Updated on March 18th, 2021 by Bob Ciura
When it comes to dividend growth stocks, not many stocks can surpass the Dividend Aristocrats. The Dividend Aristocrats are a group of 65 stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases. These companies have managed to increase their dividends every year without exception, even during recessions.
The Dividend Aristocrats have a proven ability to raise their dividends even during economic downturns. We have created a full list of all 65 Dividend Aristocrats, along with important metrics such as price-to-earnings ratios and dividend yields.
You can download an Excel spreadsheet with the full list of Dividend Aristocrats by clicking on the link below:
But even Dividend Aristocrats can encounter challenges from time to time. One of the Dividend Aristocrats battling through a tough climate is healthcare distributor Cardinal Health (CAH).
Cardinal Health is currently challenged by falling drug prices, fallout from the opioid crisis, and the threat of new competition in pharmaceutical distribution. As a result, shares are trading ~30% lower than where they were five years ago.
At the same time, the company has increased its dividend for over 30 years in a row. This track record speaks to the resilience of Cardinal Health’s business model.
The company is still highly profitable, and is making progress in its turnaround initiatives. Cardinal Health is an attractive dividend stock, due to its 3.4% dividend yield and annual dividend increases.
Cardinal Health, founded in 1971, 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 80% of the country’s hospitals.
The company has two operating segments: Pharmaceutical and Medical. The Pharmaceutical segment is by far the company’s largest, as it represents nearly 90% of total revenue. The pharmaceutical segment distributes branded and generic drugs and consumer products. It distributes these products to hospitals and other healthcare providers.
Meanwhile, the medical segment distributes medical, surgical, and laboratory products to hospitals, surgery centers, clinical laboratories, and other service centers.
The business climate for Cardinal Health is difficult right now, as it has been for the past few years. One of the biggest challenges for Cardinal is drug price deflation, which negatively impact margins in the company’s core pharmaceutical segment. Moreover, this could continue to be a challenge if political and competitive pressure on drug prices remain.
Adding to this concern is the potential for new entrants to the space, such as Amazon (AMZN) which acquired PillPack for $753 million. Previously. the razor-thin margins protected the “Big 3” drug distributors from outside competitors. But Amazon’s potential entry into the space is a significant threat to the established players. Still, Cardinal Health remains profitable and the dividend continues to be covered.
Since 2010 Cardinal Health has grown both earnings and dividends by a double-digit rate. However, this growth has stalled meaningfully in the last few years.
On February 5th, 2021 Cardinal Health released Q2 fiscal year 2021 results for the period ending December 31st, 2020. (Cardinal Health’s fiscal year ends June 30th.) For the quarter the company reported revenue of $41.5 billion, a 5% increase compared to Q2 2020. On an adjusted basis the company posted earnings of $514 million or $1.74 per share compared to $448 million or $1.52 per share in Q2 2020.
The most recent quarter was a significant step in the right direction for Cardinal Health, as the company posted 14.5% adjusted earnings-per-share growth. Once again, the medical segment led the way with 7% sales growth and 21% segment profit growth.
Source: Investor Presentation
For fiscal 2021, Cardinal Health expects adjusted earnings-per-share in a range of $5.85 to $6.10. This is an increase from previous guidance, which called for adjusted EPS of $5.65 to $5.95. For context, Cardinal Health’s fiscal 2020 adjusted EPS were $5.45, so at the midpoint of revised guidance the company expects adjusted EPS growth of ~10%.
Furthermore, there are multiple catalysts for the company to return to earnings growth going forward. A few of its specific growth catalysts include acquisitions, moderating price deflation, growth in specialty products and cost cuts. Taking these items collectively, we are forecasting 3% annual EPS growth over the next five years.
Competitive Advantages & Recession Performance
The biggest competitive advantage for Cardinal Health is its distribution capability, which makes it very difficult for competitors to successfully enter the market.
Cardinal Health distributes its products to roughly 90% of U.S. hospitals. It serves more than 29,000 U.S. pharmacies, as well as over 10,000 specialty physician offices and clinics. It also manufactures and distributes more than 50,000 types of Cardinal Health medical products and procedure kits. The company’s home healthcare business serves over 3.4 million patients, with more than 46,000 products.
In addition, Cardinal Health operates in a stable industry with high demand. The company should remain steadily profitable, as there will always be a need for pharmaceutical products to be distributed.
Here’s a look at Cardinal Health’s earnings-per-share during the Great Recession:
- 2007 earnings-per-share of $3.41
- 2008 earnings-per-share of $3.80 (11.4% increase)
- 2009 earnings-per-share of $2.26 (40.5% decline)
- 2010 earnings-per-share of $2.22 (1.8% decline)
While part of this is recession related, keep in mind that Cardinal Health’s financial results were materially impacted by its spinoff of CareFusion Corporation, which was completed in 2009. Despite this spinoff, the company’s segment revenues, segment earnings and dividend continued to grow during this time.
Moreover, earnings returned to growth in 2011 and had a strong run through 2017. Since people will always need their medications and healthcare products, regardless of the economic climate, Cardinal Health could be considered more recession-resistant than the average company.
Valuation & Expected Returns
Based on anticipated adjusted earnings-per-share of $5.98 for fiscal 2021, and a share price near $59, Cardinal Health is currently trading at a P/E ratio of 9.8.
Cardinal Health has traded hands with an average P/E ratio of about 14-15 times earnings dating back to 2010. However, this was during a time when growth was much more robust. We have used a multiple of 10x earnings as a starting place for fair value in recognition of our lower anticipated growth rate and risks in the industry. Given the current valuation, this implies a small 0.4% annual boost to shareholder returns over the next five years.
That said, if the company can return to positive earnings growth, it could justify a higher valuation. For example, Cardinal Health stock could see its valuation improve due to reduced litigation risk. Still, we prefer to be cautious when it comes to the fair value estimate.
In addition to changes in the valuation multiple, future returns will be generated from earnings growth and dividends. We expect Cardinal Health to grow earnings-per-share by 3% per year, primarily from revenue growth and share repurchases.
Finally, the stock has a current dividend yield of 3.4% due partly to an expanding payout ratio, but mostly as a result of a lower share price in the last few years. While the pace of dividend growth has slowed, the starting yield is solid. As a Dividend Aristocrat, Cardinal Health is likely to continue raising its dividend each year. Moreover, the dividend appears secure, with a projected dividend payout ratio of approximately 32% for fiscal 2021.
Putting all the pieces together – average growth and an above dividend yield offset by a small valuation headwind – our expected total return for Cardinal Health is 6.8% per year over the next five years. This qualifies Cardinal Health stock as a hold right now.
The economics of the healthcare distribution industry have deteriorated in recent years. This has impacted all the major players, including Cardinal Health.
Fortunately, Cardinal Health continues to grow revenue. And, the company has put in place a number of initiatives that should return it to positive earnings-per-share growth going forward.
High-quality companies like Cardinal Health have withstood difficult periods before, and will do so again. The history of the company, its dividend history, and its high current yield of 3.4% make the stock attractive for income investors. Total expected returns remain below our requirement for a buy rating, making the stock a hold.