Founded in 1833, McKesson Corporation is a leading healthcare services and information technology provider that plays a significant role in the pharmaceutical distribution sector, delivering one-third of all medications used in North America (McKesson - C, 2023). Headquartered in Irving, Texas McKesson Corp aims to “advance health outcomes for all” through their innovative healthcare solutions and products to healthcare providers, pharmaceutical manufacturers, and health plans globally (McKesson - D, 2023). As of 2023, the company has over 80,000 employees and operates in over 16 countries across the globe, marking it as one of the largest companies worldwide (McKesson - D, 2023). The company reported strong financial results in FY2023 with revenues increasing by 5% reaching $276.7 billion and earnings per diluted share growing by 9%. The company also returned $3.9 billion of cash to shareholders, including $3.6 billion in share repurchases signalling the confidence of the company in future growth potential (McKesson - A, 2023)

Generic Strategy

McKesson Corporation is at the forefront of enhancing patient care, operating through four distinct yet interrelated segments: U.S. Pharmaceutical, Prescription Technology Solutions (RxTS), Medical-Surgical Solutions, and International. These pillars enable McKesson to cover a comprehensive range of healthcare services, from global pharmaceutical distribution to the provision of over 285,000 products, including both nationally recognised and proprietary medical-surgical supplies and medical solutions across the United States and the globe (McKesson - R, 2023). This integrated approach is a testament to McKesson's dedication to advancing healthcare, with a culture centered on individualized attention: "one product, one partner, one patient at a time" (McKesson - D, 2023).

Backed by a solid financial foundation, McKesson has historically forged strategic partnerships to bolster their offerings and broaden their market presence. A prime example is their 2020 collaboration with Amgen, a pioneer in biotechnology, which aimed to enhance cancer care within community oncology networks. This alliance utilized McKesson's specialized oncology technology, Ontada, to revolutionize cancer treatment and facilitate the availability of groundbreaking therapies (McKesson - E, 2020). Looking ahead McKesson has a multi-faceted strategy aiming to sustain their competitive advantage and continue growth through:

1. Expedition of growth of their unique platforms for oncology and biopharmaceutical services.

2. Foster enduring growth within the foundational business by leveraging McKesson's established and resilient distribution capabilities and their compelling value offering.

3. Progressive refining and enhancement of the company's portfolio into high-value opportunities by completing the withdrawal from the European market and seeking strategic options to divest the ongoing business activities in Norway.

Value Proposition

Competitive Positioning

McKesson's diversified strategy blends differentiation and focus, positioning it to be the second-largest market cap in its sector, behind CVS Health. However, McKesson is in indirect competition, due to CVS's ventures outside of pharmaceuticals in areas such as insurance. The firms maintain a longstanding partnership, with McKesson renewing their mail-order and pharmaceutical distribution contract with CVS until 2027 (McKesson - K, 2022).

US Pharmaceuticals

McKesson's success is attributed to its U.S. Pharmaceutical supply chain, serving 40,000+ customers with branded, generic, specialty, and over-the-counter pharmaceutical drugs, via 27 nationwide 24/7 distribution centres that boast a 99.98% order accuracy rate (McKesson - A, 2023). The foundations of their efficient supply chain are built on their 2011 bet on automation, which has led to the use of guided autonomous vehicles to handle output in their national redistribution facility - reducing operational costs and increasing efficiency (McKesson, 2023).

Prescription Technology Segment

McKesson's RxTS segment has grown through strategic partnerships like CoverMyMeds and Relay Health (Santilli, 2021). RxTS increases the access and affordability of medication to patients by connecting them with over 50,000 pharmacies and 900,000 healthcare providers across the U.S. using electronic transmission of prescriptions, saving customers over $8 billion on brand and specialty medication costs since inception (McKesson - A, 2023). The success of RxTS is underscored by McKesson’s commitment to growth through both inorganic and organic methods to deliver value to customers through access to affordable medication.

Medical Solutions and International Segment

The final two business segments of McKesson consist of their medical-surgical solutions which provide supply distribution, logistics, biomedical maintenance, and more, to over 275,000 clients throughout the healthcare sector (McKesson - A, 2023). McKesson also has a global presence which is operated through their international segment which provides distribution and services to wholesale, institutional, and retail customers in Canada where they own, partner, or franchise with retail pharmacies (McKesson - R, 2023). However, due to the lack of value in their Europe operations, McKesson is divesting their operations in Norway and exiting the European market officially.

