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Important disclosures appear on the last page of this report. April 20, 2008 HEALTHCARE DISTRIBUTION (WHOLESALE DRUGS) Henry Fund Research Cardinal Health Inc. (CAH) Investment Recommendation BUY Gabriel Hilmoe gabriel-hilmoe@uiowa.edu Current Price $52.58 Target Price $72.31 Source: BigCharts.com – (5333 = DJ US Drug Retailer Index) Key Stock Statistics 52-Week Price Range $49.23 – 76.15 Market Capitalization (B) $19.45 Shares Outstanding (M) 356.59 Institutional Ownership 84.10% 60-Month Beta 1.01 Dividend Yield 0.90% Price/Earnings (ttm) 13.48 Price/Book 2.77 Price/Sales 0.22 ROA (ttm) 5.73% ROE(ttm) 10.75% Projected 5-Year Growth 13.89% Diluted EPS ($) Year 2005 2006 2007 2008E 2009E 2010E EPS 2.71 2.85 3.39 3.76 4.35 4.91 All earnings represent earnings from operations and have been filtered from net nonrecurring gains. Valuation Models Discounted Cash Flow $72.31 Economic Profit $72.31 Relative P/E (EPS08) $56.48 Relative PEG (EPS08) $60.53 INVESTMENT THESIS Cardinal Health Incorporated (Cardinal) is a leading
global distributor of pharmaceuticals and medical
supplies. The company has recently been facing margin
pressure within the supply chain services segment;
however we see this pressure abating somewhat in late
2008. We also see strong growth for the company within
the high margin clinical and medical products division.
Demographics also remain a positive for the company as
pharmaceutical demand continues to rise. The stock has
recently experienced a selloff, which we believe is
unwarranted. We view this is as a potential buying
opportunity to purchase a quality company with strong
future prospects at a discount.  (+) The higher margin Clinical and Medical Products segment con tinues to gain share in Cardinal’s business, now 26% of total profits. We view this as a
positive as it combats margin pressure in other
areas of the business.  (+) The pharmaceutical industry is expected to see an uptick in volume as well as an infusion of product
launches, particularly generics, in 2H2008. We view
this as a potential catalyst for the company to
expand supply chain services to existing customers
and an opportunity to gain more business with new
ventures.  (+) The company continues to gain exposure to higher margin products through contracting, which
we believe will continue to aid earnings growth going
forward.  (-) The company currently derives 40% of revenue from 2 existing distribution contracts with CVS and
Walgreens. We feel this focused business model
may expose the company to pricing pressure as well
as potential hardship if these contracts were omitted
from its business.  (-) The supply chain segment of Cardinal has recently experienced a tightening of margins
primarily due to customer re-pricing. This segment
currently makes up 86% of total revenue, which may
lead to reduced earnings going forward, however we
look for this environment to improve late 2008. 1
Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 2 EXECUTIVE SUMMARY The following research provides an analysis of
Cardinal Health Incorporated. The analysis includes a
high level review of the corporation, a detailed description of the company’s operating segments and how these segments compete within the industry and
current marketplace. Additionally, this research
provides an analysis of the company’s recent and forecasted financial performance, as well as positives
and negatives regarding the future opportunities for
investment in the company. COMPANY DESCRIPTION Cardinal Health Inc., founded in 1979, is a leading
distribution provider for the pharmaceutical as well as
medical supply industries. Cardinal operates as a
wholesale distributor of numerous products as well as
develops proprietary products it distributes directly or
through group purchasing organizations (GPOs). The
company operates 2 primary business sectors;
Healthcare Supply Chain Services and Clinical and
Medical Products. Cardinal further delineates these
sectors into the following operating segments:
Healthcare Supply Chain Services – Pharmaceuticals, Healthcare Supply Chain Services – Medical, Clinical Technologies and Services, and Medical Products
Manufacturing. These reporting segments were
redesigned beginning in FY 2007 as the company
divested its Pharmacy Technology Segment (PTS)
during 2Q 2007. Total revenues for Cardinal in FY 2007
from continuing operations were $87 billion. Chart 1
illustrates the operating revenue breakdown for
continuing operations in FY2007. 3 Source: FY 2007 10-K Healthcare Supply Chain Services Pharmaceutical: Through the Healthcare Supply Chain Services – Pharmaceutical segment, Cardinal distributes a wide
variety of both generic and branded pharmaceutical
products, over-the-counter (OTC) medical products,
and a diverse mix of consumer products. Collectively,
t his product line will be referred to as “pharmaceutical products” going forward. Cardinal’s pharmaceutical supply chain segment is one of the leading domestic
providers of wholesale distribution to retail customers
(including drug stores as well as pharmacies within
supermarkets), hospitals and alternate care providers,
which include mail order pharmacies within the U.S. To
support its distribution business the supply chain
management activities also include online procurement,
computerized ordering and information systems,
generic sourcing programs, inventory management and
operational consulting services. This segment also
manufactures and markets specific generic pharmaceuticals within the United Kingdom. Revenues
for this segment grew 9% YOY in FY 2007 to $76.5B
with earnings growing 14% YOY to $1.3B. This
segment currently makes up 86% of Cardinal ’ s overall operating revenue and 59% of total earnings. 3 Going into 2008 we expect the pharmaceutical business to
continue to expand, driven by high demand as well new
