In Focus

Prognosis for Cardinal Health

NOTE: For the month of July we decided to feature public companies from some of the states the Chicks live in. This week we are doing Ohio (Megan's home), which has many companies listed on the Forbes 500 list. Here are the companies we have chosen to review (along with where they appear on Forbes' list): The Limited (185), AK Steel (372), Cardinal Health (51), and TRW (114).

Ever since I became a Chick, my mother has often asked me to run some of the holdings in her own portfolio through the Chicks' Dozen. I feel bad when I have to tell her that some of her best performers fail many of our criteria. I try to make the point that this certainly does not mean that she owns a bad stock or has made an ill-informed investment. In fact, in some cases, nothing could be further from the truth. When I saw Cardinal Health (NYSE: CAH) on the list of Ohio based companies, I knew I had to write about it. This is a holding of my mother's that won't be found nestling in the Chick's Nest any time soon.

In life, I can think of several examples where sub-standard performances are not indicators of future success. Remember the asthmatic swimmer, Amy Van Dyken, who went on to win the Gold at the '96 Olympic Games in Atlanta? Or how 'bout all those 4.0 valedictorians who get rejected by Stanford University each year? You can't tell me they don't go on to have thriving careers just because they didn't meet Stanford's arbitrary admission requirements. I believe we can view Cardinal Health in the same light. Quantitatively, they just aren't Chicky. First, their margins are rather thin. Now, I know most Chicks like thin, but in this case, we want 'em fat, baby! We'd like to see Gross Margins of at least 50%. Cardinal's GM comes in at a mere 7.5%. And instead of Net Margins of 8%, Cardinal's are a low 1.5%. We Chicks also like 'em rich -- at least more in the black than in the red! Unfortunately, Cardinal is a bit anemic in this area, having a lot more debt than cash reserves.

It is important to note, however, that some companies just operate this way. Their numbers don't necessarily indicate poor financial health, but rather that their baseline, for better or for worse, may be at a different place than some other companies. Chicks just like to have the best of all worlds.great companies and stellar numbers. I must mention, Cardinal's Flow Ratio is right in line with the Chicks' standard of 1.5, meaning the cash flow of the company is quite efficient; money is coming in and product is flowing out in a timely fashion. While Cardinal Health is not the top dog in its field (as we prefer), it is the 2nd largest wholesaler of prescription drugs and surgical and hospital supplies in the U.S. With the various acquisitions the company has been making, I'm sure it will soon be a contender for that top spot. Those acquisitions, by the way, might also account for the company's rather precarious cash situation.

Up to this point, I've been treating Cardinal Health in the same way so many doctors treat their patients -- like a statistic and not a real person. Well, Cardinal Health is made up of over 45,000 real people, so let's take a look inside the company and see if we can't learn more. The company was formed in 1979 and is based in Dublin, Ohio. Their initial public offering was in 1983 and they originally traded on the Nasdaq Stock Exchange. In 1994 they moved to the "big board" (the New York Stock Exchange) and began using the ticker symbol "CAH." The company is involved in a great many areas, so I think it's easiest to think of Cardinal Health, Inc. as a sort of figurehead holding company that houses all of its subsidiaries which operate separately. The standard line seems to be that they "provide products and services to healthcare providers and manufacturers to help them improve the efficiency and quality of healthcare." Pretty ambiguous, huh? Their business is broken down into four segments: Pharmaceutical Distribution and Provider Services, Medical-Surgical Products and Services, Pharmaceutical Technologies and Services, Automation and Information Services. That didn't help, did it? I'll try to shed some light on just one area that seems to be showing the most growth.

Last week, Cardinal Health announced that it was acquiring SP Pharmaceuticals for its Pharmaceutical Technologies and Services division. Sometimes reading such news updates can offer far more information about a company than reading their official company description. I learned that a current trend for large pharmaceutical companies and emerging biotech companies is to contract out their product development and manufacturing services to companies like Cardinal Health. Such a relationship benefits the companies involved as well as the consumer. For example, if Cardinal Health is handling the manufacturing and packaging services for a large pharmaceutical, that company is then able to reduce its own manufacturing costs and redirect their dollars toward other more key components of their business, such as research and development, drug marketing and sales. This also shortens the time it takes to bring new products to the patients that need them.

Currently, Cardinal Health takes custom orders from dozens of drug companies to make and package oral, topical and inhaled drugs in a variety of forms. They hope SP Pharmaceutical will be a nice complement to their business as they make sterile, injectable drugs in liquid and freeze dried formulations. I was amazed to learn that Cardinal Health has several proprietary technologies with which we are all somewhat familiar. These include soft gelatin capsules. That's right, they have the patent on those Advil Liqui-Gels® you've been taking for that headache. And you allergy sufferers may be familiar with Zydis®, a technology that allows tablets to dissolve almost instantly on the tongue without the need for water!