Cardinal Health, Inc. (CAH) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Day 4 of Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's Healthcare Services Analyst. I'm really pleased to have Cardinal's CEO, Mike Kaufmann, here with us today. Before we get started, I just wanted everybody to know that this is a webcast for Morgan Stanley's clients only. It's not for the members of the press. And for any important disclosures, please see the Morgan Stanley research disclosure website. And with that, Mike, thank you again for being with us here this morning. And let me hand it off to you for some introductory remarks.

Thanks, Ricky. It's great to see you. And thanks to everyone for joining us. It's really a pleasure to be with all of you this morning. Before we begin, a quick housekeeping item. We will be making forward-looking statements today. And as you know, actual results could differ materially from those projected or implied. So for more information, please see our SEC filings on our IR website. For those of you who may not be as familiar with us, Cardinal Health is a globally integrated health care services and products company; a distributor of pharmaceuticals; a global manufacturer; and a distributor of medical products. And we're also a provider of performance and data solutions for health care facilities. We operate very resilient business models, are a leader in consolidated industries through our breadth and scale and we're focused on the customer. We are prioritizing, optimizing our core businesses, investing in for innovation and deploying capital efficiently. Throughout the past year, we've been taking action to drive performance and we'll continue to move forward with urgency. For example, we recently divested the Cordis business, extended our Red Oak Sourcing and our pharmaceutical distribution agreements with CVS Health and identified $250 million of additional cost savings opportunities. In August, we released our fourth quarter results and our FY '22 guidance. Since then, much of the focus from investors like all of you has been concentrated in really a couple of areas, which I thought I would touch on briefly upfront. And then we can obviously dig in a little bit deeper. So first area that we've heard a lot about is capital deployment. So let me just reiterate. We are focused on deploying capital in a balanced, disciplined and shareholder-friendly manner. We continue to allocate capital through the lens of our priorities. First, it's investing back in the business to drive organic growth; second, it's maintaining our investment-grade balance sheet; and then returning cash to shareholders. As you know, over the last few years, we've been on a journey to improve our balance sheet, and we've made tremendous progress. So going forward, we've said that we expect our debt pay down to be more modest relative to the last few years. We believe our improved capital position and strong cash flow generation will provide increased flexibility and the ability to be more opportunistic in capital deployment. For example, we said that we expect share repurchases of $500 million to $1 billion in FY '22. And along these lines, we recently initiated a $500 million accelerated share repurchase program. So in summary, on capital deployment, we're pleased with the improvements we've made to our balance sheet and our portfolio. We don't plan to stockpile cash and will evaluate in line with our priorities. And we believe we're really well positioned to create value for shareholders. The other area we got a lot of questions about was respect to our '22 guidance. We're excited about the full year growth that we expect in both segments. But to be helpful, let me remind you of a few things we said on the August call regarding to the expected cadence of the year. We said that we expected our growth to be significantly back-half weighted. In Medical, we said that we expect a year-over-year headwind -- COVID headwind of approximately $100 million in the first half of the year. And that's driven by the timing of selling higher-cost PPE. This compares to a $200 million tailwind in the second half of the year, which is primarily the favorable comparison of the fourth quarter inventory reserve that -- on PPE that we took in FY '21. We also anticipate that the elevated supply cost that we talked about and that we began to see in the fourth quarter, that they'll persist in the first half of FY '22. And then we expect that to moderate in the second half of FY '22 as the supply chain continues to normalize and we work through any of the more permanent impacts by working with our customers directly. And then in Pharma, we talked about how we're nearing the end of a multiyear project to enhance our technology infrastructure, particularly in our Pharmaceutical Distribution business, which will lead to incremental cost in FY '22, again, particularly in the first half. Those investments were started years ago, but they went live late in our fourth quarter. So we'll see extra launch costs for rollout and testing that get expensed and some of the higher depreciation costs as those assets are deployed. And then we'll see those additional launch costs begin to dissipate in the second half of '22 as well as the annualization of the expense that we started seeing in the fourth quarter last year. We also said we don't expect volumes for generics program to return to pre-COVID levels until the end of the calendar year. So we expect that to ramp up. And then let me also remind you that we had a very strong Q1 of fiscal '21 last year. And so we also have a compare there to take into account. So that cadence, first half, second half, we want to make sure everybody, it's really important to understand given some of the large puts and takes. And I'll just wrap it up with, we've been transparent about COVID and some of the other transitory items affecting our business and we'll continue to be so. And that's why we also decided to provide that normalized guidance to give investors a better approximation of our underlying growth and long-term trajectory. We expect low to mid-single-digit normalized growth in Pharma and mid- to high-single-digit normalized growth in Medical. And you combine that with strong cash flow deployment of capital effectively, and we feel really good about our positioning, our strategy and the growth that we expect in both segments. So I'll wrap it up there.