product offerings within the market. Medical: Cardinals Healthcare Supply Chain Services – Medical segment distributes a wide range of brand name and
private-label medical and lab products along with Cardinal’s own line of respiratory and surgical products that are developed within the Clinical and Medical
Products division. These products are primarily
distributed in the U.S. and Canada providing services to
laboratories, hospitals, surgery centers and physician
offices. Revenues for this segment grew 4% in FY 2007
with earnings growing just 1% YOY. The Medical
supply segment currently comprises 8% of total
revenues and 14% of total FY 2007 earnings. Chart 2
illustrates the breakdown of revenue distribution for the
pharmaceutical and medical divisions of the supply
chain service sector for FY 2007. 3 Source: FY 2007 10-K Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 3 Chart 3 illustrates the breakdown of earnings
contribution for the pharmaceutical and medical
divisions of the supply chain service sector for FY
2007. 3 Source: FY 2007 10-K As the chart shows, the pharmaceutical division of the
supply chain segment is the dominant earnings driver
for Cardinal although operating margins for the medical
segment are slighter higher. We see this trend
continuing into 2008 as pricing pressure is expected to
continue to impact the pharmaceutical line. Clinical and Medical Products Clinical Technologies and Services Cardinal’s Clinical Technologies and Services segment develops, manufactures and sells medical technology
products to hospitals and healthcare facilities. Products
that are produced in this segment include: Alaris ® intravenous medication safety and infusion therapy
delivery systems, syringe disposal centers, patient
monitoring equipment, as well as medical supply
dispensing systems for use in healthcare facilities.
Through two recent acquisitions, MedMined and
CareFusion, Cardinal also provides clinical intelligence
solutions involving products that identify and prevent
hospital-acquired infections as well bar-code identification systems. Revenues for the segment
increased 11% YOY in FY 2007 with earnings
increasing 20% YOY. We see this trend continuing as
the company continues to gain exposure in this
segment. The Clinical Technologies and Services Segment has
consistently comprised 3% of total revenues for the last
3 years, however earnings from this segment now
comprise 18% of total profit, an increase from 12% in
FY 2005 and 16% in FY 2006. 3 Clinical technologies and services products are distributed domestically as
well as in Canada and Europe. The following table
illustrates the growing contribution to earnings of the
clinical and medical products division over the last 3
years. Earnings Distribution FY2005 – FY 2007 Source: FY 2007 10-K Medical Products Manufacturing Through this segment the company develops and
manufactures surgical and medical products for use in
hospitals, surgery centers, and physician offices.
Products produced within this segment include single
use surgical and exam apparel, fluid suction and
collection systems, as well as respiratory therapy
products and surgical instruments. Through a strategic
acquisition of VIASYS Healthcare Inc, in 4Q 2007,
Cardinal is also now able to provide products geared
toward the ventilation, respiratory diagnostic and
neurological diagnostic markets. Products produced
within this segment are primarily distributed through Cardinal’s Medical Supply Chai n Services segment, however the company also engages in direct selling to
end users. Products within this segment are sold and
distributed domestically as well as in Europe and
Canada. Revenue for this segment increased 12% in
FY 2007 with earnings increasing 20% YOY. Revenues
and earnings as a percent of total have been relatively
stable over the last 3 years at 2% and 8.5%-9.0%
respectively. Chart 4 illustrates the revenue breakdown
in the Clinical and Medical Products division in FY
2007. 3 We look for continued strength and expansion in this market as Cardinal continues to focus operations
on higher margin segments. Source: FY 2007 10-K Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 4 Chart 5 illustrates the distribution of earnings within the
Clinical and Medical Products segment for FY 2007. 3 Source: FY 2007 10-K As the chart shows, Clinical Technologies are the
primary contributor to earnings in the Clinical and
Medical Products segment. We expect the company to
continue focusing on this segment line due to the
favorable margins and strong market demand. RECENT DEVELOPMENTS Supply Chain Environment Recently the company has been experiencing
depressed margins, particularly in the Healthcare
Supply Chain Services - Pharmaceutical segment. Total
operating margins have fallen off from 2.5% in FY 2005
to 1.6% in FY 2007, much of which is driven by price
deflation in the generics market as well as pricing
pressure from customers. The entire wholesale
distribution industry has experienced a deflation of
generic prices recently, negatively impacting overall
margins and profits. This, coupled with few new generic
product launches has severely reduced this segments
ability to impact earnings positively. New contract pricing with major customers has also
negatively impacted margins in the near term, however
we see a rebound in generic penetration and product
mix for the company in late 2008 early 2009, which
should help to support healthier margins in this
business. Numerous new products are expected to be
launched in late 2008 and many blockbuster brand
drugs are coming off patent in the next year or two,
which we believe will reenergize the segment. One
generic, Cardiolite, is expected to come to market in
midsummer. We view this as a huge opportunity for
Cardinal. We view the launch of the drug, which aids in
detection of coronary heart disease, as a potential
margin driver going forward, aiding the depressed
