This Stable Value Stock Is Built To Weather Market Storms

It is hard to say anything about McKesson that we have not said before — it is a high-quality business with extremely cheap shares.

The pharmaceutical distributor should earn around $15 in 2020 and will IPO its technology business, which will unlock another $20-30 of value. McKesson stock is not just cheap — it’s incredibly cheap. If we take the current $127 price and take out $25 for the technology business, we are paying about $100 for $15 of earnings — less than 7 times.

Each business has an internal business cycle. Sometimes it is linked to the economy — such businesses are usually called “cyclical.” Others have internal industry dynamics that have nothing to do with the economy.

McKesson, for example, benefited tremendously when billions of dollars worth of branded drugs lost their patents and went generic between 2009 and 2015.

This wave of profitability impacted McKesson shares. Increased profitability of generics brought new, smaller competition in the generics space, attracted by a larger profit pie. The competitive dynamics of drug distributors had not really changed much, but McKesson and other distributors were overearning — their margins were too high. Growing revenues and expanding margins resulted in tremendous earnings growth, which brought “growthy” investors into McKesson’s shareholder base. As the generics wave sagged, McKesson’s margins declined to their normal level and so did earnings. These new shareholders fled, driving the stock down.

That is when we bought the stock. Since then the market has new worries about the stock. One is that Amazon.com is entering the drug distribution business. We wrote about this non-threat earlier this year, so we won’t go into here. A second perceived threat to McKesson and other drug distributors is political. The White House is attacking the archaic way drugs are priced in the U.S. — and rightfully so.

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