Thursday, January 20, 2011

Cardinal Health offers good long term value with a margin of safety


I believe $CAH, at approximately $41/share, offers good value with a margin of safety.

Cardinal Health is a leading distributor of pharmaceuticals and medical supplies to pharmacies and hospitals. Its operations include procurement, packaging, inventory management, and logistics services. Its largest customers are CVS Caremark and Walgreen.
(Source: Morningstar.com)
I estimated the firm's WACC at 10.17% using the Capital Asset Pricing Model and the company's recent SEC filings.  ValuePro has a baseline WACC calculator here and it calculates the firm's WACC at 7.48%.  I'm going with the higher mark, 10.17%.

Recent free cash flows and noted growth rates:
YearFCF $Millions
2000531
2001699
2002975
20032215
20042279
20051697
2006866
20071136
20081034
20091878
TTM1664
Average Annual Growth: approx 26%
CAGR: approx. 15%
Internal Growth Rate: approx. 2%
Sustainable Growth Rate: approx. 6%
Consensus Forecast Industry 5-Year Growth: approx. 16% per year
Consensus Forecast Company 5-Year Growth: approx. 13% per year
Assume the company achieves a lower 5-year growth rate of 5% per year, and assume that after the next five years, the company achieves no growth or 0% growth per year forever.
Discounted Cash Flow Valuation:
YearFCF $ Millions
01664
11747
21835
31926
42023
52124
Terminal Value21932
The firm's future cash flows, discounted at a WACC of 10.17%, give a present value for the entire firm (Debt + Equity) of $20,735 million. If the firm's fair value of debt is estimated at $2,322 million, then the fair value of the firm's equity could be $18,413 million.
$18,413 million / 349 million outstanding shares = $52.76 per share. A 20% margin of safety from here is approx $42 per share and $CAH's current share price is approx $41.  I believe $CAH currently offers good value with a margin of safety for the long term on a cash flow valuation basis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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