Cencora: New Name, Same Old Economic Leverage, Reiterate Buy

Investment briefing

In January this year, I published a report on Cencora, Inc. (NYSE:COR), formerly known as AmerisourceBergen Corporation, titled "Screams quality at 15x earnings, 60% ROIC", advocating investors buy the stock to unlock risk capital across 2023.

The stock has climbed 13% since that report on a 14% total return with all dividends paid up. Since then, there have been multiple investment updates that need closer inspection.

The company put up $66.9Bn in fiscal Q3 revenues, up 11% YoY, on a 37% growth in operating income to $670mm and earnings of $2.32/share. Management also revised its FY'23 outlook, now projecting 8% YoY growth on earnings growth of 8–9%, calling for $257Bn in top-line sales on earnings of $8.80/share. It is also eyeing $2Bn of company FCF by the end of this year.

This report will analyze the following investment facts pattern:

(1). Price-implied expectations on COR's growth, business returns, earnings reinvestment, and intrinsic value,

(2). The company's economic returns (inc. projections),

(3). Comparison of market-required rates of return to the business returns and forecasts,

(4). Technical factors for consideration

(5). Valuation.

Net-net, I continue to rate COR a buy based on the culmination of factors discussed in this report.

Figure 1. COR 2-year weekly price evolution, trading with ascending channel, bouncing support-resistance.

Critical facts pattern to reiterated buy thesis

(1). Price implied expectations

COR currently sells at 15.7x forward earnings and 13.15x forward EBIT on a market value and EV of $37.96Bn and $43.16Bn respectively. At these multiples, the market expects $11.92/share in earnings and $3.28Bn in pre-tax income (43,160/13.15 = 3,280), ~8% and 17.6% YoY growth, respectively.

COR also trades at 4x EV/invested capital, demonstrating the strong market returns on its investments and expectations of earnings power going forward. Comparing its business returns of 22.4% on capital (discussed later) to our 12% threshold margin (opportunity cost at long-term market averages) the economic value of its investment is at a magnitude of 1.87x.

Comparing the market returns on its investments to the economic returns implies that earnings power is captured in its current market value, which needs to be noted. The expected ROIC (1/(EV/IC)xROIC)) on these figures comes to 5.6% (1/(4x22.4%)=5.6%). The market also expects COR to reinvest 32% of its pre-tax earnings next year, or $1.043Bn (RI = g/ROIC). It therefore anticipates COR to compound its intrinsic value at 1.78%.

Consensus estimates have COR to average ~8% bottom-line growth across FY'23–'25, and these are reasonable assumptions to carry out to FY'28 in my view. Afterward, I've capitalized its continuing value at our 12% threshold margin. Under this convention, the market's required rate of return to own COR is ~2%, ranging from 0.5% to 11% under various scenarios (Figure 2).

The critical observations here are:

(i). Investors require a small rate of return to compensate for the risk of owning COR,

(ii). Relatedly, the perceived risk in owning COR is relatively low, given the predictability of its cash flows.

(2). Economic returns and projections

Given the nature of its distribution model, COR is a low-margin, high-capital turnover business. The ratio of sales to capital employed in the business is tremendously high, coming in at 23.6x last period (on 1% post-tax margins). Each $1 of investment brings in $23 in revenues—tremendously attractive economics.

This means:

1. That COR enjoys production/distribution advantages and employs cost leadership, pricing its offerings below industry averages.
2. The bulk of its capital allocation is put towards receivables + inventories, which it then turns over many times each year.

This is efficient use of capital at its finest. As such, the $53/share of capital it had invested to operate returned $11.96/share in trailing NOPAT last period, otherwise 22% return on investment.

This is nearly double our threshold return of 12%. As seen in Figure 4, ~$5–$5.50/share of COR's post-tax earnings are economically valuable, where ~40–45% of NOPAT is converted to economic value for shareholders. Since 2020, economic returns have totaled $9.45Bn, or $152/share including all cash to owners—FCF, buybacks, and dividends paid up. So it's not surprising to see COR's market value increase by $17.2Bn over the same time.

Finally, the value of these economic characteristics is seen in Figure 5. Due to its tremendously high business returns, it has managed to grow with minimal reinvestment into incremental capital.

in the last 3 years:

• Each new $1 in sales growth took $0.02 investment (inc. M&A),
• Investment to fixed capital was $0.011 on the dollar,
• COR managed to reduce its NWC by $0.09 per $1 in sales growth over this time.

