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

Hi, good morning, everybody. My name is Erin Wright. I'm lead health care services analyst at Morgan Stanley. We're happy to have Cardinal Health with us today. We have Jason Hollar, CEO; as well as Aaron Alt, CFO; IR -- or new IR, Matt Sims. So welcome. And just for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, I will hand it over to Matt for his disclosures.

Great. Thanks, Erin. Good morning, and thanks for hosting us here today. So during the fireside chat, we will be making forward-looking statements. Our actual results could differ materially from those projected or implied. For a description of the factors which could cause our actual results to differ. Please review our SEC filings, which can be found on our Investor Relations website at ir.cardinalhealth.com. Jason?

All right. Thanks, Matt, and congratulations on the new role. I think a lot of you probably already know, Matt. He's been with the IR team for a few years. But before that, he's been with Cardinal quite a bit in Treasury and other business. So I'm sure you'll see a good continuation here of his support. So please just reach out to him as any needs that you may have. So thank you, Erin, for having us here at this conference, and thank you all for attending. I think you picked a good time to have a conference. It's an exciting time in health care and it's certainly an exciting time at Cardinal Health. So we're excited not only to be here but excited about being a part of the innovation that's currently ongoing in the industry, and it has been evolving for quite some time. And that excitement really stems from the fact of our broad reach within this incredibly broad history to start with. We reach all the way from the clinical to the operational aspects of health care. And when you think about these various business models, they really all rely on a demand for a trusted distributor that safely, securely, and efficiently provides products and services to their customers and ultimately to the end patient. And that role remains as important as ever. And we feel very well positioned not only because of our size and scale with our customers, but we have a lot of partnerships like Red Oak where we leverage the scale of others. But also just back to that breadth, we touched so much of the complexities of this industry, and we're able to provide those solutions to all those potential partners that are out there. And that goes way beyond the core distribution. That remains very important for us within our pharmaceutical distribution, our medical distribution, but it goes into more specialized areas. Our specialty business, of course, get into really complex areas like cell and gene, of course, our radiopharmaceuticals, controlled substances, we do it all, and we're able to provide that breadth of solutions to our customers so that they can continue to evolve and provide that value to the end customer and that end patient. So we feel really good about that breadth continuing to be a cornerstone of the resiliency that we've been able to benefit from over the last several decades, and we see that, that will continue to be very important going forward. So how are we doing? Well, we've had a lot of communication with you more recently. Just less than a month ago, we had our year-end earnings. And a couple of months before that, we had our first Investor Day in 7 years. So we won't be providing new business updates today, but we'll go into all those strategies a bit deeper with you today. But just to highlight a few of the things from our earnings that were less than a month ago, we finished fiscal '23 strong, which was a part of a very strong year. That was led by our Pharmaceuticals segment, seeing good growth throughout the year. Our Medical segment finished the year very strong. Remember, that's a turnaround business that had losses in Q4 of '22, losses in Q1 of '23, and we saw a very good sequential growth over the course of '23, ending the year at an $80 million profit. We had strong cash flow over the course of the year, which we deployed very responsibly, including some significant share repurchases, which, combined with our operational improvements over the course of the year allowed us to grow our EPS by 14%. With that strong performance, we had good momentum coming into '24, and we laid out in June at our Investor Day, those expectations for continued EPS growth, strong consistent EPS growth. And that was driven, again, by that expectation that we would continue to drive pharmaceutical growth. We're seeing significant growth across the board with that business. And on top of that, the ongoing progression towards the medical improvement plan and getting our Medical business to the $400 million. And then, again, continued expectation for cash flow generation to have more share repurchases so that we can get into that similar type of growth rate in '24 in that 12% to 17% rate. So feel good about that strength in '23 the momentum [indiscernible] coming into '24 as we described last month. And when you step back and think about all those activities, all that progress, all those initiatives, they're very consistent with the strategies that were laid out at our Investor Day in June, which were exactly consistent with the strategic priorities that I presented as I stepped into this role over a year ago. And those key 3 strategic priorities are, first and foremost, to build upon that growth, that resilient growth of our Pharmaceutical segment. Again, that's a business that's been performing very consistently, very well. It's benefiting from underlying strength in the secular trends of the industry, but also very specific business performance improvements. Next, of course, is driving the initiatives behind the medical improvement plan. This business is anticipated to deliver $400 million of earnings in fiscal '24, as I just mentioned, which is on the path to achieving the $650 million target for fiscal '26. This is unchanged from what we laid out in June and what we then reiterated last month. And then again, the final piece of that 3-legged stool is the ongoing relentless focus on our shareholder value creation through that consistent earnings growth through the strong cash flow and again, returning that capital to shareholders in a very responsible way. So you bring that all together, and it gives us a nice stage for that continued momentum. We're excited about that. But I think what gets me most excited is the fact that with all those accomplishments, we still see opportunity in front of us. It's still a dynamic industry where we see a lot of opportunities. a lot of opportunity for us to again go back to that very beginning comment to bring the breadth that we can bring to health care to continue to be that the rising tide that benefits our business well into the future.

