Cardinal Health Inc. (CAH) Updated July 3rd, 2018 by Nick McCullum

Key Metrics Current Price: $50 5 Year CAGR Estimate: 21.8% Volatility Percentile: 70.1%

Fair Value Price: $83 5 Year Growth Estimate: 9.0% Momentum Percentile: 3.2%

% Fair Value: 76% 5 Year Valuation Multiple Estimate: 8.9% Valuation Percentile: 98.8%

Dividend Yield: 3.9% 5 Year Price Target $129 Total Return Percentile: 98.8%

Overview & Current Events Cardinal Health is one of the “Big 3” drug distribution companies along with McKesson (MKC) and AmerisourceBergen

(ABC). Cardinal Health serves over 24,000 United States pharmacies and more than 85% of the country’s hospitals.

Cardinal Health is a global company with operations in over 60 countries and approximately 50,000 employees. With 32

years of consecutive dividend increases, Cardinal Health is a member of the Dividend Aristocrats Index.

Cardinal Health shares lost most than 20% of their value after the company reported (5/3/18) financial results for the

third quarter of fiscal 2018. In the quarter, revenue increased 6% to $33.6 billion while operating earnings declined by

10% and GAAP earnings-per-share decreased by 33%. On an adjusted basis, operating earnings increased by 3% and

adjusted earnings-per-share decreased by 9%. The company’s performance was “adversely affected by a significant

negative change in our effective tax rate primarily associated with our Cordis business.” More specifically, the company

reported an effective tax rate of 45.1%, up significantly from the 32.3% effective tax rate reported in the prior year’s

period. The issue is complicated but is nicely summarized in the following passage from Cardinal Health’s earnings call:

“the downturn in Cordis performance results created certain losses in certain judications where we cannot take the

benefit of those operating losses from a tax perspective.” Importantly, the company’s CFO also stated, “we expect to see

a decline in our tax rate going forward.” Management shared on the earnings call that earnings would have been $1.52

if not for the Cordis issue, up 9.4% from the $1.39 of adjusted earnings-per-share that were actually reported.

Because of this poor quarter of performance, Cardinal Health has revised its 2018 financial guidance. With one quarter

remaining in the fiscal year, the company now expects to generate adjusted earnings-per-share between $4.85 and

$4.95, down from previous guidance for earnings-per-share between $5.25 and $5.50. Of course, this revised guidance is

due to the performance of Cordis and its negative effect on the tax rate.

Growth on a Per-Share Basis Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2023

EPS $3.80 $3.48 $2.22 $2.67 $3.21 $3.73 $3.84 $4.38 $5.24 $5.40 $4.90 $7.50

DPS $0.52 $0.60 $0.74 $0.82 $0.88 $1.09 $1.25 $1.41 $1.61 $1.81 $2.02 $3.25

We are updating our 2018 earnings estimate to reflect Cardinal Health’s recently-revised financial guidance. Of course,

this also impacts our assessment of the firm’s valuation and future earnings growth capability. Our new per-share

earnings estimates are $4.90 in 2018 and $7.50 in 2023.

Cardinal Health’s financial results around 2009 and 2010 are materially impacted by its spinoff of CareFusion

Corporation, which was completed on September 1, 2009. Despite this spinoff, the company’s segment revenues,

segment earnings, and per-share dividends continued to grow during this tumultuous operating period.

Since 2010 – the first full fiscal year after the CareFusion spinoff – Cardinal Health has compounded its adjusted

earnings-per-share at 13.5% per year. We believe that this growth rate is likely higher than what the company will

achieve over the long-term. Our long-term earnings-per-share growth estimate for Cardinal Health is 9% per year.

Valuation Analysis Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Now 2023

Avg. P/E 9.4 7.4 15.4 15.9 12.8 13.6 18.9 19.6 15.0 13.3 10.1 15.5

Avg. Yld. 0.9% 1.5% 2.3% 2.1% 2.1% 2.5% 2.0% 1.7% 2.0% 2.4% 3.9% 2.0%

Cardinal Health has traded at an average valuation of 15.5 since 2010, the first year after the CareFusion spinoff. We

believe that a 15.5 earnings is reasonable for Cardinal Health, which gives a fair value estimate of $76. For context,

Cardinal Health is trading at $50, or a price-to-earnings ratio of just 10.1. If its valuation multiple can expand to 15.5

times earnings over the next 5 years, this will add 8.9% to the company’s annualized returns during this time period.

Safety, Quality, Competitive Advantage, & Recession Resiliency Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2023

GP/A 16.1% 14.9% 18.9% 18.2% 18.7% 19.1% 19.8% 19.0% 19.2% 16.3% 17.0% 18.0%

Debt/A 67.0% 65.3% 73.6% 74.4% 74.3% 76.9% 75.4% 79.2% 80.8% 83.0% 85.0% 75.0%

Int. Cov. 10.2 11.3 11.5 7.2 17.9 16.3 14.2 15.3 13.8 10.5 11.0 11.0

Payout 13.7% 17.2% 33.3% 30.7% 27.4% 29.2% 32.6% 32.2% 30.7% 33.5% 37.5% 39.2%

Std. Dev. 41.1% 43.8% 24.5% 25.9% 16.7% 19.0% 19.6% 20.2% 25.5% 23.9% 24.0% 22.0%

Although debt appears to be a significant component of Cardinal Health’s balance sheet, this is a bit deceptive. Because

of the company’s sourcing-and-distribution business model, Cardinal Health’s liability mix has a tremendous weighting

towards accounts payable – 45% of the company’s assets at the end of the most recent reporting period. This explains

how the debt-to-assets ratio has steadily increased without a corresponding deterioration in the company’s interest

coverage ratio.

Final Thoughts & Recommendation We believe that Cardinal Health’s investment thesis is very strong right now, primarily due to the company’s valuation.

Three factors are resulting in widespread market pessimism surrounding Cardinal Health. The first is the potential entry

of Amazon into the drug distribution industry, which has been worsened after the company’s recent acquisition of

PillPack. The second is Cardinal Health’s perceived role in the opioid crisis. The third factor is an ongoing price war within

the drug distribution industry. These challenges mean that today’s investors are being given a rare opportunity to buy an

excellent company at a great price. Accordingly, Cardinal Health earns a buy recommendation at current prices.

Total Return Breakdown by Year

3.6%

64.9%

22.7%

12.3%

-17.6%-12.4%

21.8%

-60%

-40%

-20%

0%

20%

40%

60%

80%

2012 2013 2014 2015 2016 2017 SureAnalysisEstimate

Cardinal Health (CAH): Total Return Decomposition

Total Return EPS Growth Dividend Return Valuation Change