Red-Flag Warning Signs at Cardinal Health (CAH)

Cardinal Health is a large supplier of products and services to the health care industry, primarily as a wholesaler of pharmaceuticals. Its fundamentals have badly deteriorated and several red-flag warning signs are apparent:

- Trailing Twelve Months (TTM) % change in EPS growth has been declining since 2002 for 16 consecutive quarters AND has been negative for the last 7 quarters [from Col R on the PERT-A Worksheet];

- TTM % change in Pre-Tax Profit (PTP) growth has also been declining for 16 consecutive quarters AND has been negative for the last 8 out of 10 quarters [Col S];

- TTM % change in Sales growth, from March 2002, has sputtered downwards for 5 consecutive quarters, then upwards for the next 4 quarters, and then downwards again for the next 9. For FY 2005, TTM Sales growth declined in all four quarters to 9.5% as compared to a high of 16.0% in the March 2004 quarter [Col T];

- Quarterly year over year % change in EPS growth was negative for each of the four quarters of FY 2004 AND for the last two quarters of FY 2005. EPS growth by quarter for FY 2005 was 1.6%, 5.4%, 8.4%, and -3.4 as compared to its high of 28.8% in the September 2001 quarter [Col D];

- Quarterly year over year % change in PTP growth was also negative for the the first three quarters of FY 2004 AND for the last three quarters of FY 2005. PTP growth by quarter for FY 2005 was negative for the last three quarters: 10.3%, -0.8%, -9.2%, and -4.8) [Col G].

CAH’s problems have been widely reported: difficulty and delay in changing its business model to negotiated fee-for-service contracts; investigations by the SEC, U.S. Attorney and NYS Attorney General; restated earnings and other accounting irregularities; and restructuring as well as reduction of 4200 workers.

CAH once was a good-looking company and, for the period 1996-2000, annual sales and EPS grew by an average of 38.5% and 35.2% per year for those earlier 5 years.

Not today…and not for some time!!

armin

Declining Growth Rates at JNJ Are Troubling

Johnson and Johnson’s (JNJ) fundamentals reveal disturbing trends.

Growth rates have been declining in Trailing Twelve Month Sales for the past 8 consecutive quarters, TTM EPS for the past 7 quarters, and TTM Pre-Tax Profits (PTP) for the past 5 quarters. Here are the numbers from the PERT-A Worksheet based on S&P data from NAIC as of 7-12-06, with the last reported quarter being 3-06 as of today:

…………………….PERT-A % CHANGE

……………Col R………..Col S………..Col T
………….TTM EPS….TTM PTP……TTM Sales

09-03…….17.4………..15.6……….13.9
12-03…….16.7………..13.2……….15.3
03-04…….17.7………..15.1……….16.7
06-04…….17.8………..15.9……….15.8 dn
09-04…….17.2 dn……14.7……….14.6 dn
12-04…….17.0 dn……16.9 ………11.5 dn
03-05…….15.1 dn……14.9 dn…..11.5 dn
06-05…….14.1 dn……13.0 dn…..11.5 unchanged
09-05…….13.7 dn……12.0 dn…..10.5 dn
12-05…….11.9 dn……08.0 dn…..06.7 dn
03-06…….09.7 dn……05.3 dn…..04.2 dn

JNJ’s 5-year historical growth rate for EPS has been 16.5% and 11.8% for Sales. Its 10-year growth has been 14.4% for EPS and 10.6% for Sales. This last quarter, JNJ’s 4.2% TTM Sales growth is the lowest its been in the past 18 quarters.

During the same 18 quarters, the 8.0% TTM Pre-Tax Profit growth has never been lower. And, on a quarterly year-over-year basis which is not set forth here, the PERT-A is also disturbing. Growth has slowed in EPS, Pre-Tax Profit and Sales (cols D, G and I) for the past 5 consecutive quarters. For the first time, Sales growth turned negative in the 12-05 quarter….goint back up to an anemic 1.2% growth in the 3-06 quarter.

Value Line also commented on the 2005 Sales decline in its 3-3-06 report.

QUESTIONS:

(1) JNJ is a mature company and slower growth is to be expected. But how do we decide how much slowing is a solid indicator of deteriorating fundamentals and a red flag signal to sell?

(2) Morningstar’s Pat Dorsey wrote on 2-6-06 that “it seems like slowing growth in pharmaceuticals is one of the reasons why J&J’s shares have been whacked lately” and he was not troubled by that slow down. However, my PERT-A shows ever declining growth in Sales and in EPS for almost two years and in Pre-Tax Profit for one year. Something more is happening than just slowing sales growth.

(3) What else helps to explain these declines and how would you interpret them??

armin

What are the SSG and PERT-A?

Would you like to know what is a good growth company to invest in? Are you puzzled by how to determine what is a reasonable price to pay?? How do you decide what’s acceptable in terms of Sales and Earnings growth, Price/Earnings (P/E) ratios, Pre-Tax Profit Margin (PTPM), and Return on Equity (ROE)???

This blog is about analyzing individual growth stocks using fundamental analysis. I use data about each company from S&P and my primary analytical tools are the SSG and PERT-A.

The SSG (Stock Selection Guide) is the primary method for analyzing stocks by the National Association of Investors Corp, sometimes called Better Investing. The SSG is a two-page form that tries to answer two, essential questions: (1) has this been a good quality growth company for the past 10 years; (2) is it currently selling at a reasonable price, one that will produce a 15% Total Return in the next 5 years with modest risk.

The SSG depends on judgment, hopefully good judgment that will lead to good results.

SSGers estimate future Sales and EPS growth, as well as project Hi and Lo P/Es, all for the next 5 years. Together, those facors produce a Forecast High and Low Price. To buy any stock, we seek an Upside/Downside (U/D) Ratio of 3 to 1, where the likehood of the reaching the High Price is three times greater than the Low Price. In addition, the Total Return (TR), including dividends, has to be at least 15% per year for the next 5 years on a compounded basis.

It is primarily these judgment issues I plan to discuss here. And, I will do this in the context of analyzing specific companies rather than abstract general rules.

The PERT-A (Portfolio Evaluation and Review Technique, Worksheet A) is a one-page form that displays fundamental, quarterly data for the past 10 years. PERT consists of several forms for portfolio monitoring, but I use the PERT-A worksheet to identify red flags or trends of individual stocks before they become disasters. The data is shown Quarter-by-Quarter (QbyQ) and Trailing Twelve Months (TTM).

My next two posts will analyze different aspects of Johnson and Johnson [JNJ]. Readers are invited to comment on my analyses and judgments, and also encouraged to submit their own SSGs on any growth company for discussion. Please use the following template:

____% = Future Sales Growth
____% = Future EPS Growth
______ = Projected Hi P/E
______ = Projected Lo P/E
$ ____ = Forecast High Price
$ ____ = Forecast Low Price
______ = U/D
____% = TR
____% = PTPM 5 yr ave & trend
____% = ROE 5 yr ave & trend

If you want to learn more about the SSG, etc, here are some links:

Better Investing (home page): http://www.betterinvesting.org

BiWiki (home page): http://biwiki.editme.com

BiWiki (SSG): http://biwiki.editme.com/TheSSG

Armin