distribution segment in 2H 2008. 5 Brand prices have not seen the same pricing deflation
as generic, which has been a positive for the company,
supporting margins in the supply chain business. Customers Cardinal’s largest customers, CVS Corporation (CVS) and Walgreen Co. (Walgreens) represent 21% and 19% of the company’s total FY 2007 revenues
respectively. Cardinal’s 5 largest customers, all
conducting business in the company’s Healthcare Supply Chain Services – Pharmaceutical segment, made up approximately 50% of the company’s overall revenue for FY 2007. 3 This focused concentration on a small number of customers is a cause of concern for
us. If the company were to lose any one of these
contracts the overall business results would likely
suffer. Recently the company was able resign its distribution
contract with Walgreens. This signing completed the
renewal of most major contracts for Cardinal over the
last 9 months, with the exception of CVS, which is Cardinal’s largest customer . 2 The CVS contract should be reviewed sometime mid-summer 2008. The
resigning of many of these contracts may result in
reduced operating margins for Cardinal in the near term
due to price concessions. However, we view the action
of contract renewals as a positive going forward. Major
contracts are in place for the future and we look for
margins to continue to improve towards late 2008 early
2009 as new products come to market. Acquisitions/Divestitures Third quarter 2007, Cardinal acquired VIASYS
Healthcare Inc. for $1.5 billion, which we believe will aid
the company in further diversifying its already assorted
product offering, in a sense protecting its operations
from the slowed margin business of the supply chain
services segment. 3 1Q 2008, revenue in the Medical Products and Technologies sector was up 47%, with a
large portion of that increase due to VIASYS activity. 4 Recently Cardinal announced plans to purchase Enturia
for $490 million in cash. 6 The deal, which gives Cardinal access to Enturia’s infection prevention products, serves 2 purposes for Cardinal. It will eliminate a
primary competitor in this arena and will allow Cardinal
further diversified exposure into this high-margin, high-
growth segment. Cardinal also divested its Pharmaceutical Technology
Services (PTS) unit in 2Q 2007 for $3.2 billion to
Phoenix Charter LLC, a subsidiary of The Blackstone
Group. The company has made it clear that it plans to
continue to grow through use of this influx in cash to
make strategic acquisitions that will benefit and
complement its higher margin Clinical and Medical
Products business. We view this as a definite positive,
as the company has begun to place new emphasis on
its most profitable lines of business as these products
become more and more influential to the company’s bottom line. Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 5 Regulatory Matters In 2Q 2008, the company experienced a probe from the
Drug Enforcement Agency (DEA), regarding lax
controls on it distribution practices of Vicodin. The DEA suspended Cardinal’s distribution license in the States of Washington and Florida, requiring further controls for
dispersion by distributors. The costs related to the
suspension are expected to be approximately $30
million and should be realized in late 2008, according to
the company. We do not see this trend continuing past
this event. INDUSTRY TRENDS The industry that Cardinal operates in is primarily
comprised of large, well-diversified healthcare distributors, which we view as a relatively stable area of
the market, without much risk from major macroeconomic events. The industry is generally
protected from large movements in the currency
markets, commodity pricing and overall consumer
spending as a whole. 7 Despite major pressure in customer pricing, slowed
generic volumes, price deflation and a tightening
regulatory environment, the industry has managed to
outperform many of the other major healthcare sectors
YTD. We believe there is still a huge demand for the services
these distribution companies provide, improving supply
chain efficiencies and distribution logistics. In the near
term we expect margins in the drug distribution
segments of these businesses to remain soft, however with the introduction of new “major” drugs and drugs coming off patent heading into 2H 2008, we do foresee
these margins improving. A tighter focus on generics
should also aid in improving gross margins as these
drugs do carry wider margins than the higher priced
branded names. We also view the overall consumer market as a positive
for the industry on a whole. The aging population will
continue to demand prescriptions and the drug
distribution companies will likely benefit, provided
pricing pressures from customers or the Federal
government does not become too stringent. MARKETS AND COMPETITION Cardinal health operates a highly diversified company
with a wide variety of product lines. T he company’s core business is in supply chain services, specifically
pharmaceuticals. The following competitive analysis examines Cardinal’s competitive position by segment. Based on market size and revenue stream the
company primarily competes with 2 public companies,
McKesson Corp.(MCK) and AmerisourceBergen Corp.(ABC) and a number of smaller independent and
regional wholesale distributors. Healthcare Supply Chain Services Recently McKesson has outperformed Cardinal. We
believe there has been an overreaction in the market
regarding Cardinal and the recent regulatory matters it
is facing. Overall we believe Cardinal has better
fundamentals and operating metrics, and presents
more upside going forward. Pharmaceutical Within this segment the company competes primarily
with MCK and ABC as well as other smaller regional
and independent providers. The pharmaceutical supply
segment maintains very thin profit margins. Due to the
