Cardinal: The Once and Future Wholesaler

Last week, Cardinal Health (CAH) formally announced plans to spin off its Clinical and Medical Products business. The post-spin business will be a return to Cardinal’s wholesale distribution roots, although getting back is only the beginning. Here are a few high-level thoughts on the pharmaceutical distribution business.

First, congratulations to management for (finally) resolving the DEA issues that have been plaguing the company since last November. (See Cardinal Health Resolves Controlled Substance License Suspensions.) I’ve written critically on Drug Channels about Cardinal’s handling of the situation and the impact on its market position with independent pharmacies and small chains. Cardinal even publicly apologized for its actions in June.

I’ve been a fan of George Barrett’s straight talk about Cardinal’s problems, especially when he publicly confirmed what I was saying on Drug Channels about market share losses among independent pharmacies. The company’s FY2008 10-K quantifies the damage:

• Overall revenue growth for the pharmaceutical distribution segment was 3.5%, which is below the company’s estimated rate of drug price inflation of 7.7% during the same time period. In other words, Cardinal’s revenues declined in real (inflation –adjusted) dollars.
• Revenue declined by $1.9 billion due to a “loss of customers.” The net effect was smaller because of price inflation, general volume growth, and the gain of new customers.
• Cardinal’s revenues from its smaller (non-bulk) customers declined by 1.6% ($680 million), while revenues from its bulk customers – such as CVS Caremark (CVS) and Walgreens (WAG) – grew by 10% ($3.4 billion).

Speaking of bulk customers, the CVS Caremark brand supply contract with Cardinal expires in mid-2009 – right around the time of the spin-off. In my opinion, this coincidence implies that management expects to continue servicing CVS Caremark’s retail business, which I have always viewed as the most likely outcome. See Wholesaler Impact of a Longs Drug Deal for background on the CVS Caremark/Cardinal/McKesson relationship.

Cardinal still faces many company-specific issues, as I noted inelegantly in an August Wall Street Journal article: “There are certainly some things that are out of Cardinal's control, such as the consolidation of retail customers; however, there are some specific issues that Cardinal has had to deal with...that are very Cardinal-specific.” Sounds like my training at the Department of Redundancy Department paid off!

BTW, anyone else catch the following comment by Mr. Barrett from last week’s conference call: “[W]e will be exploring opportunities to expand both into new adjacent spaces and perhaps new geographies. Having said this, our immediate focus is here at home and on our core businesses.” Cardinal Goes to China, perhaps?