Below, I explore the profitability and shareholder returns of the largest drug wholesalers, chain pharmacies, pharmacy benefit managers (PBMs), and pharmaceutical manufacturers. Thanks to consolidation, the 2014 Fortune 500 list contains only eight drug channels companies—AmerisourceBergen, Cardinal Health, CVS Caremark, Express Scripts, McKesson, Omnicare, Rite Aid, and Walgreens.
Below are my five observations from comparing these companies with the Fortune 500’s 12 pharmaceutical manufacturers and a separate survey of independent pharmacies. So, buy a vowel and enjoy a spin on Drug Channels' Wheel of Fortune 500!
Here's our exclusive Drug Channels summary of the eight drug wholesalers, drugstore chains, and PBMs on the 2014 list.
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Here’s a companion table of the 12 largest pharmaceutical manufacturers on Fortune's 2014 list.
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Methods and sources are at the bottom.
OBSERVATION #1: Drug Channels companies are bigger than manufacturers.
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.
In 2013, median revenues for the eight drug channel companies were $95.1 billion, up 1.4% vs. 2012. Median revenues for the manufacturer group were $17.5 billion.
Six of the drug channel companies rank in the top 50 of the Fortune 500 list, while the highest ranking manufacturer (Johnson & Johnson) reached only #39. The revenues of the 12 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, which artificially inflates the topline of a channel participant. Here's a reminder of how 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.
When their profits are measured by Return on Sales, profits of wholesalers, PBMs, and pharmacies are a small fraction of manufacturers’ profits. But when these profits are measured by Return on Assets, channel company profitability is about one-quarter that of pharmaceutical manufacturers.
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 2013, the average ROS for the Drug Channels group was a mere 1.3%, a decline from 2012's average of 1.5%.
In 2013, the drug manufacturers’ average profit as a percentage of revenues was a much more robust 21.4%. Thus, the ROS for the manufacturers was more than 16 times the ROS for drug channel companies.
OBSERVATION #3: When measured by Return on Assets, drug channels companies’ profitability looks much better.
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). For example, the value of product inventories and accounts receivables are more than 80% of the big three wholesalers’ current assets. (See Exhibit 34 of the 2013-14 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.) In contrast, the biggest assets of a pharmaceutical manufacturer tend to be long-term, such as intangible assets, goodwill, and physical plant, property and equipment.
The profitability of companies in the Drug Channels universe looks much more attractive this way. In 2013, the group median was 2.9% (range: -0.6% to +6.4%). In a refreshing change, Rite Aid did not have a negative ROA. Congrats!
The ROA figures for drug channel companies now look closer to those of the pharmaceutical manufacturers, whose median profit as a percentage of assets was 10.6% in 2013. The manufacturer-to-channel ratio is only 3.2X for ROA, which is a higher than last year’s ratio.
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 created valuable and innovative drugs.
OBSERVATION #4: Independent pharmacies have higher profitability than the eight largest drug channels companies, including PBMs.
The 2013 NCPA Digest provides the following data for independent pharmacies in 2012 (the most recent year available):
- Average ROS = 2.9%
- Average ROA = 14.2%
OBSERVATION #5: In 2013, investors made more money from Drug Channels companies.
In a reversal of recent trends, investors earned higher returns from the drug channels groups than from drugmakers. The drug channels group also outperformed manufacturers over the past 10 years.
Investment returns reflected last year's strong stock market performance. Here is the median Total Return to Investors in 2013 as reported from Fortune's list:
- 8 Drug Channels companies: +65.8% (range: +30.1% to +272.1%)
- 12 Drug Manufacturers: +34.8% (range: +7.3% to +115.3%)
A FEW TECHNICAL NOTES
- For consistency, all data are taken from Fortune's measurement of key financial metrics. A link to the methodology appears on the Fortune 500 main page. (Sorry, no direct link.)
- 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 2013 NCPA Digest, the ROA for independent pharmacies is computed as: Average Operating Income / Estimated Average Total Assets.
- Warning: The new Fortune 500 list is a quirky web 3.0 site that doesn’t work well on Chrome, now the most popular web browser. Thanks, clueless 22-year old web designers!