The U.S. healthcare system has been turned upside down by the Affordable Care Act. In one example, Medicare will be cutting payments for joint replacement treatment through a process called bundling, sending patients to recover at home or in rehabilitation facilities after surgery.  This new reality gives companies that operate outside hospitals, and whose products are versatile and indispensable, a great opportunity.

This is one reason why I like McKesson (NYSE: MCK), the largest global provider of medical products and services. Its products and growing networks will profit as treatment moves outside hospitals, taking advantage of new Affordable Care Act and Medicare rules.  I’m personally familiar with McKesson as I use its products in my medical practice every day.

McKesson sounds like a traditional business—part of what it does is distribute products such as Band-Aids, medications, needles and syringes, along with other disposables. But it is adept at using new technologies to expand sales and cut costs. In fact, McKesson is a prototypical Applied Technology Investment System (ATIS) stock, because of its focus on technology, automation, and supply chain management tools. ATIS is a model I developed to identify companies benefiting the most from new technologies.

For example, McKesson was ahead of its time with its first-in-the-sector partnership with IBM, a move that paid off in spades. In 2014 alone, McKesson cut $1 billion in costs by using IBM’s supply chain modeling software. The software manages inventory policies, supply flows and vehicle routes, and generates important data that managers can use to increase efficiency.

Major Market

McKesson is central to the global healthcare system because its medical supplies, medical practice management and wholesale drug distribution businesses are used in and out of hospitals.  Beyond hospitals, McKesson supplies surgery centers, doctor’s offices and individuals.

The U.S. market for medical supplies alone is $327 billion and growing. The market is divided roughly between three companies, McKesson, Cardinal Health and Amerisource Bergen, with McKesson grabbing the largest share  at 38.5% based on 2015 data.  But, because of its use of ATIS principles, we think McKesson has the best prospects to gain more market share.

One indication of that is how well McKesson used its excellent management and IBM software to handle the Medicare squeeze on hospitals. .

McKesson also has a steady ground game, expanding its Health Mart franchise, which supplies private, locally owned pharmacies.  It has further expanded non-hospital distribution channels via large grocery-store-based pharmacies including Safeway-Albertsons and, as of mid-May via a major distribution deal with Walmart.

Also, McKesson handles its growth well. It bought Germany’s largest drugmaker, Celesio, in 2013, and efforts to absorb the company are ahead of schedule.  In April 2016 McKesson bought Biologics and Vantage Oncology. Biologics is the largest independent oncology-focused specialty pharmacy in the U.S.  Vantage is a leading national provider of radiation oncology and integrated cancer centers, adding to McKesson’s already existing network of 120 integrated cancer centers across 29 states.

Get Big or Get Squeezed

As we mentioned, the government is reducing the amount of money it spends on healthcare.  And Medicare’s cost-cutting bundling plan is decreasing the amount of money hospitals will have to spend on medical supplies as well as other products and services.

To stay ahead of this, McKesson had to reduce costs and expand into areas unaffected by government spending cuts. For example, the company shifted its business away from hospitals by expanding its own drugstore franchise (Health Mart). It also expanded its generic drug distribution system globally, and through acquisitions entered into other lines of businesses such as physician practice management, specialty pharmacies and cancer care.

This ongoing restructuring has given the company a much better chance of thriving in the new healthcare marketplace.

The hidden gem in McKesson’s business plan may be the self–administered healthcare segment—in other words, patients taking care of themselves.  As more patients are discharged from hospitals early to recover at home, they have to buy supplies such as painkillers, antibiotics, bandages and other items needed for post-operative care.

Normally, the hospital would supply these items during the patient’s stay. But with bundling, hospitals no longer need to buy as much of these supplies, and hospital suppliers are feeling the pinch. But McKesson’s self-administered healthcare segments takes advantage of this shift.

Strong Financials

In the quarter ended in March, McKesson’s last quarter of its 2016 fiscal year, revenue grew 3.9% to $46.7 billion, ahead of expectations, while earnings were below expectations. The company confirmed its guidance for its fiscal 2017 year, ending in March, for $13.30 to $13.80 per share for the year.  That’s a healthy increase over $9.70 in fiscal 2016.

So why has McKesson’s stock taken a dive in the last year? The answer is simple, and the consequences mean the company is trading now at a bargain price. Investors became spooked by the Walgreens Boots Alliance, created in December of 2014. It did cause some loss of business for McKesson, but the reaction was overblown. McKesson’s 52-week high is $240.90, and it dropped as low as $148.29 over the last year.

Given the company has a strong balance sheet ($3 billion in cash), strong cash flow ($3 billion last quarter), and strong rising earnings and the ATIS edge, it’s a good buy at around $184 a share.

Buy McKesson up to $194 and expect to hold the stock for at least one to two years. Given the stock’s price currently, a 20% return in the next year is a conservative gain.

Options Play

A low-cost alternative to buying McKesson is using the Jan. 18, 2018, $195 Call Option, which was trading at $18.50 on May 20, 2016.  This option offers the opportunity to participate in the long-term potential upside of the underlying stock for a fraction of the price. 

The long-term option is perfect for a trade that could take some time to fully develop. The delta of 0.48 suggests a 48-cent increase in the option for every dollar the stock gains. That means the potential for a $4.80 change in the price of the option for every $10 gain in the stock.

Buy Jan. 18, 2018, $195 Call Option.