We continue to have a Neutral recommendation on McKesson Corporation (MCK) with a target price of $87.00. The company operates through two segments: Distribution Solutions and Technology Solutions.
McKesson is a major player in the pharmaceutical and medical supplies distribution market. The company’s Distribution Solutions segment continues to perform well, with sales increasing to $108.9 billion in fiscal 2011 (ended March 31, 2011). This segment caters to a wide range of customers and businesses and should benefit from increased generic utilization and an aging population. Due to the economic slowdown, a large number of patients are shifting to higher-margin generic drugs, and the use of generic drugs should increase significantly over the next few years as several branded prescription drugs are scheduled to go off patent, like Johnson & Johnson’s (JNJ) Concerta (patent expired) and Pfizer’s (PFE) Lipitor (November 30, 2011). We believe that the Distribution Solutions segment should continue witnessing growth and will remain a major contributor to total revenue.
We note that McKesson has been making acquisitions regularly to supplement organic growth. In December 2010, the company acquired US Oncology, which has helped McKesson expand its specialty services, particularly in oncology. Moreover, in July 2011, the company acquired management solutions company, Portico Systems. We believe that the integration of Portico’s technology with the company’s Technology portfolio will help McKesson achieve accountable and collaborative care along with reducing administrative costs. Additionally, in March 2011, the company announced its plans to acquire British IT company System C Healthcare. System C manufactures Medway software, which is used in 40 National Health Service and private hospitals in the UK. Going forward, we believe the company will continue to pursue acquisitions, which will help drive growth.
However, McKesson faces stiff competition in both the Distribution Solutions and Technology Solutions segments. The Distribution Solutions segment faces strong competition from national, regional and local full-line, short-line and specialty wholesalers, service merchandisers, self-warehousing chains, manufacturers engaged in direct distribution and large payor organizations. Besides, the Technology Solutions segment faces competition from many firms, including certain computer services firms, consulting firms, shared service vendors, certain hospitals and hospital groups, hardware vendors and Internet-based companies with technology applicable to the healthcare industry.
We are also concerned about McKesson’s dependence on a small number of customers to generate a significant portion of its revenues. During fiscal 2011, McKesson’s ten largest customers accounted for 51% of the revenues. The loss of a significant customer would have an adverse impact on the company’s revenues and operations. In fact, the company lost two customers in fiscal 2009, representing $3 billion worth of business, which impacted the performance of the Distribution Solutions segment.
McKesson’s contract with Veteran’s Administration (one of the important customers) is due for renewal in the near future. The non-renewal of this contract would be a setback for the company. Going forward, we expect investor focus to remain on the outcome of the VA contract renewal, and prefer to remain on the sidelines until further visibility is obtained on the issue.
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