Here's a Dividend Aristocrat Trading at a Discount

We believe high-quality dividend growth companies are the best stocks to own for the long-term. This is why we recommend investors looking for the best dividend growth stocks consider the Dividend Aristocrats, a group of stocks in the S&P 500 Index with 25+ consecutive years of dividend growth. The Dividend Aristocrats provide their shareholders with steady dividends, even during a recession, along with regular dividend growth. Buying Dividend Aristocrats is a great strategy for superior long-term returns -- and it's even better to buy Dividend Aristocrats when they are undervalued. Cardinal Health is an example of a Dividend Aristocrat with a high dividend yield of 4.3% that is also significantly undervalued. The stock has declined 10% year to date, underperforming the S&P 500 Index which has returned 3% so far in 2020. However, we believe Cardinal Health is trading at a meaningful discount, with dividends and annual dividend increases to add to long-term returns. Business Overview Cardinal Health is one of the Big 3 drug distribution companies along with McKesson and AmerisourceBergen . Cardinal serves over 24,000 United States pharmacies and more than 85% of the country's hospitals. The company has operations in 46 countries with approximately 50,000 employees. The company operates in two segments: Pharmaceutical and Medical. The Pharmaceutical segment makes up the lion's share of revenues (~90%), but the Medical segment remains important due to its higher margins and growth potential. As a major healthcare services company, Cardinal has been relatively insulated from the coronavirus pandemic. Demand for pharmaceutical and medical products has remained fairly stable, as consumers continue to need these products even during a recession. This has kept Cardinal's fundamentals afloat, at a very challenging time for the broader economy. On Aug. 6 Cardinal released fourth-quarter and full-year fiscal 2020 results for the period ending June 30, 2020. For the quarter Cardinal reported revenue of $36.7 billion, representing a 2% decline compared to the $37.4 billion posted in Q4 fiscal year 2019. Adjusted earnings equaled $305 million or $1.04 per share compared to $334 million or $1.11 per share in Q4 2019. For the year, the company reported revenue of $152.9 billion, a 5% increase compared to the $145.5 billion posted in fiscal 2019. Adjusted earnings equaled $1.6 billion or $5.45 per share (above prior guidance of $5.20 to $5.40) compared to $5.28 last year. Cardinal also provided a fiscal year 2021 outlook. The company expects $5.25 to $5.65 in adjusted earnings per share. How Cardinal's Growth Will Take Flight Cardinal Health has struggled to grow in recent years, as the company has been impacted by falling drug prices, which has eroded margins in the core Pharmaceutical segment. This was evident in the most recent quarter and fiscal 2020 as a whole. For the quarter the Pharmaceutical segment reported $33.2 billion in revenue (flat) and $359 million in profit (-20%). For the year the Pharmaceutical segment reported $137.5 billion in sales (+6%) and $1.8 billion in profit (-4%). Price deflation, partly brought on by the spread of generics, has resulted in lower profit margins. However, sales continue to rise, which is a good sign that demand has kept growing. Plus, Cardinal has a promising long-term growth catalyst in the form of its Medical segment. While Pharmaceutical profits are being dragged down by unfavorable pricing, the Medical segment continues to enjoy rising profitability. Medical segment operating profit rose 24% in the most recent quarter, and 15% for the full year. Collectively, the three major pharmaceutical wholesalers have a competitive advantage in the industry. Competition is held at bay by the massive scale already in place and the exceptionally low margins. Cardinal has proven itself to be a solid operator in many ways -- strong earnings for the past decade, a growing dividend and ample interest coverage. We expect 4% annual earnings growth from Cardinal moving forward, due to revenue growth and share repurchases. Expected Returns While Cardinal remains a profitable company with a growing dividend, market sentiment has taken a negative turn over the past few years. CAH stock has lost nearly half its value over the past five years. And yet, the company continues to pay its dividend, and raise the dividend each year. With 33 years of consecutive dividend increases, Cardinal is a member of the Dividend Aristocrats Index. The dividend payout ratio has ticked up slightly, but it still represents less than 40% of profits. Therefore, the company still has the ability to raise its dividend each year moving forward. In the meantime, the stock has an attractive yield of 4.3%. Not only is Cardinal a solid dividend growth stock, it also appears to be significantly undervalued. Based on expected adjusted EPS of $5.45 for the upcoming fiscal year, the shares trade at a price-to-earnings ratio of 8.4. We believe this is far too low for a highly profitable company with a leadership position in its industry, and a long history of raising its dividend. Our fair value estimate for Cardinal is a P/E ratio of 10. If it reaches this multiple over the next five years, the multiple expansion would boost shareholder returns by 3.5% per year over this period. Final Thoughts Taking it all together, we expect annual returns of nearly 12% per year, comprised of future earnings growth, returns from an expanding P/E multiple and dividends. With a double-digit expected annual return and a long history of growing its dividend, we find Cardinal Health to be an attractive stock for value and income investors.

Here's a Dividend Aristocrat Trading at a Discount

With 33 years of consecutive dividend increases, this health care name is a member of the Dividend Aristocrats Index.

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