Great. Thank you, Mike, for the update. And there's a lot to go deeper in. So first of all, kind of like just stepping back and really thinking about everything that you've done in the enterprise in the last, actually more than a couple of years really rationalized the portfolio. So as you think about the assets that you have today between Pharma and Medical and Specialty, what ties the enterprise together? How do all the pieces fit?

Yes. Our focus on the portfolio was from day one of coming into the job, and it was really about making sure we were the rightful owner of assets as well as making sure we could focus on the businesses that would matter and simplify our structure, particularly internationally, where it was incredibly complicated. So if you think about the moves we took by removing the China business and Cordis particularly, both of those businesses had a large impact on our international cost structure, which we now are much more simplified so that we can move forward. And then obviously, naviHealth was about thinking about who is the rightful and best owner for that asset and making sure that we took care of it. So we're always evaluating our entire portfolio. That's something we do regularly and we'll continue to do that going forward, remaining -- we're really going to stay focused on maintaining really disciplined when it comes to looking at all of those businesses. We know our expertise lies in providing distribution and performance solutions for customers across both Pharma and Medical. And so that's where we want to focus. We've got a deep understanding of acute care customers. So businesses and opportunities to serve that class of customers more effectively are always going to be areas where we're focusing our organic growth and potentially tuck-in M&A. But overall, we're really focused on -- we feel like we have a lot of tailwinds. You've heard me talk several times about our growth businesses. So as you think about our portfolio, to your question, we really see Specialty, at-Home, Nuclear, Medical Services and Outcomes, those 5 areas, as businesses that together should drive double-digit revenue and profit growth for us in FY '22 and beyond because they really have a lot of favorable industry trends. They're very complementary to our core businesses. They have specialized offerings and they take advantage of the breadth and scale. And they're margin-accretive for us. So those are some of the areas I would mention off the top.

Great. Thank you. So when you think about the Pharma segment, generics, clearly a really big driver of investment sentiment. I think it was Dr. Reddy at their presentation last week, they pointed to some slowing generic deflation. What are you seeing in the marketplace? And I think what are the KPIs that you're tracking for just signals of change?

Yes. I can't go into specific KPIs. As you can imagine, we look at a lot of internal data, external data. We work a lot with Red Oak to understand how they're viewing the various manufacturers and what they're seeing out there. So it's an area that, as you can imagine, as you said well, it's a critical area for us. So we spend a lot of time looking at buy side, sell side, all those types of drivers of not only pricing and cost, but also volumes and opportunities and how effective we are at launching new products. I would say, as we've talked before many times, I think looking at sell-side deflation alone is -- can be very misleading, because you have to both look at the cost deflation as well as sell side because one taken out of context without the other is just tough. But overall, what I would say is that we have seen really consistent dynamics over the last couple of years. And we've seen a nice balance between the sell side dropping and what we're effectively able to do on the cost side. And so when we wrap our whole generics program together, I would say it's generally consistent over the last couple of years. And we would expect our overall generics program to be a tailwind for us in FY '22.

