Click here to see the original post and comments from September 2021.
Today, I delve into the financials behind Cardinal’s relationship with its largest customer, CVS Health. In Cardinal’s 2021 fiscal year, CVS purchased more than $42 billion in pharmaceuticals from the wholesaler—about double the figure from 10 years ago. The new report also reveals that CVS Health’s payment terms with Cardinal give the wholesaler an often-overlooked cash flow benefit.
I also compare Cardinal’s relationship with CVS to McKesson’s relationship with CVS. The two wholesalers sell more than $90 billion in pharmaceuticals to CVS Health—making it the largest U.S. drug purchaser.
Like McKesson, however, Cardinal Health has discovered that CVS is its worst best friend.
Longtime readers know how much I (truly) enjoy Securities and Exchange Commission (SEC) corporate filings. Regulatory and legal requirements force companies to disclose important factual details about their businesses. These filings offer a fascinating—if opaque—source of competitive intelligence that surprisingly few people bother to read closely. I’ve been told that even some CVS Health executives are unaware of how much information its biggest suppliers are required to reveal.
Click here to savor all 96 pages of Cardinal Health’s 2021 10-K filing.
ICYMI, I provided a comparable analysis of McKesson in How CVS Health Drives McKesson’s Distribution Financials.
BILLIONS AND BILLIONS
Cardinal Health primarily supplies CVS Health’s retail pharmacies, while McKesson primarily supplies CVS Health’s mail and specialty pharmacies. Last month, Cardinal announced that it had renewed its distribution agreement with CVS through June 2027.
The chart below traces the evolution of Cardinal Health’s sales to CVS since 2011. We estimate that in Cardinal’s 2021 fiscal year, its sales to CVS Health were more than $42 billion—up by $2.5 billion (+6%) from the previous year’s figure. Purchases by CVS Health account for about 30% of Cardinal’s U.S. drug distribution business.
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Cardinal’s sales to CVS Health have grown along with CVS’s retail pharmacy revenues:
- CVS Health’s retail pharmacy businesses is among the largest in the industry. (See our list of the top 15 U.S. pharmacies of 2020.) We estimate that for the four quarters of Cardinal Health’s 2021 fiscal year, CVS Health’s retail pharmacy and long-term care prescription revenues increased by 6.7%. (This figure is slightly higher than the reported growth in CVS’s purchases from Cardinal.)
- From 2010 to 2020, CVS acquired stores and/or prescription files from at least 15 small chains that had operated more than 375 combined stores. CVS has probably acquired other retail pharmacies, but those transactions have not been publicly disclosed. See Section 2.3.4. of our 2021 Economic Report on U.S. Pharmacies and Pharmacy Benefit Managers. Note that McKesson has remained the primary wholesale supplier of brand-name drugs to CVS pharmacies within Target stores following that 2015 transaction.
- CVS retail pharmacies have benefited from prescription volume associated with CVS Health’s Maintenance Choice program. The program shifts maintenance prescriptions dispensed by Caremark’s mail pharmacy, which is supplied by McKesson. We estimate that more than 28 million covered lives were enrolled in the program.
Like other large pharmaceutical wholesalers, Cardinal Health doesn’t need external financing to operate its business.
This becomes clear when we examine the company’s cash conversion cycle, which measures how many days it takes a wholesaler to convert inventory purchases into cash from its customers. This cycle combines the following three elements:
- Days sales in inventory (DSI): the inventory holding time
- Days sales outstanding (DSO): the time needed for a wholesaler to collect accounts receivables from a customer
- Days payable outstanding (DPO): the time in which a wholesaler pays a manufacturer (supplier)
For its 2021 fiscal year, Cardinal’s overall cash conversion cycle was slightly negative (-1 day). This figure reflects its entire business, which includes significant revenues and costs associated with medical-surgical products. These figures also vary by customer and product type. We estimate that Cardinal Health’s cash conversion cycle for its pharmaceutical business is lower—i.e., more negative—and closer to the cycles at AmerisourceBergen and McKesson.
The slightly negative cash conversion cycle means that, on average, Cardinal Health got paid for the products it sold at roughly the same time that it had to pay for those products.
Cardinal Health doesn’t explicitly report the underlying cash conversion cycle for its relationship with CVS Health. However, we can compute a few key facts about this relationship:
- Using data disclosed in Cardinal’s 10-K, we have computed that on average, CVS Health paid Cardinal Health in 21 days during the 12 months ending on June 30, 2021. This was faster than the combined average for all other Cardinal Health customers. Note that CVS Health paid Cardinal Health a few days more quickly than it paid McKesson (per our previous article).
- Wholesalers typically agree to pay brand-name manufacturers in 30 to 40 days.
- Wholesalers’ inventory levels for brand-name drugs are typically about two to three weeks. Wholesalers can hold lower levels of inventory for products that sell quickly and can be readily replenished.
The cash cycle also shows why wholesalers emphasize payment terms and inventory levels when negotiating distribution agreements with brand-name manufacturers.
For more on the importance of the cash conversion cycle to wholesalers’ businesses, see Section 5.3. of our 2020-21 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors. We will release the 2021-22 edition in early October.
HOW TO WHOLESALE
CVS Health’s scale has allowed it to negotiate extremely favorable rates with its wholesale suppliers, McKesson and Cardinal Health. DCI estimates that Cardinal Health’s operating profit from CVS is below 0.4%. Hence, a favorable cash conversion cycle is essential.
You might also recognize that this super-low margin reflects the Golden Rule of the Channel: Whoever has the gold gets to make the rules.