FY 2024 Profit Decomposition (Refinitiv, 2023)

Macroeconomic Dynamics

The Fed has taken a hawkish approach to combat high inflation by increasing rates by 5.25% since March 2022. Consequential, tighter credit markets and output reductions have and will continue to dampen consumer spending and increase economic uncertainty, illustrated by the reduction in GDP growth by 22% since July 2023 (U.S. Bureau of Economic Analysis, 2023). Despite no rate movement in the recent Fed meetings, Fed Chair Powell has suggested rates may stay higher for longer to achieve their inflationary target which will continue to hamper spending and output. While it is not the objective, the possibility of a recession because of the hawkish stance of the Fed is real. In 8 of the recessions since WWII, the housing market decline has been a leading indicator demonstrating some predictive value, since September 2022, there's been a 15.8% drop in available houses and an 11.4% decrease in new listings, largely due to rising mortgage rates (Refin, 2023; Leamer, 2007).

The nature of the healthcare industry is non-cyclical and protects companies from harsh economic conditions as the demand for medication will not diminish significantly. During past recessions, including the early 90s, early 2000s, and the 2007-09 financial crisis, healthcare expenditure in the U.S. rose as a share of GDP, indicating that medical spending remained stable even as other sectors contracted (Lo, 2020 ). McKesson falls under this umbrella and has a beta of .5302, however, its business segments are still exposed to risks from the higher interest rate environment:

Operating and input costs will increase throughout McKesson’s distribution centres, putting pressure on the recent resilient revenue growth and cash flows of the firm. If increased expenses were fronted into prices, it may incite consumers to look elsewhere for medical solutions.
Part of McKesson’s strategy is to enhance its product and service offerings through M&A activity such as the recent acquisition of Rx Savings Solutions (RxSS) to increase its RxTS offerings (McKesson - P, 2022). However, in periods of tight credit markets and economic uncertainty companies may seek to preserve cash and shift focus away from growth strategies. This may impact the growth strategy of McKesson’s oncology and biopharmaceutical services.
Revenues of their higher markup branded medications may decrease as consumers substitution for cost-effective generic medications.
Sales of their medical solutions segments may decrease as consumers limit hospital visits due to the higher costs.

Industry Analysis

Bargaining Power of Buyers

Tough and turbulent times lie ahead for consumers and while they will not be able to fully substitute the use of medication, they have a high level of bargaining power to backward integrate or to substitute generic medications and OTCs for branded products. Shifts in consumer behavior will adversely impact the demand and margins of key customers of McKesson who may force their hand to negotiate more aggressively with distributors for lower prices or shift to lower-cost distributors. McKesson has positioned itself well to reduce the power of customers through vertical integration of subsidiary Health Mart, which owns and operates over 5,000 pharmacies across 50 U.S. states and reduces the possibility of being undercut in price by competitors. (McKesson - H, 2023). The company also signed a sourcing agreement with Walmart in 2016 for generic pharmaceuticals and an expanded long-term distribution agreement, the agreement has delivered scale and volume for both companies while reducing the bargaining power of both the buyer and supplier (McKesson - J, 2016).

Strong and healthy customer relationships will also guarantee healthy demand and price levels, McKesson’s recent 5-year business agreement with retail pharmaceutical conglomerate CVS Health until 2027 illustrates the quality of their customer relationships (McKesson - K, 2022). It is also worth noting that McKesson provides products and services to more than half of hospitals in the US and 96% of the top 25 health plan providers (Vaisala Inc, 2023), demand for which will not falter due to the inelasticity of their portfolio offerings. Sound strategic decisions and relationships have allowed McKesson to reduce the level of power buyers have over them, however, must continue to be vigilant when monitoring consumer behavior to hold their strong market position.

Supplier Power

In the pharmaceutical sector, the number of qualified suppliers is constrained by the substantial knowledge, capital, and regulatory compliance required, not to mention the patents held by industry leaders such as Pfizer and Johnson & Johnson. This concentration typically elevates supplier bargaining power.

Yet, McKesson has effectively mitigated this power through longstanding operations spanning over two decades, fostering strong relationships that balance the dynamics between supplier and distributor. Since 2006, the CDC has relied on McKesson for the critical distribution of vaccines under the Vaccines for Children Program, reaching over 1.8 million children via roughly 44,000 healthcare providers (McKesson - S, 2023). The noted diversification into high-value oncology and biopharma businesses - including a joint venture with HCA Healthcare — will further diversify its supply base, thus enhancing its negotiating leverage and reducing future supplier dependency (McKesson - L, 2023). These initiatives underscore McKesson's proactive approach to reinforcing its market position against the backdrop of supplier influence.

Despite measures made to limit the bargaining power of suppliers, their largest business segment relies heavily on suppliers. Therefore, the company will always be subject to some power of suppliers due to their low numbers.

