Winter is coming sooner for Big Three wholesalers

McKesson disappoints on Q2 earnings call; stock drops 23%. Update: Cardinal reports more revenue, less profit

So, McKesson missed analysts’ estimates of 2017 Q2 earnings by 9¢, and missed the quarterly revenue estimate of $51.4 billion by about $1.5 billion—these are reasons for the company’s stock to drop 23% in one day (Oct. 28), erasing some $9 billion in market cap? But in fact, the pullback on the stock price may be more about what the company was saying about its future earnings—and that’s what has broader implications for both drug wholesaling and drug sales in the US.

John Hammergren, McKesson CEO, blamed the lower earnings on two factors: “moderating branded pharmaceutical inflation trends, compared to previous expectations” (translation: drug prices aren’t rising as fast as McKesson had expected; such inflation ultimately adds to the company’s earnings); and “customer pricing” (i.e., what pharmacies are willing to pay for McKesson services) becoming “competitive activity that is broader than our original expectations, more aggressive, and across several areas of our US pharmaceutical business” (translation: McKesson is being undercut by other wholesalers; rumor has it that this is primarily AmerisourceBergen). The company is shaving its expected FY2017 earnings by $1.08.

The moderating price inflation of branded drugs has been occurring during the current year, despite all the headlines around Mylan’s EpiPen, and five- and six-digit figures for some newly launched drugs. Manufacturers had been accustomed in recent years to jacking up prices by 3-6% or more, and sometimes doing this more than once a year. In keeping with the implications of this trend, numerous biopharma companies saw their stock prices drop during the day as well. The price increases of generics that had been occurring up to this year have moderated as well. Typically, wholesalers, as well as generic manufacturers themselves, generate the most profit just after a drug loses patent exclusivity; with a dropoff in generic conversions, this bodes ill for both.

AmerisourceBergen’s stock price fell some 13% that day, as did Cardinal’s, falling 9.8%. But in fact, all of the Big Three have seen declining prices during this year, off some 30-40% from recent highs. In the McKesson earnings report, CFO James Beer noted that the company is shaving 30-40 basis points (that’s 0.3-0.4¢, which gives a sense of narrow margins that wholesalers operate with) off its sales to customers. On the bright side, Hammergren noted that its Specialty Health unit is continuing double-digit growth; and that “We are making a fundamental change to the structure in terms of our relationship with both providers and manufacturers as it relates to hundreds of specialty products. We are charging separately for the supply chain value we add across a wide array of product categories and manufacturers.”

AmerisourceBergen will be announcing its quarterly earnings on Nov. 2, and Cardinal on Oct. 31. Investors will then be able to see if all of the Big Three are tracking similarly.

10/31 update: Cardinal Health reported, this morning, higher revenue but lower profit--the pharmaceutical segment was up 14%, to $28.8 billion, but segment profit decreased 19%, to $538 million, due to "pharmaceutical pricing and, to a lesser extent, reduced levels of branded inflation." Non-GAAP guidance for 2017 (the company is reporting Q1 2017 results today) is projected to be 3-7% higher than 2016, but that estimate has been trimmed by a percentage point or two from an earlier forecast.

11/2 update: see related story for AmerisourceBergen's quarterly statement