Spring must be here, because it's time for my annual review of the Fortune 500 list.
The subject of profits comes up frequently in reader comments on the blog. This review will give you some facts and perspective on the profitability of the largest drug wholesalers, chain pharmacies, and pharmacy benefit managers (PBMs). And to keep things spicy, I also compare this group to independent pharmacies and manufacturers.
By a conventional metric (revenues), the biggest drug channel participants are substantially larger than pharmaceutical manufacturers.
The profitability of drug channels companies looks better when compared to manufacturers using an appropriate metric such as Return on Assets rather than Return on Sales.
The profitability of a typical independent pharmacy is well above the median profitability of the nine largest drug channels companies.
Investors earned greater average total returns from the manufacturer group last year, but better returns from the drug channels group over the past 10 years.
Here are the nine largest drug wholesalers, pharmacy chains, and PBMs that on the 2009 Fortune 500 list along with rank and links to the financial data as reported by Fortune:
McKesson (MCK): 15
Cardinal Health (CAH): 18
CVS Caremark (CVS): 19
AmerisourceBergen (ABC): 26
Walgreen (WAG): 36
Medco Health Solutions (MHS): 45
Express Scripts (ESRX): 115
Rite Aid (RAD): 100
Omnicare (OCR): 392
The channel intermediaries are much larger than the manufacturers. Median revenues for the nine drug channels companies were $59 billion in 2008 versus $23 billion for the manufacturers. Three companies – McKesson, Cardinal Health, and CVS Caremark – are in the top 20 of the Fortune 500 list, while the highest ranking manufacturer (J&J) only reached #46.
This perhaps surprising observation derives from the fact that the Fortune 500 rankings are based on sales revenues, so there is substantial double-counting of dollars among the drug channels companies. For instance, revenue from the same prescription could be counted at least three times by companies on this list if:
the drug is sold by a wholesaler to a pharmacy;
the drug is sold by a pharmacy to a consumer; and
the pharmacy receives reimbursement from a PBM.
As you can see in the table below, Return on Sales (ROS; profit as percent of revenues) was in the low single digits for all companies in this group, regardless of their position in the supply chain (retail pharmacy, wholesaler, or PBM). The median ROS for the Drug Channels group is 2.2%.
(CLICK TO ENLARGE TABLE)
However, ROS is a flawed measure of profitability for channel intermediaries due to the revenue double-counting. The more meaningful metric is Profits as a % of Assets, a.k.a., Return on Assets (ROA). ROA relates ROS to the balance sheet assets required to generate an income statement profit. The biggest part of a drug channels company's balance sheet are current assets (cash, product inventory, or accounts receivable), whereas the biggest assets of a pharmaceutical manufacturer tend to be long-term assets such as intangible assets, goodwill, or physical plant, property, and equipment.
The profitability of companies in the Drug Channels universe looks much more attractive on this basis. The group median is 5.3% (Range: -9.4% to +14.1%). I bet you can guess which company is at the bottom.
The ROA figures for drug channel companies are now closer to the pharmaceutical manufacturers, whose median profits as a percent of assets was 11.5 percent in 2009 (Range: -7.1% to 17.8%). The manufacturer-to-channel ratio is now only 2.2X for ROA (versus 9X for ROS). In my opinion, the higher ratio for drug makers reflects a risk-return tradeoff. The additional profitability for manufacturers can be considered an innovation/risk premium. Discovering and developing new medicines is expensive, risky, and time consuming.
The 2008 NCPA Digest provides the following data for independent pharmacies in 2007 (the most recent year available):
Median ROS = 3.0%
Median ROA = 14.8%
Investment returns for everyone were dismal in 2008 as measured by the median Total Return to Investors for 2008 reported in Fortune's list (and as measured by the performance of my 201K retirement plan).
9 Drug Channels companies: -27.2% (Range: -88.9% to +24.7%)
9 Drug Manufacturers: -12.7% (Range: -45.7% to +24.4%)
A FEW TECHNICAL NOTES
All analyses rely on Fortune's (admittedly crude) measurement of key financial metrics for consistency.
I only include Drug Channels companies that earned a majority of their revenues from pharmaceuticals. This criterion excludes other retail formats with pharmacies (supermarkets and mass merchants). I do not separate the revenues from each company's various lines of business.
The ROA for independent pharmacies is computed as (Median Operating Income / Median Assets) based on data on page 15 of the 2008 NCPA Digest.
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