Key observations from the 2012 Fortune 500 list:
- Most drug channel companies rank more highly on the Fortune 500 because they are bigger (in revenues) than pharmaceutical manufacturers.
- Drug channels companies are pretty profitable. In 2011, median profitability of drug channels companies was up slightly vs. 2010.
- Beware of the "pennies in profit" fallacy, which reflects revenue double-counting within the channel system. Channel companies' profitability is about half of the profitability of pharmaceutical manufacturers when using an appropriate metric such as Return on Assets.
- In 2011, investors earned higher returns from drug makers than from the drug channels group. This is a switch from previous years, although the drug channels group outperformed manufacturers over the past 10 years.
- The profitability of a typical independent pharmacy is well above the median profitability of the 10 largest drug channels companies, including PBMs.
THE COMPANIES
Here are the 10 largest drug wholesalers, pharmacy chains, and PBMs on the 2012 list along with Fortune 500 rank and links to the financial data as reported by Fortune. Note that Catalyst appeared on the list for the first time this year.
- McKesson (MCK): 14
- CVS Caremark (CVS): 18
- Cardinal Health (CAH): 21
- AmerisourceBergen (ABC): 29
- Walgreen (WAG): 32
- Medco Health Solutions (MHS): 36
- Express Scripts Holding (ESRX): 60
- Rite-Aid (RAD): 113
- Omnicare (OCR): 389
- Catalyst Health Solutions (CHSI): 455
REVENUES
The channel intermediaries are much larger than the manufacturers. In 2011, median revenues for the 10 drug channels companies were $71.1% billion, up 3.6% vs. 2010. Median revenues for the manufacturer group were $18.4 billion, up 6.3% vs. 2010.
Six of the drug channels companies are in the top 50 of the Fortune 500 list, while the highest ranking manufacturer (Pfizer) only reached #40. For comparison, the 12 largest pharmaceutical manufacturers on the Fortune 500 list have revenues ranging from $67.9 billion (Pfizer) to $4.8 billion (Celgene).
Note that the Fortune 500 rankings are based on sales revenues, so that double-counting artificially inflates the top-line of a channel participant. Here's how a single prescription can be hypothetically counted as revenue by four Fortune 500 companies:
- Manufacturer A sells a pallet of WonderDrugium to Wholesaler B. Manufacturer A reports the net revenue from the sale on its income statement.
- Wholesaler B sells a case of WonderDrugium to Pharmacy C. Wholesaler B reports the net revenue from the sale on its income statement.
- Pharmacy C dispenses a WonderDrugium prescription to a patient. Pharmacy C is reimbursed via a combination of the patient's co-payment 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.
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 supply chain (retail pharmacy, wholesaler, or PBM). In 2011, the weighted average ROS (not shown) for the Drug Channels group was 1.8%, up slightly from 2010's weighted average of 1.7%.
In 2011, the drug manufacturers’ weighted average profit as a percentage of revenues was a much more robust 15.9% of revenues (range: 8.8% to 33.4%). Thus, the manufacturer-to-channel ratio is 8.7X, i.e., the ROS for the manufacturers was about nine times the ROS for drug channels companies.
PROFITS: RETURN ON ASSETS
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 channels company's balance sheet are current assets (cash, product inventory, or accounts receivable), whereas the biggest assets of a pharmaceutical manufacturer tend to be long-term assets such as intangible assets, goodwill, or physical plant, property, and equipment.
The profitability of companies in the Drug Channels universe looks much more attractive on this basis. In 2011, the group median was 4.5% (Range: -7.4% to +9.9%). Without peeking, can you guess which company had the negative ROA? (Hint: It's a survivor.)
The ROA figures for drug channel companies now look closer to the pharmaceutical manufacturers, whose median profits as a percent of assets was 9.9% in 2010. The manufacturer-to-channel ratio is only 2.2X for ROA, about the same ratio as last year. The difference in part reflects 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 actually created valuable and innovative drugs.
INDEPENDENT PHARMACIES
The 2011 NCPA Digest provides the following data for independent pharmacies in 2010 (the most recent year available):
- Average ROS = 3.0%
- Average ROA = 20.9%
You know my motto: Everyone is entitled to their own opinions, but not their own facts. Sorry to be the bearer of good news!
INVESTMENT RETURNS
Investment returns reflected last year's decent stock market performance. Here are the median Total Return to Investors in 2011 as reported from Fortune's list:
- 10 Drug Channels companies: +11.1% (Range: -17.3% to +42.7%)
- 12 Drug Manufacturers: +19.9% (Range: 1.6% to +64.1%)
A FEW TECHNICAL NOTES
- For consistency, all data come from Fortune's measurement of key financial metrics. Click here to review Fortune’s methodology.
- I only include Drug Channels 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.
- The ROA for independent pharmacies is computed as (Average Operating Income / Estimated Average Assets) using data from the 2011 NCPA Digest.
