Two Pitches for the Price of One: CareFusion and Cardinal Health
A potential buying opportunity arose in a stock that I am a big fan of yesterday that I thought some of my CAPS friends would find interesting. I am currently a shareholder of a pharmaceutical distribution company called Cardinal Health (CAH). I like CAH because the company is reasonably values, has raised its dividend every year since for the past thousand years, and it should benefit from several trends in the healthcare sector, including the large number of medications that are scheduled to go generic in the coming years, any expansion of the number of insured by the recent healthcare legislation, and the aging population.
Yesterday a Cardinal competitor, Medco Health Solutions (MHS) brought down the entire drug distribution sector, including Cardinal Health, when it stated in its quarterly conference call that not as many drugs as it had originally expected were going to go generic in 2011 and it might fall a little short of its forecasts.
Mr. Market completely ignored the fact that the generic pipeline is set to ramp right back up again in 2012. I'm very content to sit on CAH and collect its dividend while I wait for the huge tailwinds that are scheduled to begin blowing at some point over the next several years arrive.
Not only has Cardinal Health presented investors with an attractive entry point, but its recent medical device spin-off, CareFusion (CFN), has as well.
CareFusion makes a variety of medical devises including patient identification systems for hospitals, IV pumps, automated dispensing systems, and ventilation / respiratory-related products.
I missed the boat by not purchasing CareFusion immediately before or after its spin-off from CAH. CFN took off like a rocket, soaring from $17.25 to $30/share before coming back to Earth slightly and settling in at its current $21.50/share.
As Joel Greenblatt described in his outstanding book, You Can Be a Stock Market Genius, the stock of spun-off companies often performs extremely well because this sort of special situation allows the new company to provide significant incentives to its management, use its own stock and capital to pursue acquisitions and growth initiatives, and have a management that is able to focus on its core business rather than one that is distracted with the day to day operation of the former parent company.
The company's stock has been falling despite the fact that there was recently a major positive development in its largest business line, infusion pumps. This segment currently accounts for a quarter of CareFusion's revenue. Its largest competitor there, Baxter International (BAX) has been devastated by problems with its products in the sector. It was just forced by the Food and Drug Administration to recall its competing product in the infusion pump segment. The recall impacts 200,000 units, which amounts to 25% of the potential market for this product over the next two years. This disaster for Baxter should open the door for CareFusion to steal market share in the coming months.
At twenty times trailing earnings, CFN isn't dirt cheap by any stretch of the imagination. However, the stock is significantly cheaper than it was a few short months ago. Plus, while I am loathe to look at forward earnings, CFN is supposedly currently only trading at forward P/E of 12.5 times.
Another potential catalyst for an increase in CFN's stock is an improvement in margins. One might say, margins, smargins at first glance, but this is a legitimate opportunity for the company to improve the price of its stock. Heck, Bill Ackman's entire thesis for investing in Kraft (KFT) revolves around the company's ability to improve its margins.
CareFusion's margins are currently among the worst in its sector, its operating margin is 13% compared to Baxster's 19%, so there's ample opportunity for the company to improve.
I have decided to go long CareFusion in CAPS today with a starting price of around $21.50/share.
I came up with everything in the Cardinal Health portion of this post on my own. I have been long the company for some time. Some of the data for the CareFusion portion of this post came from a great Seeking Alpha interview with Mark C. Minichiello, the CIO of QCA Capital Management (link).