Threat of Substitutes

In the pharmaceutical wholesale landscape, the threat posed by substitute distribution models is generally perceived to be moderate to low. This is primarily due to the substantial initial capital investment required for pharmaceutical companies to establish distribution networks and cultivate relationships with retail pharmacies. Despite this, some pharmaceutical giants, notably Pfizer and GlaxoSmithKline (GSK), have pioneered the 'Direct to Pharmacy' (DTP) approach. However, this innovation faced resistance from wholesalers and has consequently been limited to select products. McKesson has responded by facilitating a direct-to-patient distribution channel, offering manufacturers an alternative pathway to reach consumers (Singhvi, 2012). For certain specialty drugs, such as Jazz Pharmaceuticals' narcolepsy treatment Xyrem, manufacturers opt for direct distribution to ensure stringent control and safety due to the drug's need for careful handling and potentially severe side effects if misused (Taylor, 2010). It is in cases such as this that McKesson may not be able to mitigate the threat of substitutes due to safety concerns surrounding its handling.

Competitive Market With High Barriers to Entry

The financial analysis comprehensively illustrates the competitiveness of the pharmaceutical distribution industry with McKesson’s peers illustrating higher levels of growth than them. The competitive rivalry of the industry is high as the industry is mature with established market leaders. Firm growth comes from taking market share from competitors through technological advancements and pricing strategies.

There are also high barriers to entry to the industry including significant capital investment, specialised logistics, and compliance with strict regulatory standards which diminish the probability of market share being taken from new entrants. Established companies such as McKesson would have a significant cost advantage over new peers with lower fixed costs per unit, giving them a competitive edge over companies who are looking to break into the industry. However, the company should be cognisant of technological advancements and research in the supply chain industry that may lower the barriers to entry into the industry.

While several factors present a high level of risk to McKesson’s market position as illustrated throughout the investment risk section (below), the company has been able to utilise its resources effectively to limit the threats of such risks through growth projects into new markets, strategic acquisitions and longstanding quality relationships and agreements with suppliers and customers.

Investment Catalysts

Goodbye Obesity

In November 2023, the FDA approved Zepbound, a new injection-based medication designed for chronic weight management in patients with at least one weight-related condition (FDA, 2023). This approval follows successful clinical trials where Zepbound demonstrated a statistically significant reduction in body weight compared to placebo recipients. In the United States, the obesity epidemic is widespread, with approximately 70% of adults classified as obese or overweight. This demographic incurs notably higher medical costs – an average of $1,861 more per individual than their non-obese counterparts (FDA, 2023; Centre for Disease Control and Prevention , 2023).

The combination of Zepbound's approval and the high prevalence and escalation of obesity in the US underscores a substantial market opportunity for this medication. The projected growth in demand for Zepbound is considerable, signalling a potential surge in revenue and market share for McKesson. Despite the inevitable competition for distribution contracts, McKesson's expansive and sophisticated supply chain and distribution network position the company competitively to capitalize on this emerging market opportunity.

The Patent Cliff

The patent cliff describes the phase when pharmaceutical patents expire, leading to the end of exclusivity and enabling competitors to manufacture similar products. This scenario creates a fertile ground for McKesson to expand its generic medication offerings. Notably, 54 drug patents are set to expire in 2024, and in 2023, the patent for Humira, the world's second highest-selling drug in 2021, is expiring, with Amgen already initiating production of a biosimilar version in January 2023 (GreyB, 2023; Mock, 2023). The biopharma sector anticipates several impactful patent cliffs from 2023 to 2030, poised to transform the market landscape (Mock, 2023).

For McKesson, these patent expirations present significant opportunities, especially in increasing the availability of cost-effective generics, thereby enhancing their market presence and sales. This change fosters competitive pricing and opens new customer segments, strengthening ties with generic drug manufacturers. McKesson is well-positioned to utilize these market shifts to bolster its market share and revenue, particularly in its RxTS segment, while also contributing to the broader goal of healthcare affordability.

Oncology Opportunities

McKesson's strategic focus on augmenting its oncology network, exemplified by its collaboration with Nashville Oncology Associates, expands its reach of cancer care, particularly in the Nashville area (McKesson - V, 2023). This move complements its already extensive network, including partnerships with US Oncology Research and the Sarah Cannon Research Institute, as well as its oncology technology division, Ontada. McKesson's oncology portfolio supports a vast network of independent providers, aligning with the anticipated growth in the global oncology drug market, which is expected to surge to $484.32 billion by 2030, at a 13.0% CAGR (Fortune Business Insights, 2023). The American Cancer Society's projection of approximately 1,958,310 U.S. cancer cases by the end of 2023 underscores the growing demand for McKesson's specialized services, potentially enhancing its market share and revenue (Fortune Business Insights, 2023). The vast service offerings position McKesson suitably to capture the growth of the oncology market while also being able to deliver on core values of advancing patient outcomes.

