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McKesson and Cardinal Health announced an agreement to extend their partnership with CVS through June 2032. McKesson serves CVS mail-order and specialty pharmacies, and Cardinal serves CVS retail pharmacies. Shares for both firms are up a mid-single-digit percentage.

Why it matters: CVS is the largest customer for both McKesson and Cardinal, making up roughly 24% (over $90 billion) and 28% (over $70 billion) of total revenue in fiscal 2026, respectively, so securing the relationship through 2032 is crucial for both firms' long-term growth ambitions. Major contracts like this typically have a 5-year maturity timeline, and the CVS partnership for both firms was previously set to expire in 2027. We expected McKesson and Cardinal to extend their relationship without a major issue, given they have worked together for well over a decade and Cardinal also has a generics sourcing joint venture with CVS. That said, we have seen cases of large customers leaving their distributor for another in recent years; OptumRx left Cardinal for McKesson and Publix left Cencora for Cardinal, both in 2024. So, we think the CVS announcement, coupled with the affirmation of both fiscal 2027 and long-term EPS targets, looks great for long-term investors.

The bottom line: We maintain our fair value estimate for Cardinal ($235) and McKesson ($930), and both firms' shares look appropriately valued. Locking down such an important partner also underpins narrow moat ratings, as it reinforces McKesson's and Cardinal's position in the distribution marketplace and strengthens the already high switching cost between the distributors and CVS. The timing of the announcement is also worth highlighting since it comes less than two months after Cencora announced that certain prescription volume is leaving Walgreens. We think some of the lost Walgreens volume is shifting to CVS, which would benefit both McKesson and Cardinal.

We raise our fair value estimate to $235 per share from $215 to account for recent cash flows and outlook for fiscal 2027.

Our midcycle revenue growth assumption of 6% is mainly driven by continued growth in US pharmaceutical distribution. Historically, branded drug price inflation has been a key driver behind wholesalers’ revenue growth. Additionally, increased utilization of high-priced specialty drugs and an aging US population are tailwinds for long-term revenue growth. Fiscal 2024 and 2025 saw a heightened boost as high inflation pushed branded drug manufacturers to raise their prices and a robust commercial demand for GLP-1s, and we expect a similar environment for fiscal 2026, though the incremental growth contribution from GLP-1s is likely to moderate as the year-over-year comparison gets tougher from an increasing base.

We forecast Cardinal Health’s gross margin to slowly recover over the long term. Generic drugs, despite carrying a materially lower price tag than their branded counterparts, have an outsize impact on wholesalers’ margins. Because generics manufacturers often compete with each other for the same indication, wholesalers have greater pricing power with them than with branded manufacturers. Generic drug prices rose during the mid-2010s due to increased generic use and an FDA backlog, but prices fell, as did wholesalers’ margins, as more manufacturers entered the market and the FDA approved more drugs. We now see generic drug prices stabilizing and expect wholesalers’ margins to recover accordingly. We also expect some margin tailwinds from more biosimilars entering the market. Biosimilars aim to offer cheaper options to specialty drugs, and although they carry lower prices than their branded alternatives, wholesalers can extract higher margins from them. This should foster margin improvement for Cardinal Health, especially since specialty drugs and biosimilars are poised to take an increasingly larger share of dispensed drugs over the next five years.

We assign Cardinal Health a narrow moat rating because we believe the characteristics of the US drug distribution market and customers’ unlikeliness to move to a different distributor (switching costs) should uphold its competitive position and support economic profits for at least the next 10 years.

Pharmaceutical wholesalers fill a central role in the supply chain for prescription drugs, with over 90% of all prescription drugs in the United States going through wholesalers. While pharmaceutical distribution is their cornerstone, drug wholesalers have a complex role that extends beyond distribution and have developed essential partnerships with their customers. By contracting directly with manufacturers for branded and generic pharmaceuticals (and leveraging their substantial purchasing power), the big three wholesalers (McKesson, Cencora, and Cardinal) are able to consistently negotiate for the lowest rates on the market, typically significantly below that of the wholesale acquisition cost. Additionally, a full-line wholesaler will typically stock over 21,000 stock-keeping units associated with prescription drugs and negotiate with roughly 1,200 manufacturers, a task less efficiently accomplished by retail pharmacies on their own.