Great. And just a reminder for everyone listening to the webcast, if you have any questions for Mike, please just type it into your browser and I'll relay it. And thank you for those who have already submitted their questions. So Mike, when we think about generics, it's really not just about pricing. It's also about volumes. And for a couple of quarters now, you did highlight that you're not seeing the same volumes coming back and that has impacted results. How is the current COVID resurgence shaping your view about volume recovery?

Yes. So again, we have to go back to August because I don't want to update here. But what we said in August was that we expected the -- what I'll call more of those COVID-related generics in the sense of not that they treat COVID, but that they're the types of products that seem to have had lower volumes because we haven't seen earaches and sore throats and those types of things. So the drugs that are often dispensed for those, the antivirals, anti-infectives, so those, those have come back a little slower than all the rest of the generics. We've seen a steady uptick through our fourth quarter last year, and we do expect that unless something changes dramatically here, that we would see those come back and be more back to pre-COVID levels, hopefully, by January 1 is our plan. So we would hope to be there by our Q3, be back to pre-COVID levels on those drugs.

So to your point, you've sort of baked that into your guidance, the guidance was somewhat conservative, in thinking that it's going to take longer for the recovery to happen. And what we're seeing with Delta seems to fit in line with your thinking.

Yes. And it was built in, in the sense, too, of not only built into our guidance for the year, but also one of the items I mentioned, as you look at the cadence of first half to second half, while the much bigger drivers are the actual other items of COVID, as I mentioned, the $100 million negative in Medical and some of the other costs, this buildup of generics being behind is also one of those drivers of first half cadence versus second half cadence.

So if we're on the topic of the impact from COVID on the medical supply side, we're also seeing some of those byproduct of COVID. And one of them is the upstream inflationary pressure that's impacting the supply business. So first of all, if you think about these pressures, and we're hearing about -- you were one of the first to talk about it on the second quarter, but we're hearing about it from others in the conference. Can you pass the cost downstream to the clients?

Yes. That's -- it's a great question, Ricky, and it's something that I'm also seeing and hearing from -- just about every industry is talking about this, the cost of the container to get in regardless of whether it's medical supplies or not, the cost of fuel, drivers, labor, wages, everything. So as we said, we started seeing those in the fourth quarter and expect those. That's one of the reasons, again, I mentioned the cadence that I do, is that we are -- we got to be focused on our customers, right? The #1 thing for us is making sure we're taking care of our customers. And last year, at this time, roughly -- probably a little earlier in this last year, we saw the high increases on the PPE. And we worked with our customers to put in the right type of program, the supply assurance program so that we would be able to buy at those higher costs and pass it through and have a fair give and take with our customers on that. And that's something that we're working through now with customers, trying to understand whether these costs are going to be more permanent, which ones are more transitory. Right now, our current cadence assumes that these will start to dissipate in the second half and that some of them will start to come back down. But as we look at that and work with our customers, we do believe there are opportunities to take increases with our customers. But we want to do that in a smart and educated and fair way with our customers. And we also want to understand what's more permanent and what's transitory.

And then are you seeing other areas of the business where there is cost inflation? Or another topic that's been discussed here is wage inflation.

Yes. It's interesting. On the pharma side, I'm sure they're seeing it, for anybody importing pharmaceuticals. But we really haven't seen any impact. As I've mentioned, we're not really seeing it in our generics side, the balance still continues to be there. And the branded pharmaceutical manufacturer price increases, again, we're not expecting that to be different than we expected. And so it looks like on the pharma side, we're not seeing that necessarily impact any of the dynamics we expect for the year. So I think these impacts particularly sit more on the Medical side related to the products. And also, it's also country by country. In certain countries, you are seeing wage inflation; other ones not as much. We have seen wage inflation. We did anticipate that in our guidance for the years that we would have wage inflation. Now it could exceed what we expected or it could be less, but we did assume some additional wage inflation this year with the way we built our guidance.

I got a question here from the audience specifically about electives. So how are electives tracking relative to expectations in your first fiscal quarter?

