In case you didn't know, the big three drug wholesalers – AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson Corp (MCK) – have been major participants in this trend.
Thanks to the fee-for-service transition, wholesalers have been able to reduce inventory investments and generate unprecedented levels of cash flow from operations. Wholesalers have used their cash to repurchase shares ($8.4B since January 2004), repay debt, and fund acquisitions. As a result, all 3 wholesalers now have very strong balance sheets and respectable Earnings per Share (EPS) growth.
Here are the total value of share repurchases by the Big 3 from 2004:Q1 through 2007:Q1, courtesy of Larry Marsh at Lehman Brothers:
ABC = $2.0 billion
CAH = $4.4 billion
MCK = $2.0 billion
You can see their relative stock performance using this nifty Yahoo! stock chart. Since January 2004, McKesson’s stock has doubled and AmerisourceBergen is up 80%. Cardinal’s stock performance has lagged the other two wholesalers, but they have also bought back more stock than the other two combined. Perhaps this is a signal that the company considers its shares to be undervalued.
The WSJ article suggests a few reasons for buybacks.
- Buybacks are a tax-efficient way to return cash to shareholders. Dividends are taxable but there is no tax due on a share buyback unless investors sell their shares.
- Buybacks signal that the company doesn’t know how to grow.
- Buybacks can benefit corporate executives, especially if their compensation is tied to EPS and share-price targets. Buybacks also benefit executives with large holdings of stock options.
I see at least three major ways for wholesalers to grow their core distribution businesses, so I’ll let you judge the relative merits of the other two possible explanations.