fact that 86% of Cardinals revenues are derived from
this segment the company is highly competitive on
pricing, the ability to handle large volumes, and the
quality of support services and inventory management
systems it provides. Cardinal has been able to maintain industry high
margins over the past few years due to contracting
arrangements, however competitive pressures have
impacted recent contract redesigns and these margins
have begun to revert to the mean, which will likely
impact future profitability going forward if the company
is unable to gain exposure to more profitable drug
offerings. Financial metrics for the competing public
companies are provided below. 3 As the table above illustrates, Cardinal trades at a
discount to its primary competitors. We believe Cardinal
is positioned well going forward and expect even more
positive metrics as more focus is put on higher margin
segments. Medical The medical distribution segment competes for
business both domestically and in Canada. The major
factors driving competition within this segment include
price, order accuracy, product offerings, and service Market Cap (B) P/E (ttm) EPS (ttm) ROA (ttm) ROE (ttm) Cardinal 19.21 13.32 4.05 5.73 10.75 McKesson Corp 15.31 16.99 3.12 3.62 14.93 AmerisourceBergen Corp 6.53 15.90 2.53 3.68 14.11 Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 6 offerings. Unlike the pharmaceutical segment, the
medical segment competes across a large customer
class with many different distributors participating
including; Owens & Minor, Inc., Fisher Scientific
International, Inc., Physician Sales & Service, Inc.,
Henry Schlein, Inc., and Medline Industries. 3 The following table shows select financial metrics where
available for companies in this segment. The table above again illustrates that Cardinal is
currently trading at a discounted P/E multiple, even
though its financial metrics remain competitive. We
view this is as an opportunity to purchase Cardinal at a
discount relative to its peers. Clinical and Medical Products Clinical Technologies and Services This segment faces competitive pressure domestically
and globally. Within this segment Cardinal competes
primarily based on quality, innovation, value
propositions and price. Competitors within this segment
include Hospira, Inc., Braun Medical, Inc., Baxter Int’l, Inc. and Fresenius AG. 3 Specific company financial data is provided below where available. Medical Products Manufacturing The Medical Products Manufacturing segment
experiences competition both domestically and
internationally. Factors within this industry driving
competition include; innovation, product performance,
quality and brand recognition. Primary companies
operating within this segment include; Kimberly-Clark
Corp., Coviden Ltd. (formerly Tyco HC), Telefex Inc.,
Medline Industries, Inc, Ansell Ltd., 3M Company,
Gettige AB, Drager Medical AG, and Respironics. 3 Due to the limited financial information for these companies
a financial metrics comparison is not provided. ECONOMIC OUTLOOK In general, the healthcare industry is a defensive
industry during economic downturns. Spending
generally does not subside as much as it does in non-
staple industries. However, Cardinal and its competitors
continue to operate in an economic environment where
volatility has been ever increasing . Cardinal’s FY 2007 operating results did not appear to be negatively
impacted by the current macroeconomic environment. Any negative results can generally be linked to internal
industry pressures; however, future impacts to profits
may be a result of the overall economy if recessionary
trends persist. Operating results should be monitored
carefully to ensure that the current monetary tightening
is not adversely impacting the business. Real GDP Real GDP growth, which is an indicator of the overall
health of the economy, has been stagnant recently.
This trend is expected to continue, leading to what
many economists believe will be a recession. In
general, Cardinal is not a company directly impacted by
slowed output or even slowed consumer spending. The
products Cardinal develops and distributes are
generally thought of as fundamental healthcare
products required to provide proper medical attention.
Slowed GDP growth generally does not have the same
significant impact on this industry as it does for other
superfluous products and services. Cardinal is, however, operating in an economy that has
slowed severely as of late and looks to be continued
down that path, at least in the first half of 2008. We
believe Cardinal will maintain its growth expectations in
this environment; however the company may be forced
to react strategically if this current environment persists
and pricing pressures persist to customers and
ultimately to the company. The Henry Fund projects
GDP growth rates for the near term 6-months at 0.80%
and 2.64% for the next 2 years. The table below shows the seasonally adjusted change
in GDP growth from 2000 – 2007. Source: Federal Reserve San Francisco -Fed Views 10 National Healthcare Expenditures Per the Centers for Medicare and Medicaid Services
(CMS), national healthcare expenditures in the U.S. are
expected to grow to $2.4 trillion in 2008, a 6%-7%
increase from the previous year 8 . The healthcare Market Cap (B) P/E (ttm) EPS (ttm) ROA (ttm) ROE (ttm) Cardinal 19.21 13.32 4.05 5.73 10.75 Owens & Minor 1.68 22.93 1.78 5.59 12.52 Thermo Fisher Sci. 23.81 33.17 1.72 3.14 5.49 Henry Schein 5.16 24.42 2.36 7.79 14.46 Market Cap (B) P/E (ttm) EPS (ttm) ROA (ttm) ROE (ttm) Cardinal 19.21 13.32 4.05 5.73 10.75 Hospira 6.77 49.93 0.85 8.19 8.81 Baxter 37.95 22.92 2.61 9.87 25.89 Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 7 distribution industry is directly impacted by healthcare
spending and as spending fluctuates; there is more or
less money in the system to funnel back to retailers,
developers and ultimately distribution companies.