Well, that was all my questions. So...

I tried to answer everything upfront so that we -- you don't need to go into further.

You mentioned just some of the strength across the core pharma distribution business. Can you talk a little bit about kind of your guidance for that mid- to high single digit operating [ prop ] growth? And can the strong core drug utilization experience continue? And I think that, that's a big question that we get from a lot of investors.

Yes. I think I set the stage and I'll let Aaron walk you through the...

Sure. Thanks for doing that. Look, Jason said the key words, momentum, resilience, strong fundamentals, utilization, right? We were pleased at our recent Q4 earnings to provide an update to our guidance, of course, the 12% to 14% non-GAAP EPS growth over time. But for the pharma segment, which is to the point of your question, we did confirm our guidance there, which is the 10% to 12% revenue growth, driven in part by the upsurge in GLP-1s, as we talked about at the time as well as really reconfirming that given the resilience, given the strong fundamentals, given the fact we've got the right team and the right strategy, that 4% to 6% profit growth certainly seems achievable for us from a fiscal year '24 perspective as well as in the long term. That's driven by expectations of strong volume in generics. It's driven by consistent market dynamics as we often talk about from a generic perspective, it's driven by continued prescription strength across the board, including the branded portfolio. So perhaps across the board, not as strong as some of the elements we saw in fiscal year '23, and we've talked about that in our earnings releases as well.

And you mentioned generics, and yesterday, we were speaking to another distributor about kind of the generic pricing environment. But just generally speaking, can you speak to drug pricing environment but also specifically on the generic side. Are you seeing pockets of inflation or just easing deflation? What is your experience?

Yes. For generics overall, let me start with utilization. That is an area that we've seen very consistent improvements ever since the COVID volatility. Since then, it's been much more predictable and much more like what we've seen historically. So that utilization has been very broad strength across all of our different classes of trade, but also all of our different customers. Within the specific question on pricing, yes, there's always going to be pockets of different movement. But ultimately, the consistent market dynamics is what we express as our description of where it's at. What that means is that you got to look at both the buy side and the sell side together and not focus on any one side of that. And what we continue to see is that those continue to move in tandem with one another. So when you get down to like a margin per unit, we see those dynamics being very consistent to what we have seen over really the last several years. So we're really not seeing that much different in this market.

Okay. You mentioned also the GLP-1. So we understand that they're less profitable or not as favorable from a profitability standpoint. But can you provide some color on the EBIT dollar tailwind that, that provides just from the volume of loan and just understand a little bit more about how that kind of contributes to overall operating profit growth now and what your expectations are in the future and how we should think about the potential margin opportunity also associated with oral solid versions of GLP-1?

