McKesson: GLP-1 Contributed More Than 1/3 Of Growth (NYSE:MCK)

McKesson (NYSE:MCK) published their Q3 FY24 earnings on February 7th, reporting 15% topline growth and 12.2% adjusted EPS growth. I highlighted their growth opportunities in GLP-1 medications and their significant share buyback program in my introductory coverage. I maintain a ‘Strong Buy’ rating with a fair value of $660 per share.

Strong GLP-1 Growth and Prior Authorization Network

In Q3 FY24, McKesson delivered 15% revenue growth on a constant currency basis and 12.2% adjusted EPS growth, as indicated in the table below. They generated $100 million of free cash flow in the quarter and $2.9 billion in the trailing twelve months. Additionally, they returned $2.6 billion to shareholders through shares repurchases and stock dividends year-to-date. Notably, as of December 31, 2023, they still have $7.3 billion in stock repurchase authorization. Given their market cap, their shareholder return policy appears quite generous.

My key takeaway is the impressive growth driven by McKesson’s GLP-1 medications, with GLP-1 revenues reaching $7.5 billion, contributing 60% to year-over-year growth. As highlighted in my introductory coverage, GLP-1 presents a significant growth opportunity for the company in the near-term. Currently, GLP-1 revenue represents approximately 9.3% of group revenue, contributing around 5.5% of organic revenue growth in the quarter, more than a third of the total growth.

McKesson’s success in GLP-1 medications can be attributed to several factors. Firstly, they have established a robust prior-authorization network for branded pharmaceuticals, including GLP-1 medications. Their ability to provide prior authorization services for the majority of GLP-1 medications in the market simplifies the reimbursement process, benefiting both patients and pharmaceutical companies. This scaled network solution positions McKesson to capture the significant growth potential of GLP-1 drugs.

Furthermore, market leaders like Novo Nordisk (NVO) have experienced substantial growth in their GLP-1 business, with a 52% increase in constant currency in the recent quarter. As reported by the media, Novo Nordisk’s plans to expand production facilities indicate a commitment to scaling up GLP-1 manufacturing, further bolstering the growth prospects for GLP-1 medications. As McKesson possesses a massive distribution channel and network, they are well-positioned to capitalize on the increasing demand for GLP-1 medications, ensuring continued growth opportunities in the near future.

FY24 Outlook

McKesson has raised its full-year outlook, as illustrated in the slide below, projecting 11%-14% revenue growth and 8%-11% adjusted operating profit growth. Additionally, they plan to buy back $3-$3.5 billion of their own shares, representing approximately 5% of outstanding shares, a significant move worth noting.

Several factors contribute to McKesson’s full-year guidance. While GLP-1 revenue is expected to continue growing, the rate may moderate due to the explosive growth experienced in Q4 FY23, leading to challenging comparables. Additionally, the opening of two new distribution centers in the U.S. over the past year will contribute to additional growth for the company. Given the strong growth momentum observed in the past nine months, significant surprises in Q4 FY24 results are not anticipated.

During the earnings call, management provided insights into FY25 guidance, indicating alignment of the U.S. pharmaceutical and Medical-Surgical Solution segments with long-term growth targets. Moreover, prescription technology solutions are expected to achieve the high end of their long-term growth targets. This technology aims to improve medication access for patients by facilitating connectivity across healthcare entities. GLP-1 is projected to remain a notable growth driver for the prescription technology segment in FY25.

According to an interview with Eli Lilly’s (LLY) CFO, despite doubling manufacturing capacity by the end of 2023, it is anticipated that demand for GLP-1 medications will outpace supply in 2024. Therefore, GLP-1 is expected to continue driving significant growth for McKesson in FY25. Considering GLP-1 revenue already comprises close to 10% of group revenue, a 30% year-over-year growth in GLP-1 volumes could contribute an additional 3% to topline growth for McKesson. With the company historically delivering around 6% topline growth, an anticipated 9% revenue growth is expected for FY25.

Valuation

Maintaining alignment with the company’s guidance, I continue to project FY24 assumptions and estimate a 5% year-over-year reduction in shares outstanding, as previously analyzed.

Taking into account the discussed assumptions for FY25, including 9% revenue growth composed of 6% core growth, 3% from GLP-1, and an additional 6% from normalized revenue growth aligned with historical averages, I maintain a 5% year-over-year reduction in shares outstanding as previously analyzed.

Regarding margins, the growth of GLP-1 medications, which carry lower margins for McKesson, is expected to exert pressure on operating margins. However, historical trends suggest that the company’s operating expense growth has been lower than gross profit growth in recent years, indicating some operating leverage. Additionally, McKesson’s divestiture of low-growth markets in Europe is anticipated to contribute to margin expansion.

Considering all these factors, I project modest margin expansion for the company in the coming years, as illustrated in the DCF summary below. Retaining other assumptions from the previous model, the calculated fair value remains at $660 per share. Notably, the stock price is trading at an attractive valuation of 14x free cash flow.

Key Risks

Rite Aid’s bankruptcy: In the quarter, McKesson recorded an additional pre-tax GAAP provision for bad debts of $515 million, or $381 million after tax, within the U.S. pharmaceutical segment due to Rite Aid’s bankruptcy. Despite this, they continue to provide interim distribution to Rite Aid, as stated in the earnings call. Management expressed that Rite Aid’s bankruptcy is not expected to have a material impact on FY24’s adjusted EPS. However, the potential financial risk associated with Rite Aid’s bankruptcy primarily pertains to provisions for accounts receivable.

Conclusion

I admire McKesson’s extensive distribution network and their prescription technology, particularly in providing prior authorization for GLP-1 patients. The stock appears significantly undervalued, and I maintain a ‘Strong Buy’ rating with a fair value of $660 per share.