The three big wholesalers act as an oligopoly. They make up over 90% of the overall US drug distribution market, effectively servicing the market, and they have done so for the past 20-plus years. We anticipate most of the market to continue to be serviced by these three players over the next 10 years, with minor changes in market share among them.

Drug distributors work extremely efficiently and effectively to service its customers. Their largest customer base is chain pharmacies/stores, but they also serve independent pharmacies, hospitals, long-term care centers, and mail service pharmacies. Most of the top 15 pharmacies by sales in the United States, which make up nearly 75% of overall pharmacy industry prescription revenue, have some sort of partnership with one or more of the three big wholesalers that have lasted for many years. In 2024, approximately 90% of overall dispensed prescription drugs in the United States were sold to retailers, which include chain pharmacies and mass merchandisers, independent pharmacies, and food stores. The three wholesalers already have long-standing relationships with the biggest retail pharmacies.

Cardinal Health covers roughly one-fourth of the US drug distribution market. CVS, the firm’s largest customer, made up 30% of fiscal 2025 revenue, or over $65 billion. Cardinal also serves group purchasing organizations Vizient and Premier, which collectively made up 27% of Cardinal's fiscal 2025 revenue. Cardinal Health extended its pharmaceutical distribution partnership with CVS through June 2029. This is a mutually beneficial situation for a multitude of reasons. CVS is Cardinal Health’s largest customer and has been for more than 20 years. Knowledge gained over years of partnership is hard to replicate with a new wholesaler. This is especially true for big retailers because we estimate that Cardinal Health has specific coordination and management systems that could take months to develop for a new distributor. Furthermore, it is highly unlikely that a customer will get better pricing by switching from Cardinal Health to either McKesson or Cencora because the cost of time lost during a transition and restructuring phase would not make it viable for a new distributor to offer better rebates than the original distributor. Distributors also offer consulting, logistics, as well as data and analytics services to their customers. We estimate that Cardinal Health offers different and customized services to its customers, especially its big retailer customers, so both the distributor and customers can work at maximum efficiency and effectiveness. And we believe these services make the relationship between Cardinal Health and its customers stickier. For customers, switching to a new distributor would mean the loss of operational expertise that they have achieved over the years of working with their original distributor. In our view, these combined reasons act as a catalyst behind big retailers sticking with their distributors and locking down their relationships with long partnerships. This is evident from the fact that no major retailers have switched distributors in the last 10 years, and we expect this trend to continue for the next 10 years.

Cardinal Health started a generics procurement joint venture with CVS in 2014 named Red Oak Sourcing. The 50/50 joint venture combines the buying power of Cardinal Health and CVS to achieve a healthy buy-side margin from generic drug manufacturers. It is the largest generic drug purchaser in the US, making up over a third of the overall domestic generics purchasing volume. This is crucial for a drug distributor’s profitability because while generic drugs make up roughly 10% of wholesalers’ top line, they make up over two-thirds of their gross profit. Since there are multiple generic drug manufacturers that aim to effectively produce the same drug, they have to compete with each other to win over a contract with one of the three big wholesalers. This provides major pricing power to Cardinal Health, compared with when they purchase branded drugs, which helps them drive a significantly higher margin from generic drugs. Switching costs would entail unraveling of the joint venture and result in pharmacies facing higher acquisition costs for generics, which constitute the vast majority of dispensing volume. Since CVS has a financial stake in this relationship, it is highly unlikely that it will stop working with Cardinal and move to a new distributor, especially in the next 10 years.

Cardinal Health distributes pharmaceutical products to nearly one third of the industry, leading to substantial negotiation leverage with generic drug manufacturers.

Increasing strategic priorities on specialty assets helps diversify Cardinal's revenue and profit channels into high-growth and high-margin industries.

Technology advancements continue to improve Cardinal Health’s performance and present new opportunities for wholesalers.

Reimbursement pressures on pharmacy and provider customers have led to an emphasis on cost containment, pressuring Cardinal Health’s profitability.

Scrutiny from the public and politicians over exorbitant branded and specialty drug list prices could result in lower price inflation long term, slowing Cardinal’s top-line growth.

Although unlikely, the loss of Optum's contract calls into question the long-term viability of Cardinal's relationship with the firm's other key customers.