Healthcare spending is not projected to drop in the near
future, however governments, domestically and abroad,
are all looking into ways to curb mounting healthcare
costs. If healthcare spending were to actually retract,
healthcare distribution would likely be adversely
impacted. Cardinal has already seen some of this pricing pressure
from customers, however much of this pressure was
due to internal industry pressure and not necessarily a
reduction in healthcare spending. If healthcare
spending were to retract due to macro pressure,
Cardinal would also experience this retraction in its
business. Source: Health Affairs.org - U.S. Health Spending Projections for
2004 – 2014 Government Sponsored Healthcare Government sponsored healthcare programs (Medicare and Medicaid), play an integral role in America’s overall health expenditure measure. In 2006, the two programs
paid a combined 34.4% of the overall healthcare bill 8 . This segment of healthcare spending is integral to the
pharmaceutical and medical products business,
because the reimbursement rate for such products is
generally dictated by the Medicare system and the
products are not priced in an open and free market. Source: NCHC- Impact of Rising HC Costs Recent projections by CMS show Medicare expenditures are expected to increase annually by
8.8% from 2005 – 2016. 8 Cardinal’s primary end-user clientele in the past has been a wide domestic
population suffering a wide variety of ailments, but the
most prevalent has been the elderly population
suffering chronic illness. We believe the consistent
increase in public spending will continue to aid demand for Cardinal’s distribution services and medical products well into the future. Consumer Price Index According to the Bureau of Labor and Statistics (BLS),
medical service inflation was 5.2% for the year ended
December 2007 as opposed to 4.1 for the overall
consumer price index. This increase is generally
attributed to price increases in hospital and related
services as well as prescription drug prices. Outside of
transportation and energy, medical services experienced the highest price growth in 2007. Source: Centers for Medicare and Medicaid Services Healthcare related inflation has generally tracked higher
than the overall price index, and we do not foresee this
pattern subsiding. We also do not see inflation in
general, maintaining its current pace long term.
Cardinal, as well as other healthcare distribution
companies, has continued to hear cases for reduced
pricing initiatives domestically and abroad. This may
reduce the heightened inflationary trends of the medical
services and products industry. We do not see this
happening in the near term. In general, as overall inflation climbs, the purchasing
power of consumers is greatly impacted. A cause for
concern going forward for companies like Cardinal is
that end users will not view their medications as a
necessary staple if inflation gets out of control. Non-
essential pharmaceuticals and medical procedures may
as a result decline, reducing demand for the newest
technology. We project a 4.15% inflation rate for the Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 8 short term 6-month period going forward and a 3.40%
inflation rate for the 2-year period going forward. CATALYSTS FOR GROWTH Expansion into New Products Cardinal continues to expand into new diversified
product lines through acquisitions and innovations.
These products are being developed and acquired
primarily within the Clinical and Medical Products
segment. Revenue gains in this area have proven to be
advantageous for the company with resulting profit
margins in this segment higher than the dominant
distribution segments. We believe management ’ s focus to grow this business line will support earnings going
forward and will help to diversify the company away
from any major downturns that the company may
experience in the fairly “tight margin ” distribution businesses. Opportunities with New Drugs We believe the company will continue to improve its
supply chain service segments through 2008 and
beyond. We expect this to be primarily driven by an
increase in generic drug volume in the market in late
2008. We also see further expansion of the generics
market, which maintains higher margins than branded
names, beyond 2008 as major blockbuster drugs like
Ambien, Fossamax, Paxil, Zyrtec come off patent and
generic counterparts begin to compete. We also view the opportunities with the Cardiolite
offering which is scheduled for midsummer as an
opportunity for Cardinal to make progress in the
margins of its distribution business, which has been
suffering under a lack of volume as well as pricing
pressure from customers. Aging Population Another primary catalyst for Cardinal is the changing
demographics, both domestically and globally. Globally
the number of people aged 65 and over is likely to
increase over 100% from 1994 to 800 million in 2025. 9 Source: AgingStats.gov – U.S. Census Bureau Continued aging will no doubt increase the prevalence
of chronic disease which requires constant medication.