Yes. Certainly, GLP-1s are an important category we've highlighted even in Aaron's comments already, that was part of the rationale for raising our revenue from -- pharma revenue guidance from the Investor Day to our earnings last month, we bumped it up 1% to 2% there to reflect that the GLP-1s are expected to be even stronger than what we anticipated before. So it's -- it's a meaningful part of our revenue increase, but not the majority of that revenue increase. So it certainly impacts that line item substantially more than our earnings. As we've highlighted before, it's not a substantial impact to our earnings. We don't expect that to be the case in the near- and medium-term. What I'd say about GLP-1s is it's important for the patient, which means it's important for our customers, which means it's important for us. So we like broad utilization. It's good for the industry to have that innovation. It's good for there to be more volume pushed through the distribution pipe. That helps us operationalize that and operate more efficiently and effectively. But it's not something that you should expect to be meaningful to our earnings anywhere in the near- to medium-term.

And more broadly, can you -- and sticking with the pharma side of the business and part of your transformation also -- it's a little bit on -- focusing on specialty too or maybe someone considering you kind of under-indexed, can you build out sort of the specialty platform over time? What's feasible? What can you do near-term as well as longer term? And then how can you do that without triggering price competition margin dilution?

Yes. Well, if you consider over $30 billion under-indexed on specialty, then maybe so. We're very proud of the growth. That $30 billion-plus that we have currently, is compounded growth of 14% over the last 3 years. So it is very large. It's a very large scale, and it's growing very nicely because we have the right team and the right strategies in place to grow it. And that's how we've been operating. And incrementally to that, we are continuing to invest both organically and inorganically into the space. It does have the benefit of the secular trends that we think will allow it to continue to grow at good margins. I would look at especially in a couple of different buckets. You really have to break it down to each of the therapeutic areas. Certainly, we've announced our expansion into oncology further. We do have billions of dollars of business there to start with, but we're growing more aggressively there with the launch of Navista network, which is our platform to provide even more value to our community oncologists customers. And that was launched at our Investor Day in June and we provided some updates last month on that. We continue to build that out. We continue to have more and more senior leadership come underneath that umbrella, both internal and external talent. So we've got the team established. We have a clear objective. Importantly, we spent a lot of time with our customers, both before Investor Day when we built out the concept, but now that it's been publicly disclosed, we've been even more aggressive at going out there and talking to both current and prospective customers. And what's really clear to us is we have the right strategy. We have the right strategy that works for us, which is we're very focused on those community oncologists that require flexibility and more independence. That's what we bring. That's how we're going to do it differently. That's our differentiation. And by the way, we do know that model. That's very much like the retail independent model. There's plenty of pharmacies out there that want to be independent, and that's the role that we can play in oncology like what we do in other spaces. Now the other 60% of the specialty business outside of oncology, we are very much an advantaged player in many of those areas. The second largest being rheumatology. We were large and relevant before, and we went even further with our investments in Bendcare acquiring the GPO and investing into their MSO that's a little over a year ago as well. That gives us a key advantage position there. But in a lot of the other therapeutic areas, we continue to be advantaged as well. So we're in a good position to be able to continue growing on that $30 billion as we have in the past.

I would just add 2 things, if I could, adjacent to that, which is you asked earlier about our pharma guidance, 4% to 6% in implicit -- built into that is double-digit profit growth within the specialty portfolio as well within our nuclear business as well. And the other thing I would add on specialty is -- as we're thinking about M&A as a tool, and I'm sure we'll talk about capital allocation later in the conversation, right? Our focus from an M&A perspective is very firmly on specialty as well.

And in thinking about sort of also within the specialty business, biosimilars being a potential driver for you more on the Part B side not Part D, correct? And -- and how are you thinking about the opportunity there? And how are you already playing into that as well?

Yes. I think it's very consistent with my opening comments that biosimilars is a great example of that innovation across the industry that we will participate in, no matter if it's Part B, Part D in all pockets of the industry. We have the capability, the customer relationships, we'll be able to benefit with that. We've highlighted really for at least the last couple of years, probably more like the last several years that this has been a nice consistent tailwind for us. And the business opportunities continue to get larger as more of those products come to market. But it's clearly, it's another component, just like what Aaron just walked through about specialty in general, I would think about biosimilars as being part of that enabler to get to that double-digit growth. It's part of the reason why we had that double digit growth leading up to this year, and it's part of the confidence that we have that we'll continue growing double digits in that part of our business well into the future.