Investment Risks

Litigation Worries

From the late 2010s to 2022, McKesson, alongside Cencora and Cardinal Health, was accused by US states of contributing to the opioid crisis in the US. They were accused of failing to prevent illegal opioid diversion, a situation linked to approximately 500,000 overdose deaths from 2009 to 2019 (Reuters, 2022). Opioids have been found to reduce pain and induce sedation however they also have harmful effects which increase with higher doses such as respiratory depression, addiction, tolerance, dependence, and overdose. The litigation settled in February 2022 whereby the companies involved agreed to resolve all opioid-related lawsuits in return for a 19.5 billion payout to the communities of 46 of 49 eligible states over 18 years (McKesson - G, 2022). McKesson is required to pay the most from the accused of $7.4billion.

The association with opioid lawsuits may strain relationships with suppliers and customers wary of negative publicity. Furthermore, the potential for future legal challenges could divert company resources, diminishing investor confidence and possibly shifting investment towards competitors. The perceived risk of ongoing litigation may weigh on McKesson's market standing as a leading healthcare distributor, influencing stakeholder trust, and ultimately impacting the firm's valuation.

FDA Game Changer

In February 2022, the FDA's Drug Supply Chain Security Act (DSCSA) introduced new regulatory frameworks for wholesale drug distributors and pharmacies, requiring enhanced FDA reporting, inspections, and product tracing. Retail pharmacies face heightened regulatory obligations, as transactions above a 5% threshold for office use, or any sales to wholesalers, will need a pharmacy license as a distributor to prevent unauthorized sales (Rumore, 2022). While DSCSA requirements are not required until November 2024, McKesson is adapting operations for DSCSA compliance and is committed to aiding customer integration of the complex regulations (McKesson - Q, 2023). The impact of DSCSA on McKesson’s value is reliant on firm proactiveness to comply, lack of compliance will result in fines and penalties for McKesson and reduce shareholder returns, which may prompt shareholders to invest in compliant competitors.

ESG Analysis

Environmental

Joining 2,000 companies globally, McKesson has committed to achieving their target GHG emissions to limit global temperature rising to 1.5 degrees. With the approval of SBTi, they have committed to reducing GHG emissions by 50% by FY2032 from base year FY2020 and ensuring that 70% of their suppliers have their own GHG SBTi reduction targets approved by 2027 (McKesson - N, 2023). McKesson’s GHG reduction approach includes procurement of renewable energy to enhance their efficiency, illustrated by an agreement signed with a renewable energy project developer (VPPA) to purchase 15 MW of renewable energy for a solar project in Texas and solar panels in their distribution centres – some of which have met 63% of electricity needs since they went online (McKesson - N, 2023).

Sustainability

In the past McKesson has come under fire for its labour practices, particularly related to employee compensation in 2013 however it seems the firm has learned. McKesson now promotes a workplace with a sense of purpose and appreciation for the voice of their employees (McKesson - N, 2023). In 2022, McKesson piloted health literacy and financial stability programs to provide improve employee wellbeing, 98% of health literacy attendees reported finding them helpful and 91% said they will change how they take care of their family after the program (McKesson - N, 2023). McKesson also offers a Scholarship assistance scheme for children of employees for a full scholarship to the accredited institution of the student’s choice. In 2023, McKesson was part of “America's Best Large Employers” as voted by Forbes, highlighting their progress in labour practices (McKesson - N, 2023).

Governance

McKesson regards sound governance principles as a crucial element of long-term value delivery to shareholders. Their governance and sustainability committee take a broad view of diversity to include all backgrounds and genders. Of their five board committees three are chaired by women and currently, 36% of board members are women. In 2023, McKesson won awards for “America’s Greatest Workplace for Diversity” by Newsweek and “Best Employers for Diversity” by Forbes (McKesson - N, 2023). The diverse and equally represented workforce of the firm is presented in the table below, underscoring how crucial equal representation is to McKesson in delivering value to shareholders.

Financial Assessment and Peer Analysis

Profitability

McKesson Corporation has established itself as a frontrunner in the pharmaceutical supply chain sector, leveraging innovative solutions, strategic partnerships, and an efficient supply chain network to clinch a market-leading position. Over the past five years, McKesson has outstripped its peers, reflected in its superior share price appreciation and consistent expansion.

