McKesson Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

McKesson is a healthcare services company that distributes pharmaceuticals, provides healthcare technology, and offers business support solutions. It operates primarily in North America and Europe, serving pharmacies, hospitals, and other healthcare providers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

  • McKesson is a diversified healthcare services company with three main segments: U.S. Pharmaceutical, Prescription Technology Solutions (RxTS), and Medical-Surgical Solutions, and a small international segment.
  • U.S. Pharmaceutical is the largest segment and it supplies branded and generic pharmaceuticals, over-the-counter products, and other healthcare products to retail chains, independent pharmacies, and health systems in the United States. It includes pharmaceutical distribution, direct-to-patient dispensing, specialty pharmaceutical services, and more recently, some digital health tools for pharmacists. The Company is known for having a huge distribution network with great coverage in the United States.
  • Prescription Technology Solutions (RxTS) segment provides enterprise-wide solutions for healthcare providers. These solutions include software, connectivity, technology and automation tools for things such as patient care, care delivery, inventory management, and pharmacy and payment processing.
  • Medical-Surgical Solutions provides medical-surgical supplies and solutions to hospitals, physicians, outpatient centers, and other healthcare providers.
  • International segment is smaller, and offers specialized pharmaceutical distribution and related services in Canada and Europe. McKesson Canada is a large pharmaceutical distributor. The company is trying to expand its reach in Europe.

Recent Developments & Management Outlook

  • The company is facing higher expenses primarily in relation to distribution and fulfillment. Management is focused on reducing costs through operational excellence initiatives, process improvements, automation, and AI integration in operations.
  • The company is planning to improve their margins by focusing on higher margin products and higher growth markets.
  • McKesson is leaning on building its data and analytics capabilities to generate insights from its massive amounts of data, and to provide analytics solutions to its customers.
  • The company continues to pursue growth opportunities through acquisitions, most recently acquiring the remaining shares of Rx Savings Solutions in January 2024, and has other potential acquisitions in the pipeline.
  • A key focus is the implementation of a company-wide operating system called “Unified Platform”, which is expected to improve efficiencies, reduce costs, and drive organic growth for the company.
  • Management is actively managing the company’s debt, and is committed to maintaining investment-grade credit ratings. The debt-to-capital ratio is being closely monitored. Management also mentioned they have a long-term target for debt.
  • The company continues to improve its share buyback program.
  • Management is closely watching inflationary pressures and their impact on the company’s costs.
  • The company is working on ways to streamline and automate processes while simultaneously improving the customer experience.

Financials in Detail

  • Revenue Trends: McKesson’s revenue is driven largely by the U.S. Pharmaceutical segment, which constitutes around three-fourths of its total revenue. While the U.S. Pharmaceuticals segment is showing stable growth, the Medical-Surgical segment has shown strong growth, and the Prescription Technology Services and International segments are growing at a faster rate than the U.S. Pharmaceutical segment.
  • Margins: McKesson generally operates in an industry with high sales but a lower net margin. The company’s net margin (net income/revenue) is around 1-2% . This is partially because of the way that the company makes money–it is a large distributor of pharmaceuticals, and the profits for distributors are always fairly thin. But the company is improving its operating margins by implementing operational excellence initiatives and process improvements.
  • Profitability: Profitability is measured by return on capital. ROIC has been in the range of 10-14% and is showing gradual improvements in the last few years.
  • Liquidity & Leverage: McKesson has a current ratio (current assets/current liabilities) that is approximately 1, which is slightly below the benchmark level of 2, but it is not problematic because of the predictable nature of the business. The company’s debt to total capitalization ratio has increased a little, but continues to be manageable. Management is focused on maintaining an investment-grade rating.
  • Cash Flow: A substantial portion of cash flow of the company comes from operations, and the company also uses this cash to buy shares and to pursue acquisitions.
  • Growth: The company has been growing its revenues through various methods including acquisitions and organic growth. Though there is still some level of debt, the growth has been mostly based on equity financing.

Moat Analysis

  • McKesson’s economic moat comes from its size and scale as well as switching costs related to its high degree of integration into customers’ businesses and complex regulatory issues related to the industry.
  • The company has vast distribution networks, especially for pharmaceuticals in the United States. The size of this network makes it extremely costly for a new competitor to enter the market.
  • There is an emphasis on customer loyalty–mostly because McKesson’s systems are integrated into its customers’ business operations.
  • There is a decent degree of regulatory compliance that can be hard for a new entrant to navigate.
  • Given all this, we are giving a moat rating of 3, because while some of the things provide a moat, some areas are vulnerable. The size and network effect gives the company an edge, but they are not impossible to replicate over time. While switching costs are good, they can be minimized in certain circumstances. And while regulatory compliance provides some protection, regulations can also change over time to harm business.

Risks to the Moat and Business

  • Generic Drug Pricing Pressure: Prices for generic drugs can be very volatile, and if prices for generic drugs drop due to competitive pressures, that can have a major effect on earnings and profitability for distributors.
  • Intense Competition: McKesson has several large rivals in each of the sectors it competes in.
  • Disruptive Technology: Disruptive technology, especially in the healthcare industry, might make distribution capabilities obsolete or shift competitive advantages in the industry.
  • Consolidation in Healthcare: Increased consolidation in the healthcare industry has given more power to a few companies who now have more bargaining power over suppliers.
  • Customer Concentration: A small number of customers drive a substantial portion of the company’s business. As a result, the loss of even one of those customers could have a negative impact on business.
  • Regulatory Changes: Changes in government regulations or healthcare policies can result in a major disruption in the business. This is particularly true in a heavily regulated industry such as the healthcare industry.
  • Increased Operating Costs: Costs related to distribution and fulfillment are increasing due to labor shortages, global issues, and inflation, which can reduce the net profit of the company.

Understandability

  • The basic business model of McKesson is pretty straightforward: distributing pharmaceuticals and medical supplies to healthcare providers, and providing technology solutions and business services.
  • However, its financial statements are really complex because of multiple segments, complicated acquisitions, accounting rules for pharmaceutical distribution, and also because of the nature of the business in which various adjustments, fair value calculations, and complex consolidations are present.
  • It takes a little bit of experience with financial statements and the healthcare industry to fully understand all the moving pieces of this business.
  • For these reasons, I am giving a rating of 2 to the understandability of the business.

Balance Sheet Health

  • McKesson has an adequate current ratio of close to 1, which is not ideal, but fine given the stable business model, strong cash flows, and consistent operations.
  • The debt to equity and debt to capitalization ratios are on the higher end, though management is committed to bringing down the ratio.
  • The company has generated enough cash from operations to be able to meet debt payment obligations.
  • Because of these factors, I am rating the balance sheet health as a 4.

Finally, we are assigning the following ratings:

McKesson Corporation (MCK) | Moat: 3 / 5 | Understandability: 2 / 5 | Balance Sheet Health: 4 / 5

McKesson is a healthcare services company that distributes pharmaceuticals, provides healthcare technology, and offers business support solutions. It operates primarily in North America and Europe, serving pharmacies, hospitals, and other healthcare providers.