How should we think about regulatory changes, increased transparency of the PBM or IRA or other dynamics that could impact your business? I guess most of your business has moved over to more of that fee-for-service type of model over time and maybe I guess, allows you to be a little bit more inflated. But what are you on lookout for from a regulatory perspective?

Yes. You really [ haven't ] nailed it the way you asked the question is that our branded business is well over now 95% fee-for-service and just not that much reliant upon the contingent aspect of that brand inflation. So in what little we have is all concentrated in the third quarter each year. But the essence of your question is, that goes back to that resilient business model. We provide a service to the industry. Again, safely, securely, efficiently delivering those pharmaceuticals medical products to the end customer. And we have 1% margins, right? I mean we make a lot on that. And so when there are different models that are out there, we can't be the ones absorbing it. We need to be paid for the value that we provide within that. So as those models evolve and they'll continue to evolve like they have for the previous several decades. We have a strong game plan in place. We have a strong precedent and history in place. And the business model is reliant upon being paid for the value that we provide. And we have lots of evidence and experience in doing that, and the expectation is very clear that we'll continue to do all that.

I was surprised to see the traditional drug distributors get caught up in some of the more PBM promotion around contracts. Mark Cuban's entity as well as Amazon Pharmacy, how can you play a role in some of those concepts and where there opportunities/factors that we should be thinking about.

Yes. It goes back to that breadth that we can be a key partner. We are -- the distributors are key partners within all those models. There's still a distributor in the middle of each and every one of those models, again, safely, securely, efficiently, delivering those products to that end customer. We have that distribution pipeline established very low cost. Back to the regulatory complexities. A lot of these models have certain aspects. But when you think about the breadth of the complexities with all the different products. Again, you got to -- you can't just service part of their needs, you have to service all of your customers' needs, whether that's generics, whether that's specialty, biosimilars, controlled substances. These are all very different types of distribution processes. They're what we do each and every day. We don't have to reinvent our process to be able to establish that. So we see ourselves as being a critical enabler to each and every one of those business models.

Okay. Great. I want to switch over a little bit to the medical side of the business. And obviously, you have some bold plans there, $650 million in EBIT, I think, by 2026. Can you give us some color on visibility and your confidence in sort of that goal or that updated goal? And I mean that's still above where even consensus is today. So...

Yes. So we laid out the medical improvement plan a little over a year ago, and there were at that time, 4 key pillars may remain the same 4 key pillars. And 3 out of those 4 pillars are absolutely unchanged from when we laid that out before. So let me start with those 3, and then I'll touch on the one that has pushed out 1 year, consistent with your question, Erin. So of those 3 key pillars that we have not made any changes to, by far, the largest impacts for -- across the whole medical improvement plan is the mitigation of the inflationary pressures. So that was about $300 million that net we were impacted by a couple of years ago, and we've been working through initiatives to both reduce that cost as well as improve the pricing behind it. We are on track to achieve that goal of fully mitigating that by the time we exit fiscal '24. We entered fiscal '24 at about 50% mitigation. So this started in the -- about a year prior to that. So we started '23 at around 20%, and we got that to 50%, and we're on track to mitigating it to the full 100% by the end of the year. When you break apart that mitigation, there's really 2 key components to it. On the cost side, biggest benefit we expect to see continue to roll through our P&L is the international freight that's the part that had increased by nearly 10x a couple of years ago and has now come back down to pre-COVID levels. It's taken some time for that to work through our balance sheet to benefit us in the P&L. And we started to see some big benefits from that in the fourth quarter of last year. So that is -- very high confidence, it's going to happen as that continues to roll through. The other side of this is on pricing. And the price adjustments we're asking for are just to get us to covering that inflationary cost. There's no margin uptake with this. In fact, we have absorbed many hundreds of millions of dollars over the last 3 years on behalf of our customers because these contracts, we're not adjusting real time to reflect that. So we've made improvements in the flexibility of the contracts. We are now rolling forward those temporary price increases as these contracts renew. So we have very good confidence that, that will continue to roll through as we go through this fiscal year. But a lot of the actions are now completed, and it's a matter of just executing to that ongoing rollout. So that takes us -- that's the biggest piece. Now we take the other 2 components that are on track. It's the growth of our growth businesses. These are the secular trends of at-Home and OptiFreight continuing to be strong double-digit type of growth. and then our ongoing cost reductions, we're still working through simplification actions. Like last year, we had exited 4 additional countries and exited 2 additional manufacturing plants. So we saw opportunities to further simplify how we operate and reduce our costs. Those are all on track. The one item that we pushed out was the recognition of the volume benefits from our Cardinal Health branded product. And that is in really entirely a timing item. When you think about the inputs into our volume growth, it's being driven by those leading indicators, it's being driven by the improvements that we made in customer service, the CLI scores from our customers by investing in our products, investing in the capacity, in the distribution channel, product innovation, things of that nature. And those investments are on track and consistent with what we expected. And the results of that are as expected. It's just taking longer for that to turn into the volume that we had anticipated. We are seeing the underlying utilization in the industry be -- with some slow growth, maybe some low- to mid-single-digit type of growth. So we know the volume out there is out there for the industry. And now that we have our service levels for that, we can more fully participate in that volume growth, especially as we get to the second half of fiscal '24.

