Key observations from the new Fortune list:
- Drug channel companies have higher revenues than pharmaceutical manufacturers, so they rank higher on the Fortune 500. This results from quadruple-counting of prescription revenues within the channel. See my explanation below.
- Drug channels companies are profitable. When their profits are measured by Return on Sales, profits of wholesalers, PBMs, and pharmacies are only one-tenth of manufacturer profits. But when these profits are measured by Return on Assets, channel company profitability is about half that of pharmaceutical manufacturers.
- For the second straight year, investors earned higher returns from drugmakers than from the drug channels group. However, the drug channels group has still outperformed manufacturers over the past 10 years.
- The profitability of a typical independent pharmacy is higher than the profitability of the eight largest drug channels companies, including PBMs. Sorry to be the bearer of...good news?
I have gathered the eight drug wholesalers, pharmacy chains, and PBMs on the 2013 list along with their Fortune 500 ranks and links to the financial data as reported by Fortune.
- McKesson (MCK): 14
- Walgreen (WAG): 37
- Rite Aid (RAD): 113
- Omnicare (OCR): 416
Here's a handy, exclusive Drug Channels summary of the data for these eight companies. (Click to enlarge.)
Click here to view the 13 largest pharmaceutical manufacturers on Fortune's 2013 list.
The channel intermediaries are much larger than the manufacturers. In 2013, median revenues for the eight drug channel companies were $87.1 billion, up 4.2% vs. 2010. Median revenues for the manufacturer group were $17.3 billion.
Six of the drug channel companies rank in the top 50 of the Fortune 500 list, while the highest ranking manufacturer (Pfizer) reached only #41. The revenues of the 13 largest pharmaceutical manufacturers on the Fortune 500 list range from $67.2 billion (Pfizer) to $5.5 billion (Celgene).
Note that the Fortune 500 rankings are based on sales revenues, so that double-counting artificially inflates the topline of a channel participant. Here's how a single prescription can hypothetically be counted as revenue by four different Fortune 500 companies:
- Manufacturer A sells a pallet of WonderDrug to Wholesaler B. Manufacturer A reports the net revenue from the sale on its income statement.
- Wholesaler B sells a case of WonderDrug to Pharmacy C. Wholesaler B reports the net revenue from the sale on its income statement.
- Pharmacy C dispenses a WonderDrug prescription to a patient. Pharmacy C is reimbursed via a combination of the patient's copayment and reimbursement from PBM D. Pharmacy C reports the revenue from the prescription on its income statement.
- PBM D reports the reimbursement paid to Pharmacy C as "Network Revenue" on its income statement.
As you can see in the table above, 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 channel (pharmacy, wholesaler, or PBM). In 2012, the weighted average ROS (not shown in the table) for the Drug Channels group was 1.6%, a decline from 2011's weighted average of 1.8%.
In 2012, the drug manufacturers’ weighted average profit as a percentage of revenues was a much more robust 17.7%. Thus, the manufacturer-to-channel ratio is 10.9X, i.e., the ROS for the manufacturers was about 11 times the ROS for drug channel companies.
PROFITS: RETURN ON ASSETS
ROS is a flawed measure of profitability for channel intermediaries due to the revenue double-counting. A 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 channel company's balance sheet is current assets (cash, product inventory, or accounts receivable). 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 this way. In 2012, the group median was 4.3% (range: -5.0% to +6.4%). Once again, Rite Aid was the only company with a negative ROA.
The ROA figures for drug channel companies now look closer to those of the pharmaceutical manufacturers, whose median profits as a percentage of assets was 8.9% in 2010. The manufacturer-to-channel ratio is only 2.1X for ROA, about the same ratio as last year.
The difference reflects partly the innovation/risk premium associated with the expensive, risky, and time-consuming business of drug discovery. Pharmacies, wholesalers, and PBMs wouldn’t exist unless manufacturers actually created valuable and innovative drugs.
The 2012 NCPA Digest provides the following data for independent pharmacies in 2011 (the most recent year available):
- Average ROS = 2.9%
- Average ROA = 14.5%
Investment returns reflected last year's strong stock market performance. Here is the median Total Return to Investors in 2012 as reported from Fortune's list:
- 8 Drug Channels companies: +16.6% (range: 3.6% to +25.6%)
- 13 Drug Manufacturers: +20.4% (range: -3.7% to +79.5%)
A FEW TECHNICAL NOTES
- For consistency, all data are taken from Fortune's measurement of key financial metrics. Click here to review Fortune’s methodology.
- I include only those drug channel 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.
- Using data from the 2012 NCPA Digest, the ROA for independent pharmacies is computed as: Average Operating Income / Estimated Average Total Assets.
P.S. Congratulations to Bob Belknap of Boehringer Ingelheim for winning HDMA's 2013 Nexus Award for Lifetime Achievement. Well done, Bob!