Update on McKesson

I first looked at MCK almost exactly two years ago. I used puts to enter into a position June-Dec 2018. My effective cost basis is about $124. Currently, the stock trades between $140-$150.

Over the past two years, revenue has increased from $202B to $220B. A massive buyback at attractive prices has reduced share count by over 12% (214M to 188M). The sword of a punishing opioid settlement hangs over MCK, and half the health care industry. But let’s leave that aside for now, and look at normalized earnings power.

The company guided adjusted EPS of $14.50/share for the upcoming year. This is reasonable considering 5% growth in revenues, and 1.2% net income or FCF margin [$222B * 1.05 * 0.012 = $2.8B or ~ $14.50/share]. Litigation aside, the core business is above average, and should command at least a market multiple on earnings [15-18x] giving it an enterprise value of $42-$50B. Net debt is about $5B. Let us be lazy, and just subtract that outright to yield about $37B-$45B equity value or per share appraisal of $195-$240.

Now let us turn to the litigation part. For a primer see this and this (NPR). There is a fair bit of helpful disclosure on MCK’s website. We still need some numbers. This academic paper suggests an annual cost of $80B (comparable with the SNAP program).

The settlement of drug distributors (and Teva) with two Ohio counties was $260M. MCK took a $82M charge in 2Q 2019 to reflect that.  There was some rumor that distributors had settled the nationwide case for around $18B to be paid out over 18 years. We can just add this liability (MCK’s share) to long term debt.

The present value of this for MCK is probably around $4-5B. This implies a loss of $25-$30 of value per share. Accounting for this gives us a $165-$210 target price range [say $185 point estimate]. In any case, the downside seems reasonably well-capped at current prices.

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