Critically, it managed to grow the free cash spun off to shareholders by $2.4Bn with absolute minimal reinvestment, and despite razor-thin margins.

(3). Comparison of economic returns to market expectations

There is scope for COR to outpace market expectations in my opinion. The market expects 37% YoY growth in pre-tax earnings on a 5.6% return on existing capital, with COR to reinvest 32% of EBIT and to compound its value by ~1.8%.

The steady-state numbers shown in Figure 5 are reasonable estimates to carry forward in my view, albeit with 2% NWC intensity with each $1 in sales growth.

With these estimates in mind:

(1). COR would invest $550—$614mm each quarter, a 21–22% reinvestment rate, (more than double the market's expectations annualized),

(2). Pre-tax earnings could span from $3.3Bn–$3.73Bn, ahead of market expectations, otherwise 33% YoY growth,

(3). This would result in 21–23% return on existing capital, in line with COR's historical averages, and 3.5–4x the market-implied forecasts

Consequently, the company could compound its intrinsic value at 5.1% each period under this convention, again well ahead of the market's view and its required rate of return.

(4). Technicals well supported

Critical insights are gleaned from objective measures that analyze COR's market technicals. Its market profile from Q1–Q3 this year is particularly telling. It shows the distribution of price and time spent at each value area.

Crucially, markets tend to move from pockets of high usage to low usage, completing a long-term distribution in doing so. As seen in Figure 6, the area of low usage in COR's quarterly profile is biased to the upside. For investors to fill the distribution, this would involve a vacuum pull towards the $180–$200 region, supporting further upside.

Figure 7 depicts this in an alternative view, clearly showing market is negatively skewed, supporting the notion of a number of incremental price gains to the upside.

Figure 6.

Figure 7.

Consequently, we have upside targets ranging from $214–$260 on the point and figure studies below. This corroborates the prospect of additional upside, with price action continuing along a 45-degree support line as I write. In my view, this is constructive.

Figure 8. Upsides ranging from $214—$260/share, corroborating small incremental price gains shown in the negatively skewed distribution in the market profile.

As to trend action, both daily and weekly cloud charts support a bullish view. The daily chart has the lagging line currently testing the cloud top, and this should be noted. It needs to nudge above this to continue the bullish trend.

Meanwhile, the weekly chat—which looks to the coming months—has both price and lagging lines well above the cloud, clearly supporting a bullish outlook. Hence, over the long term, I continue to remain constructive on COR's price action.

Figure 9. Daily cloud chart—looking to the coming weeks

Figure 10. Weekly cloud chart—looking to the coming months

Valuation and conclusion

It has been demonstrated thus far there is reason to foresee a change in market expectations embedded into COR's equity stock, thereby supporting a bullish view.

What's more, the company's economics are so strong that even with the extended price gains, we've still got COR on a platter at 15.6x forward earnings, 15% discount to the sector. It has also created $55 in market value for every $1 in net asset value as a testament to this. The trailing ROE is 371% but paying 55x book value reduces this to 6.75% for the investor, still ~3x the market's required rate of return.

More critical to the valuation debate is the following:

1. Compounding COR's intrinsic value at the function of its ROIC and reinvestment rates illustrates how the firm has unlocked substantial value for its owners (Figure 11).
2. Further, the market appears to have recognized this, and been an accurate judge of its fair value over time.
3. Extending the calculus forward at the steady state numbers from earlier (inc. the 2% NWC growth) implies the company could trade at a market value of $40.77Bn or $203/share, offering ~9% value gap from its current marks. This is ahead of the market's required rate of return and expected growth in intrinsic value.

Hence, there is both support for COR to outpace market-implied expectations and a number of catalysts for it to do so. In my opinion, this warrants a reiterated buy rating.

In short, the market has been an accurate judge of COR's intrinsic value over these last few years, recognizing the firm's economics on each pass. In my opinion, what's currently priced in may be under-appreciating COR's ability to compound shareholder wealth further, evidenced by:

(i). Its returns on capital required to run the business,

(ii). Growth in profitability+ cash flows without the need for extensive reinvestment,

(iii). Discounted relative valuations which offer exceptional value compared to sector peers,

(iv). Supportive technicals.

Net-net, my opinion is there is scope for COR to outpace market expectations and that there are multiple inflection points that can drive this.