You mentioned the volume growth just now, but just general medical utilization trends, you would characterize it is growing faster than what you're seeing, I guess, at the moment, right?

Well, the underlying utilization for the industry is as expected, which is the slow growth, and we still are not at year-over-year growth for that part of our business, but that is as expected, yes.

Okay. And then how receptive -- and you mentioned the price increases, how receptive are customers choose these price increases really in this invite?

Yes. When you think about what we're asking our customers to cover, it is only the cost that we're covering for them for the last 2 to 3 years. It's a very modest percent in the total price of the product. It is lower than the anecdotal evidence I see in many, and I'll say most other industries. And the costs that we're incurring are not unique to us. They are industry-wide costs. They are things like the underlying commodity inputs, polypropylene, polyethylene fuel as it relates to distribution and things of that nature, of course, labor. And many of those costs are have plateaued in terms of the input costs. Again, international freight is the only one that's come down. The others have largely stayed plateaued. And of course, labor continues to increase but at levels that we had expected. So what we're asking for is just covering that cost in an industry that has the same level of price/cost pressures. And ultimately, it needs to be passed down to the end user of those products and services.

It's probably worth translating this, Erin into -- from a medical guidance perspective because the -- as we've talked about the medical business, it is a turnaround. There are there is heavy lifting underway. And what we guided for the year for Medical was $400 million of operating income it's significantly back half loaded, right? Jason has talked through many of the drivers of that business, and we're making progress on the inflation mitigation over the course of the year, and that will continue to benefit us but it will really hit as we move through the year. Similarly, the volume trajectory with respect to the Cardinal Health brand comes much more in the back half of the year. And so the guidance we gave at our recent earnings call was $400 million for the year significantly back half loaded. Q1 will seasonal, of course, from our largest business as well for other drivers. It will be the lowest quarter from an OI perspective for us in that business. We'll see sequential improvement over the course of the year. We expect Q1 to be generally consistent with the core operating performance from our Q4 of last year.

For the entire enterprise or that's just for medical?

That's just medical.

Yes. So since we're talking about the quarterly progression, also on the pharma side of the business, what should we be thinking about?

On the pharma business, we typically see our strongest quarter historically in Q3 because that's when the drug manufacturers take their price increases. And so that's where we see the highest dollar profit for the pharma segment.

But we've not called out like year-over-year growth rates being anything different quarter-to-quarter. It's the nominal number we would expect to be the highest in the third quarter, given that dynamic.

Okay. And just bigger picture, can you talk a little bit about the synergies between pharma and Medical? And your long-term kind of rationale for staying in the business versus divesting the business, buying back...