Dissecting revenue growth, McKesson's competitors, namely Cencora and Cardinal Health, have surpassed growth rates of 9.35% and 8.47%, respectively. Despite this, McKesson's consistently higher operating profit and EBITDA margins highlight a more profitable operational framework. The fluctuation in asset turnover ratios does not overshadow McKesson's robust competitive stance, reflecting an efficient allocation and utilization of assets in driving sales. This is further corroborated by an impressive Return on Invested Capital (ROIC) of 91.8%, underscoring McKesson's adeptness in deploying assets to yield shareholder profits (Refinitiv Eikon, 2023). These indicators of market-leading profitability and operational efficiency bolster investor confidence in McKesson's potential for sustaining shareholder returns in the foreseeable future.

Shareholder Relationships

Shareholders have been rewarded for the past operational success of McKesson, the company has had a dividend yield of .6% for the past two financial years and a repurchase programme mentioned in the company overview (Refinitiv Eikon, 2023). However, McKesson's dividend yield pales in comparison to its peers—with Cardinal Health and Cencora yielding 19.3% and 1.05%, respectively (MarketBeat, 2023). This discrepancy suggests that although McKesson is returning value to its shareholders, there is room to escalate this value to stay competitive.

Valuation

Given the capital-intensive nature of the pharmaceutical distribution industry, the EV/EBITDA, P/E and FCF yield are employed to analyse the valuation of McKesson relative to its peers. McKesson has an EV/EBITDA multiple of 9.47 below that of competitors, given McKesson’s strong multiples EV/EBITDA valuation may insinuate an undervaluation of McKesson relative to its peers and an attractive investment (Refinitiv Eikon, 2023). Potential undervaluation is further underscored relatively low P/E ratio of 13.32 however share buybacks in April 2023 of 1.8 million may buoy share prices and explain the depressed figures (S&P Capital IQ, 2023). Despite the potential ramifications of the share buyback scheme, McKesson boasts the lowest P/E of competitors who are also engaging in buyback schemes (Cencora, 2022; Cardinal Health, 2023). Share price hitting a 52-week high recently, conjoined with low multiple indicates potential undervaluation of McKesson.

Debt

McKesson has demonstrated a reduction in debt since 2019, witnessing a decline of 26.3%, accompanied by a corresponding decrease in interest payments. Notably, there was a minor uptick in interest expenses in 2023, which can be linked to rising interest rates. This trend positions McKesson advantageously as it navigates through periods of economic uncertainty. Concurrently, the efficiency of the company's capital deployment has seen improvement, as high Return on Invested Capital (ROIC) of McKesson. With an interest coverage ratio standing at a robust 18.62, McKesson is well-equipped to meet its debt obligations. The quick ratio, currently at 0.51, does not present significant worry as it aligns with industry peers (Refinitiv Eikon, 2023). McKesson's FCF trajectory in exhibit 19 delineates a strong liquidity position that also beats competitors. Moreover, an average inventory turnover of 26.58 days and the sustained demand driven by the non-discretionary nature of their products bolster the company's defence against liquidity challenges (Refinitiv Eikon, 2023).

Investor Sentiment

An analysis of McKesson would not be complete without recognition of the market sentiment of the company. As of November 19th, 2023, JP Morgan Chase raised its potential upside of McKesson to $514, presenting an “overweight” rating on the stock (Zolmax, 2023). They joined UBS Group which raised the potential upside to $480 and rated the company a “buy” (NewsRoom, 2023). While such recommendations and positive sentiment will not directly influence the share price, they can provide certainty for investors who may be on the fence about investing in McKesson.

Investment Recommendation

Based on the comprehensive analysis of McKesson Corporation, the investment recommendation for the company is a strong buy. The company has a dominant market position with a distinct product and service portfolio to diversify revenues and a clear growth strategy, particularly in their oncology segment. The company has demonstrated the ability to extract value from global technological shifts with their automation bet, utilise M&A for growth and withdraw from offerings they do not believe extract maximum value as seen with their divesting of operations in the EU. The company has reported exciting revenues and earnings growth trends with each earnings announcement and is well-positioned to capture the value opportunities within the pharmaceutical industry including the approval of diet medication Zepbound, an ageing population and a future patent cliff. Competitors pose a high level of risk for the firm; however, performance metrics have shown that they operate at a higher efficiency compared to their peers and could potentially be undervalued based on multiple analyses. Financial health and increasing profit levels position the firm well to weather a potential macro-economic downturn, the low beta value and non-cyclical nature of their business offerings may also attract investors to McKesson as a safe investment in turbulent times who reward shareholders through dividends and buyback schemes.

McKesson Corp - Quality at a Discount