The demand for more medication as well as the
prevalence of new drugs will likely increase with this
change in age increasing the demand for sophisticated
distribution systems and logistics, which Cardinal is in
place to provide. Acquisitions The company continues a commitment to expanding its
high margin Clinical and Medical Products division
through acquisition and innovation. We believe the company’s new focus to expand this business will continue to support and improve profit levels of the
overall business. With the influx of cash due to the PTS
divestiture in 2007, we look for more small but effective
acquisitions to continue into 2008, which we feel will be a major influence on the company’s profitability going forward. INVESTMENT POSITIVES  Cardinal operates a highly diversified business
offering large scale supply chain and distribution
services as well a more highly specialized and
diversified Clinical and Medical Products segment
that produces high-margin products. We believe this
business model positions the company extremely
well to take advantage of changes in the market
place as well as support its operation during periods
of sluggishness in certain segments.  Through new management and recent acquisition
activity the company has gained more exposure to
the high margin Clinical and Medical Products
market. We see this is a strong positive for the
company as its product offering becomes more
diverse and profitable.  The continued aging of the population should
continue to produce a market that maintains high
demand for pharmaceuticals and other distributed
products. Cardinal maintains a strong position in this Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 9 area providing leading distribution and logistical
services that will no doubt grow in demand as the
pharmaceutical segment becomes more specialized
and distribution volume expands.  The company continues to look for strategic
acquisition opportunities to aid in the growth of the
Clinical and Medical Products segment. We feel this
focus on improving margins and profitability will aid
the overall business going forward. 1Q 2008
experienced 47% revenue growth largely driven by
the VIASYS transaction. We see this successful
trend continuing with Enturia.  We believe the market will see an increase in
generic volume in 2H 2008 due to new offerings as
well as patents expiring in major pharma. We believe
this will aid Cardinal in improving operating margins
in the distribution business if they make a concerted
effort to grab these opportunities. Cardinal has also
committed to gaining share with independent and
regional pharmacy customers, which offers more
exposure to higher margin clients. INVESTMENT NEGATIVES  Cardinal derives 40% of its revenues from two
customers, CVS and Walgreens. We view this is a
great exposure to contract pressure as well as
pricing pressure. Historically, Cardinal has maintained margins that were slightly higher than
the industry average. However, with numerous major
contracts being re-priced recently, these margins
seem to be reverting to the mean. The CVS contract
is set to be reviewed this summer, and we believe
the pricing pressure that will result from this may
further depress profitability for this business
segment, Cardinals largest.  The company may not be able to overcome
depletion of profitability in its distribution business. If
the Clinical and Medical Products segment is not
able to make headwinds in supporting overall
profitability, the company may experience reduced
earnings going forward.  The overall generic market continues to see price
deflation. If this deflation continues and is not
combated with new offerings, margins will likely
remain soft in the distribution business. We do not
see margins associated with generics reverting to
brand name levels, however without new product
introductions the profitability of the market will
continue to suffer.  Cardinal is in the middle of the domestic healthcare
discussion regarding price reduction. If political and
policy events influence industry pricing methods the
company will likely experience earnings retraction. VALUATION Based on the attached relative valuations and
discounted cash flow (DCF) model the target price for
Cardinal Health Inc. is $72.31. The DCF assumes a
13.3% CAGR over the next 5 years (slightly less than
analyst estimates of 14%), continuing value growth of
3.50%, and a weighted average cost of capital of
7.99%. Cardinal is currently trading in the $52 range,
representing a 27% discount to our best estimate price.
We feel that Cardinal has strong future prospects and
as the largest player by market cap in its industry is in
the best position to capitalize on future opportunities.
Near term, the stock is likely to continue to trade at the
current discount given the current macroeconomic
conditions and overall market sentiment, however we
feel that Cardinal has been oversold based on this
broad market sentiment and is undeservedly
underpriced. The stock operates in an industry that can
be classified as defensive, as its primary business is
distributing pharmaceuticals, which we believe will not
suffer the same long term slow down as other retail and
distribution industries. We see great room for margin improvement going
forward as the company refocuses on higher margin
products as well as looks to improving soft margins and
