Profit Headwinds for Cardinal Health

Cardinal Health (CAH) has had a tough week.

The roll-out of its shiny new wholesale business was tarnished by some bad news -- earnings will be down sharply in its next fiscal year starting on July 1. See Cardinal Health Sees FY10 Pressures, Then Momentum from Dow Jones for details.

Thursday's stock price was 17% lower than Tuesday's close. Ouch.

The company provided the following useful snapshot of the "headwinds" (their words) for the soon-to-be-independent wholesale distribution business. This chart appears as page 57 in the "Cardinal Health Analyst and Investor Day Presentation" file on the Investor Relations page of their website. (Sorry, no direct link.)

I've discussed some of these issues already on Drug Channels and (in more depth) in my 2009 Wholesale Distribution Economic Report on Pharmaceutical Wholesalers.

Here's some help decoding three items on the slide above along with links to previous blog posts.

"Pricing/Customer Renewals"

The elephant in the room remains the status of the CVS Caremark (CVS) brand drug supply agreement, which reportedly expires at the end of June 2009. CVS Caremark is now the single largest customer of the two largest drug wholesalers -- McKesson services the mail operations of Caremark and Pharmacare while Cardinal Health services CVS' retail operations. (See Wholesaler Impact of a Longs Drug Deal.)

The down arrow reflects the Golden Rule of the supply chain: Whoever has the gold makes the rules. Recall the comments by McKesson's Corporation's (MCK) CFO about "increased pressure on our sell-side margins" and the subsequent loss of two large customers? (See Wholesalers In the News.) Nonetheless, we still have no public statements about the status of the CVS Caremark contract.

"DSA Transition Timing"

Dave Yost of AmerisourceBergen (ABC) broke the news in a January earnings call that Pfizer had signed a fee-for-service deal with wholesalers beginning in January 2010. These agreements can limit a drug wholesaler's gross margin, although there are usually offsetting cash flow advantages. (See Drug Wholesalers and the Credit Crunch.)

Cardinal acknowledged its ongoing use of forward buying as recently as August 2007. (See Investment Buying: Not Dead Yet, although the link to the source article is in fact dead.) I have some future concerns about the increased bargaining leverage from larger post-consolidation drug manufacturers, although this does not appear to be a factor in FY10. (See My Comments on MRK-SCP.)

"Portfolio repositioning"

Cardinal is now trying to restructure its relationships with Medicine Shoppe franchisees, reversing a previously announced strategy of selling this business. Cardinal's drug wholesale business lost a fair amount of market share among independent pharmacies due to the 2007-2008 license suspensions. (See Cardinal: The Once and Future Wholesaler.) At one point, the suspensions had even prevented Cardinal from selling products to its own Medicine Shoppe franchisees. (See Cardinal's Latest DEA Deal.)

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There's plenty more to dissect from Cardinal's admirably compact summary of business challenges. I hope this post gets you thinking about any possible implications for your own business in (or with) the pharmacy supply chain. You know where to find me if you want to chat.