The market is full of drama. Yesterday, two stocks fell more than 11%. These are rather big drops for dividend growth stocks and warrants further investigation.
First, there’s Cardinal Health Inc (NYSE:CAH) which declined by 11.5%. It dragged down its competitors: McKesson Corporation (NYSE:MCK) and AmerisourceBergen Corp. (NYSE:ABC) by more than 4% as well.
Then, there’s W.W. Grainger Inc (NYSE:GWW) that fell 11.4%.
One I think is undervalued. The other not so much.
Why did Cardinal Health shares fall?
The company expects its earnings per share (“EPS”) for this year to come out to about $5.35 — which is the low end of its guidance.
Additionally, the company is acquiring Medtronic’s (NYSE:MDT) patient product portfolio for $6.1 billion, which is a big acquisition — coming out to a quarter of Cardinal Health’s market cap after the 11% pullback.
The acquisition will add diversification to Cardinal Health’s portfolio, and there won’t be dilution to current shareholders as the company plans to finance the acquisition with $4.5 billion in new senior unsecured notes (i.e. debt) and existing cash.
The acquisition is expected to close in Q3 (i.e. fiscal Q1) and is expected to be accretive to earnings in the first fiscal year and even more accretive after that. “By the end of fiscal 2020, the company assumes synergies will exceed $150 million annually,” as stated from the press release linked above.
It seems the acquisition will actually benefit shareholders over the long run. Still, the market generally likes to drag down the share price of the acquirer, which is Cardinal Health in this case. Adding in the EPS forecast, the shares were dragged down quite harshly.
Is Cardinal Health a bargain?
At $72.40 per share, it trades at a multiple of 13.5 based on EPS of $5.35. Assuming a multiple of 15 and its EPS to grow 9.3% per year, Cardinal Health can deliver more than 14% per year over the long term.
Why did W.W. Grainger shares fall?
In Q1, Grainger missed earnings and revenues. Its sales increased 1%. Partially, it had to do with the company’s pricing strategies, which resulted in lower prices but higher volume in the U.S.
Grainger will continue its pricing strategies in the U.S. through 2018 and expects to lower its prices by a total of 6.9% in the period. As well, it expects is gross margin to contract by 3.3%.
Since the U.S. is its core market, which contributes about 78% of its sales, this was big news and shares reacted by falling 12%.
Grainger believes the new pricing will allow it to gain more business in the fragmented industrial distribution industry, which the company is a relatively big player in.
Is Grainger a bargain?
With the company’s most conservative guidance, it expects its 2017 earnings per share (“EPS”) to be $10.65, which would imply a multiple of 18.4 at the recent trading price of $196.
Across 26 analysts, they estimate Grainger to grow its EPS at a compound annual growth rate of 8.2% in the next three to five years.
Even if I give Grainger a generous forward multiple of 19.5 in 2021, the estimated rate of return would only by 7.8%, which is not good enough in my books.
If the shares fell to below a multiple of 16 (i.e. below $170.40 per share), I’d take another look at the company as a potential bargain.
Between the two companies whose shares fell more than 11% on the same day, I’d choose Cardinal Health. However, we don’t know how long negative sentiment can stay for the stock. So, interested investors can consider starting a position here or allow it to consolidate or recover some grounds before buying.
This content came primarily from excerpts of two of my Seeking Alpha articles:
- Is Cardinal Health A Bargain After Falling 11.5% In A Day?
- Is W.W. Grainger A Bargain After Falling 12% In A Day?
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Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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