Yes. Similar to the business update. I'm not going to provide new updates on our portfolio review. But what we did highlight before is that there are synergies between these 2 segments. They do have a common customer base, common logistics and transportation type of process. So we leverage centers of excellence and things of that nature to maximize the underlying efficiencies between the 2 different businesses. And so there is some level of synergies between those 2. But let me answer the real essence of your question, Erin, and that is, we think that question of the strategic fit and the synergies or dissynergies between the businesses, that's one of the components, one of the criteria that we look at in the business review, but there is more to it than that. The other couple of criteria that are really important for us that we've used for all of our businesses through this process is also -- how is the operating performance of that business? And if it's not performing consistent with its capability, then are we the rightful owner to get that business there. So that's something that's got to be worked through as well. And then, of course, I'm sure it's not a surprise that the underlying strength and health of the capital markets, including interest rates, the level of interest rates. Those are all very relevant to evaluating not only the value of each of our businesses, but those 3 criteria interplay upon one another. And so we need to look through this -- the lens of each 3 of those criteria, continue to work on above and beyond. No matter what happens with this Medical business, the key takeaway is we know near-term actions are consistent across all the strategies, and that is we have to execute the medical improvement plan. This business is not performing to its capability. It has made significant improvements over this last year, but we still have a ways to go to get more in line with what it's capable of. And we're confident we're focused on the right actions and the right plans to be able to get us there.

And nuclear, I assume as a part of the discussion from a strategic review standpoint.

Yes. We did all the work, and we gave our takeaways at the Investor Day in June, and we highlighted that as we did that work, we got even more excited about the future of that business. So we are retaining and investing in that business. We announced at that point, some additional investment. We're doubling down on the Theranostics business. This is a relatively small part of the business but very fast-growing, and we already have fully subscribed our capacity for the first phase of the Theranostics and that gives us confidence that we can continue to grow that business at a very brisk clip. This is a business that has now eclipsed over $1 billion, it's about $1.2 billion of revenue. It is a little over $100 million of profitability, EBIT. So it's a nice contributor, and we highlighted that this business is expected to double its profitability from fiscal '21 to '26, and we highlighted that we're on that track to be able to get there. So it's growing nicely, very consistent growth. We had a bit of volatility during COVID because it does have a little bit higher fixed cost structures as well contribution margins. But outside of that, it's -- the core business as well as the Theranostics, and we see that there is some additional opportunity to perhaps as we get into further growth with cell and gene. There's such a unique capability of the logistics aspect of that business and with our 3PL that we think that there's some possibilities to further create value across these businesses over time. So we couldn't be more excited about the progress to date and where we see the business going in the future.

And Alzheimer's is potentially being a driver there?

Yes. I would put that along with all that other innovation I talked about early on that Alzheimer's is not something I see as being a blockbuster type of benefit to our business. But I see it as one more example of the many types of innovation that's out there that we will participate in that. There's a lot of things that have to be decided in terms of how the PET scans are used by physicians through this process. And so we feel well positioned for it, and we are already seeing good growth in this space, and it's just one more opportunity for a rising tide, so that we can further benefit from that as well.

And lastly, capital deployment priorities here buyback versus M&A and you continue to invest in some of your businesses, if you could comment on that?

Sure. I had a couple of thoughts, and we had $4 billion of cash at year-end, as we talked about. We promised to generate at least $2 billion of adjusted free cash flow and our prioritization decision making is consistent with what you would run from a long-term investment in the business. First, we're going to invest in the business, and we've got about $500 million of CapEx planned for the year. We're going to preserve our investment-grade credit rating. We're feeling good about that. We've had great stewards of our capital structure over time. We committed that we would continue to support our dividend. We've raised it 30 years plus, 5 years in a row, it was 1% more. And we also committed to $500 million of baseline share repurchase during our fiscal year '24 following on the significant repurchases we did during fiscal year '23. After that, we then have the opportunity to look for are there high ROI investments in the business, right? We'll invest there first. We are also actively looking at M&A opportunities, which are core to our strategy. We'll be very disciplined on our approach to M&A, and then we'll consider a further return of capital to shareholders really in that order of priority.

Awesome. Great. Thank you so much. I appreciate the time.

Thank you.

Thank you.