volume in its primary distribution business. We also
believe small strategic acquisitions will continue to
benefit Cardinal. The acquisitions made in late 2007
VIASYS, and committed too in early 2008, Enturia, will
continue to improve profitability and aid in diversification
into new areas of the Clinical and Medical Products
segment. If margin pressure in the supply chain business were to
persist well into late 2008 we would suggest
conservatism toward Cardinal as this may indicate
further slowing to profits in the company’s primary business. We would also suggest a tight monitoring on the company’s ability to take advantage of the
Cardiolite offering in conjunction with GE Healthcare’s Myoview cardiac imaging product. This product could
prove to be a large revenue driver for the company if
distributed and marketed correctly. However, any
issues in the launch could detract from any potential
gain Cardinal may have realized. Regulatory pressure also persists for the company,
however we believe the license suspension as well as
changes in management will protect the company from
any further losses related with the DEA anti-diversion
issues. Trading Discipline Based on our analysis, the potential upside for Cardinal
is approximately 37% from the current trading price. Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 10 After review of FY 2008 results, if potential upside were
to approach 10% or below we suggest re-evaluation of
the stock to properly consider any changes in the company’s operating results as well as any positions the Henry Fund may maintain. We also recommend
diligent monitoring of quarterly results to gauge margin
levels of the coming quarters. REFERENCES 1. Cardinal Health Inc, 10-Q 1Q FY 2008 2. Thomson Financial – GS Equity Research March 11, 2008 3. Cardinal Health Inc, 10-K FY 2007 4. Conference Call 1Q 2008 – Q1 FY 2008 Earnings Call FY 2008 Essential to Care 5. Cardiolite.com 6. Reuters.com – “Key Development – CAH” 7. Standard and Poor’s Stock Report – Stock Report: Cardinal Health Inc - April5, 2008 8. Centers for Medicare and Medicaid Services-National
Healthcare Expenditure Report 9. Census.gov-Fact Finder 10. Federal Reserve Bank of San Francisco- FedViews 11. BigCharts.com 12. X-rates.com 13. U.S. Department of Commerce-Business and Industry 14. Kaiser Family Foundation
IMPORTANT DISCLAIMER This report was created by a student(s) enrolled in the Applied
Securities Management (Henry Fund) program at the University of
Iowa ’s Tippie School of Management. The intent of these reports is to provide potential employers and other interested parties an
example of the analytical skills, investment knowledge, and
communication abilities of Henry Fund students. Henry Fund
analysts are not registered investment advisors, brokers or officially
licensed financial professionals. The investment opinion contained in
this report does not represent an offer or solicitation to buy or sell any
of the aforementioned securities. Unless otherwise noted, facts and
figures included in this report are from publicly available sources. This
report is not a complete compilation of data, and its accuracy is not
guaranteed. From time to time, the University of Iowa, its faculty,
staff, students, or the Henry Fund may hold a financial interest in the
companies mentioned in this report. Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 11 Cardi nal
He
a
lth Inc K
ey
A
s
s
um
pti
on
s
of
V
al
ua
ti
on
M
od
el T
i
c
k
er Sy m
bo
l CA
H 72.31 $
3.25% 3.30% 3.35% 3.40% 3.45% 3.50% 3.55% 3.60% 3.65% 3.70% 3.75% Cur
r
en
t S
ha
r
e P
r
i
c
e $52.58 A
s
of
4/
20
/20
08 0.762 91.42 $
92.44 $
93.48 $
94.55 $
95.65 $

96.78 $
97.94 $
99.14 $
100.38
$
101.65
$
102.96
$
0.812 86.10 $
86.99 $
87.91 $
88.85 $
89.82 $

90.81 $
91.83 $
92.88 $
93.96 $
95.07 $
96.21 $
E
f
f
ec
ti
v
e T
ax
Rate 30.0% A
v
erage r
ep
orted T R f
or 2 y ea
r
s 0.862 81.29 $
82.09 $
82.90 $
83.73 $
84.59 $

85.46 $
86.36 $
87.28 $
88.23 $
89.20 $
90.20 $
Nor
m
al
Cas h (% of
Rev en
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) 2.00% B
as
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on
3
y
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r
hi
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c
al
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ng
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tl
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ers 0.912 76.94 $
77.64 $
78.37 $
79.11 $
79.87 $

80.64 $
81.44 $
82.26 $
83.09 $
83.95 $
84.83 $
Ri
s
k
-
F
r
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Rate 3.71% 10
-
Y
ea
r
T
-
B
on
d (4/20 /08
) 0.962 72.97 $
73.60 $
74.25 $
74.91 $
75.59 $

76.28 $
76.99 $
77.71 $
78.46 $
79.22 $
80.00 $
Ma
r
k
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Ri
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um 4.82% B
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B
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d 1.012 69.34 $
69.90 $
70.48 $
71.08 $
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72.31 $
72.94 $
73.59 $
74.25 $
74.93 $
75.63 $
B
eta 1.01 B
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68.67 $
69.24 $
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65.34 $
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66.38 $
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Cos t o
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Deb t 5.12% Com pu
ted
