AmerisourceBergen (NYSE:ABC) and two large rivals effectively control the market for distributing drugs from drug manufacturers to drug retailers, hospitals and similar locations where consumers go to fill their prescriptions. The industry has grown steadily for more than a decade now, but is showing little sign of slowing down.
At a healthcare conference earlier this year, Amerisource provided an overview of its business and expectations for growth. Industry growth has been solid, as the need to distribute drugs increases, along with an aging population. The expiration of patents on blockbuster drugs also favors the distribution players, as they are able to garner higher profit margins.
Over the past decade, this has roughly translated into 19% annual profit growth for Amerisource. It sees great potential for the coming decade, with demographics of older Americans supporting organic growth and the expansion of healthcare coverage overall, meaning more overall patients. Management sees closer links between the distributors and drug manufacturers over time, which it plans to combine with internal “cost containment efforts” to continue to grow profits in the double digits.
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Outlook and Valuation
Amerisource has long-term financial goals to grow the top line at industry rates but leverage that into annual earnings above 15%. This is expected to come from cost cutting and distribution efficiencies, which management expects to translate into operating margin expansion over time. Free cash flow should continue to come in at about reported net income, and it plans to return at least 30% of free cash flow generated to shareholders. This will stem from dividend payouts and share buybacks.
For the full year, analysts currently project sales growth of 1.2%, total sales just over $81 billion, and earnings of $2.82 per share or annual growth of around 10%. This represents a forward earnings multiple of just below 13.
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The Bottom Line
Amerisource’s archrivals include McKesson (NYSE:MCK) and Cardinal Health (NYSE:CAH). All are currently trading at forward P/Es in the low double-digits. All three generally perform the same function of distributing drugs but differ somewhat in their geographic mix and clients served. Henry Schein (Nasdaq:HSIC) and Express Scripts (Nasdaq:ESRX) also serve as rivals.
Express Scripts recently merged with Medco Health Solutions to form the largest pharmacy benefit management firm. Last year, Medco was Amerisource’s largest customer at 19% of the top line. According to a company filing, its contract with Medco runs through March 2013, but appears to be stable as there are few alternative options out there. Overall, the industry has great growth prospects and the leading players are trading at very reasonable earnings valuations given the expansion expectations.
At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.