Yes. We want to be careful again here about updating. So our thought was, when we set guidance for the year, that even though we knew Delta was starting to come back a little bit, our assumption was is that it would not have -- our guidance didn't really assume a large increase like we saw last year where electives were shut down completely and you saw all that. So what I would say to try to be at least helpful on that because I can't update is, remember, there's different puts and takes. So while electives might hurt our acute distribution and products business, let's say, because less electives, our lab business is likely to be more positively impacted by more testing and more opportunities there. And so we're going to have to really take a look at this at the end of the first quarter and give everybody a better view at the end of the quarter of how we see the puts and takes around potentially how electives are tracking out for not only the first half but how we see it in second half.

So I want to touch on specialty. You highlighted specialty as one of these growth areas that you're looking to scale. It's the fastest-growing area within Pharmaceutical spin. And you've built the business organically. So how do you scale from here? And what's holding you back? Or what's the loading factor from deploying capital into making it a bigger part of the infrastructure?

Yes. I would say in specialty, I'll probably comment on three areas that really come to my mind. There's the downstream especially, providing products to oncologists, nephrologists, all the various ologists. There's the upstream services business. And then specifically, I'll call out biosimilars. So those would be kind of 3 buckets. As far as downstream, selling products to the providers, the various physician offices, as you know, that's a highly consolidated area. And so deploying capital from an M&A standpoint, it's not really possible from there. So what we're really focused on is creating superior offerings and superior customer experience. And so through our technology group as well as working directly with the customers on various logistics opportunity like having an amazing cold chain, really focusing on information and data for them, we're really focused on improving our offerings and delivering world-class service so that we can win our -- or more than our fair share of business down there. As we -- you and I have talked about in the past multiple times, we are smaller in oncology than our competitors, but we are larger in other areas like nephrology and rheumatology. And we want to keep those leads in those areas. And as products launch in those areas, those will be nice up -- tailwinds for us in those businesses. And so we continue to focus on that. So that's kind of where our focus is, downstream, which is, again, superior customer service and best-in-class offerings. On the upstream services, that's, I would say, the area where we see the most ability to deploy capital, is buying more businesses that can provide services to manufacturers. Now as I've said multiple times, this is going to be in a very disciplined way. It's going to be much more of a tuck-in. Some of the acquisitions that we have done in that space, like our 3 -- our Sonexus hub that we have in that space, has been doing very nicely. They're having wins. Our 3PL business is having wins. And so we continue to grow in our upstream services businesses. But those 3 areas, that's probably the area, if we decided to deploy capital in a disciplined way, would be the most likely area we would deploy in terms of M&A. But again, it has to be at the right multiple. We have to believe it can grow. It has to have the right culture, the right financial metrics, those types of things. And then lastly, on biosimilars. A couple of years ago, we hired some folks that were just totally dedicated to that space, that are experts in that space. And that's an area that we're finally starting to see be a tailwind for us as a company and I think as an industry. There's -- with the first interchangeable biosimilar being approved, still a lot to be figured out yet on that one and exactly how that's going to play, but knowing that the FDA is willing to have interchangeable biosimilars, I think, is something we all should keep our eyes on as a potential profit driver for distributors and for us. And we think, again, while we're maybe smaller positioned in oncology, biosimilars are going to show up in a lot of other ologies and in retail. And with our relationships with CVS and other large customers as well as our very large share in retail, we think we have some real opportunities to drive value to our bottom line over the next several years in biosimilars.

Yes. I mean biosimilar clearly is one of those areas that we've been waiting for, for a long time. So if you think about it, because in the last couple of years we've seen the market developing. I think now there's more predictable sort of penetration patterns. So if you think about it, what's the biggest lessons or takeaway for you as you've seen the biosimilar market grow and as you think about those future opportunities? What type of products are more successful versus others?