on
W
A
CC pag e. 1.162 60.08 $
60.51 $
60.93 $
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62.27 $
62.74 $
63.21 $
63.69 $
64.19 $
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Cos t o
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qu
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ty 8.59% Com pu
ted
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57.83 $
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59.44 $
59.86 $
60.29 $
60.73 $
61.17 $
61.63 $
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55.35 $
55.70 $
56.07 $
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56.81 $
57.19 $
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W
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ted
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CC pag e. CV
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s
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on 5 Y
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CA
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2.46% 2.71% 2.96% 3.21% 3.46% 3.71% 3.96% 4.21% 4.46% 4.71% 4.96% 3.57% 160.85 $
143.25
$
128.91
$
117.00 $
106.96 $
98.37 $
90.95 $
84.46 $
78.75 $
73.68 $
69.15 $
3.82% 145.57 $
130.82
$
118.59
$
108.30 $
99.52 $

91.94 $
85.33 $
79.52 $
74.36 $
69.76 $
65.62 $
V
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120.23
$
109.69
$
100.71 $
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86.23 $
80.30 $
75.06 $
70.38 $
66.18 $
62.39 $
DCF V
aluat ion
T
ar
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et 72.31 $


4.32% 121.91 $
111.10
$
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94.01 $
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81.10 $
75.76 $
71.01 $
66.75 $
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E
P
V
aluat ion
T
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4.57% 112.56 $
103.15
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76.49 $
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67.32 $
63.42 $
59.89 $
56.67 $
Cu
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r
ent
Disc o
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t 27.28% 4.82% 104.43 $
96.17 $
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82.75 $
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72.31 $
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63.95 $
60.36 $
57.10 $
54.13 $
5.07% 97.29 $
89.98 $
83.60 $
77.97 $
72.97 $

68.50 $
64.48 $
60.85 $
57.54 $
54.53 $
51.77 $
Rela t
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08 56.48 $


5.32% 90.98 $
84.47 $
78.73 $
73.65 $
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65.02 $
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54.93 $
52.14 $
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Rela t
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/E
09 56.85 $


5.57% 85.35 $
79.51 $
74.34 $
69.72 $
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61.84 $
58.44 $
55.35 $
52.51 $
49.91 $
47.51 $
5.82% 80.31 $
75.04 $
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58.90 $
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50.26 $
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6.07% 75.76 $
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56.19 $
53.28 $
50.61 $
48.16 $
45.89 $
43.79 $
Rela t
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e P
E
G
09 60.88 $


BETA CV
G
r
o
w
t
h Risk Free Rate MRP Henry Fund Research THE UNIVERSITY OF IOWA Henry B. Tippie School of Management 12 Car
d
inal Hea lt
h
Inc Rev en
ue
an
d E
arni
ng
s
Dec om
po
s
i
ti
on
(
00
0's
) F
i
s
c
al
Y
ea
r
s
E
nd
i
ng
J
un
e 3
0 2005 2006 2007 2008E 2009E 2010E 2011E 2012E CV Gros s
P
rofit T
ota
l
Rev en
ue 72,66 6,000
79,66 4,200
86,85 2,000 92,99 3,794
99,65 6,447
106,3 97,95 8
112,3 30,65 5
118,0 58,03 3
123,5 24,01 4 CO
G
S 68,20 6,300
74,85 0,200
81,60 6,700 87,37 7,569
93,57 7,403
99,90 7,683
105,4 22,32 0
110,7 97,46 4
115,9 27,28 8 G
r
o
ss
P
r
o
f
it
Befo r
e E
xpen se
s 4,459 ,700 4,814 ,000 5,245 ,300 5,616 ,225 6,079 ,043 6,490 ,275 6,908 ,335 7,260 ,569 7,596 ,727 G
r
o
ss
M
ar
g
in Bef o
r
e E
xpen se
s 6.14% 6.04% 6.04% 6.04% 6.10% 6.10% 6.15% 6.15% 6.15% T
o
t
al
O
p
er
atin g
E
xpen se
s 2,677 ,500 2,969 ,100 3,871 ,600 3,417 ,522 3,637 ,460 3,883 ,525 4,100 ,069 4,309 ,118 4,508 ,627 G
r
o
ss
P
r
o
f
it 1,782 ,200 1,844 ,900 1,373 ,700 2,198 ,703 2,441 ,583 2,606 ,750 2,808 ,266 2,951 ,451 3,088 ,100 O
p
er
atin g
M
ar
g
in 2.5% 2.3% 1.6% 2.4% 2.5% 2.5% 2.5% 2.5% 2.5% Net
E
ar
n
ing
s 1,182 ,132 1,220 ,236 1,369 ,914 1,371 ,703 1,529 ,726 1,633 ,209 1,763 ,591 1,853 ,511 1,939 ,327 Net
M
ar
g
in 1.63% 1.53% 1.58% 1.48% 1.54% 1.54% 1.57% 1.57% 1.57% Rev e
nue by
S
e
gme nt Heal thc
are S up
pl
y
Cha i
n S
erv
i
c
es
-
P
ha
r
m
ac
eu
ti
c
al
: Non-Bu l
k
Cus tom ers 39,570,500 40,174,900 42,672,800 44,166,348 45,712,170 47,312,096 48,731,459 50,193,403 51,699,205 Y
O
Y
G
r
o
w
t
h 1.53% 6.22% 3.50% 3.50% 3.50% 3.00% 3.00% 3.00% B
ul
k
Cus tom ers 24,084,400 29,872,000 33,900,000 37,629,000 41,768,190 45,945,009 49,620,610 53,094,052 56,279,696 Y
O
Y
G
r
o
w
t
h 24.03% 13.48% 11.00% 11.00% 10.00% 8.00% 7.00% 6.00% T
o
t
al
HS
CS
-
P
h
ar
maceut ica
l 63,654,900 70,046,900 76,572,800 81,795,348 87,480,360 93,257,105 98,352,069 103,287,455 107,978,900 Heal thc
are S up
pl
y
Cha i
n S
erv
i
c
es
-
Me
di
c
al 6,823,000 7,198,600 7,513,900 7,814,456 8,127,034 8,452,116