Celesio from Elliott, a stakeholder in Celesio. The agreements with Haniel and Elliott will enable McKesson to obtain the minimum requisite of a 75% stake in Celesio for the acquisition to go through. McKesson expects to close the transactions by Feb 6, 2013.

The combined group is expected to have annual revenues in excess of $150 billion. McKesson expects to realize annual synergies between $275 million and $325 million by the fourth year of obtaining operational control of Celesio.

McKesson expects to launch a tender for the remaining outstanding common shares of Celesio in the fiscal fourth quarter. The company anticipates gaining operational control of Celesio in the first half of fiscal 2015.

Our Take

Third quarter results did not surprise us. We are impressed with McKesson’s relentless efforts to acquire Celesio. McKesson has a history of successful acquisitions. We believe the Celesio acquisition is a step in the right direction and will allow McKesson to gain a foothold in Europe, thereby geographically expanding its core operations further.

We note that rival AmerisourceBergen (ABC) entered into a strategic ten-year pharmaceutical distribution agreement with Walgreen (WAG) and Alliance Boots GmbH in 2013.

McKesson currently carries a Zacks Rank #3 (Hold). Right now, Cardinal Health (CAH)  looks attractive with a Zacks Rank #2 (Buy).

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