That's a great question. I don't know that I would say there's a rule of thumb yet. It really depends on how the brand -- the original brand innovator decides to play, right; how early they go potentially to other parties for deeper discounts; how they lock up; how they decide to do those types of things; how the PBMs and others decide to work through in their formularies. And so I think that has been different item by item. And as you know, it's been very different in Europe and other countries than it has been in the United States. What I have seen is -- that's been good news is that I would say that, first of all, manufacturers have been very willing to work with us on biosimilars in terms of, one, giving Cardinal complete access to them. But even more importantly, as they launch these products, having the right appropriate DSA rates in place when it's brand-focused and having the right discussions with us, oftentimes here in advance of, if they get interchangeable status working with us. The other nice advantage that we have is our Red Oak relationship. And as I mentioned before, by definition, an interchangeable biosimilar does go through Red Oak for us. So being the largest generic buying entity in the world, having them and their capabilities working with us on those retail biosimilars, I think's going to be an opportunity for us going forward. But I would still say a lot of unknowns. But what we've seen so far is that net-net, biosimilars drive better profitability for us than typically the brand innovator does.

So Mike, in your prepared comments, you said that capital deployment is one of the most frequent questions that you're getting from investors. And clearly, over the last year, you've strengthened your balance sheet quite meaningfully. You're still more measured in your buyback guidance, you did $500 million ASR. But there's still some transitory factors here that are limited. Your capital deployment execution, let's call it this. When we were in the last inning of the opioid settlement here is one to think of. So if we think past the transitory factors, how should we think about what would a buyback program could look like in more of a steady-state-type environment for you?

Yes, a couple of things. I would say we might be in later innings. I wouldn't say we're in the last inning of opioids. We still have this 120-day period for the cities and counties and then we have to work through that. So we, again, want to make sure that we're focused on the mid- to long-term health of the business and focused on that. So really good progress has been made. We feel good about the progress. We believe this is the right solutions for the country, for the cities, for the counties, for the states and for the distributors. So we're hopeful that will come to conclusion. So that's something that's still on our radar that we're continuing to evaluate. As you know, we still have a receivable coming in from the IRS that we're keeping an eye on in terms of how that would affect it. But -- and we also said that we would this year be buying down -- or paying off that last $850 million of debt, of which a chunk of it, we've already made a -- made whole call on almost -- close to $600 million of the $850 million. So we have worked through that. Our view is it really goes back to the priorities. First of all, it's investing in the business; making sure we improve our balance sheet, which I'm glad you recognize. I think we've done an excellent job of improving our balance sheet. But to help people understand, we do believe going forward we'll be much more modest in our debt pay downs because we believe we've now got our balance sheet in apportion, which then means more money can move down to the next area, which is being opportunistic in returning cash to shareholders. We still believe that M&A can be an area that we would do. But again, we would stay focused on tuck-in acquisitions. Our track record, we haven't really done a lot of M&A since I've been CEO. The ones we have done have worked well. So we know how to do it and how to do it well. But we will be focused more on tuck-in M&A there and returning cash to shareholders.

So Mike, we have time for one more question. And again, stepping back, when we think about sort of investment perceptions of Cardinal in your asset base, what do you think that competitively maybe you need to do better? Or are there elements of the story that you think are not well understood or appreciated by investors, but it will be 12 months from now?

Yes. Thanks for that. I guess, first of all, I think a lot -- we know there's a lot of noise. We own it. We take full accountability and ownership of our results in both last year and going forward, we understand that. There is a lot of transitory noise in our financial statements. As you know, it's particularly evidenced by just the inventory write-off we had in Q4. And what we want to do is focus on the mid to long term, that we can't let that transitory noise and COVID moving parts get in the way of doing the right thing to focus on our customers so that they feel really good about who we are. So one of the things that I really feel good about us as a company is our focus on the customer; our focus on our employees. We've built a very strong culture around diversity and inclusion and getting after things and having a sense of urgency, and so we're going to do that. But I think the things people should recognize, we're focused on the mid to long term. We're going to deploy capital with the right priorities, right, invest for growth and improving the balance sheet and returning cash. And we think we have a lot of tailwinds in growth businesses that should help drive our business in '22 and beyond.

Great, Mike. As always, a pleasure to have you on and to have these conversations. Thank you very much.

Always good to see you, Ricky. Take care.