Cencora, Inc. (COR) Earnings Call Transcript & Summary

Hi, everyone, and good afternoon here. My name is Erin Wright. I'm Morgan Stanley's health care services and distribution analyst. I'm pleased to have AmerisourceBergen CEO, Steve Collis, with us today; as well as CFO, Jim Cleary. ABC is a leading drug distributor, both in the United States and globally now. And we're happy to have you here with us today. So for some disclosure remarks here, for important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, thanks again, and I'll hand it over to Steve for some introductory remarks. Thanks.

Good. I'll just come up here for the introduction. Good to see all of you. It's -- we do appreciate these presences to be in front of our stakeholders more than we ever have because it has been rare. And it's also -- I want to congratulate Erin and tell you we're excited about your new role and look forward to working with you. So I'm sure a lot of you are familiar with AmerisourceBergen, but in case you're not, we're a leading global health care company with a foundation in pharmaceutical distribution complemented by higher-margin, higher-growth businesses and services across our footprint. When we think about AmerisourceBergen, we'd like you to think particularly about our expertise in specialty, both here and increasingly in the rest of the world and some of the outstanding portfolio companies we have. We create differentiated value for our stakeholders by living our purpose to be united in our responsibility to create healthier futures. Specifically, we do this through 5 strategic imperatives, which we take very seriously. We actually -- one of the seminal events from AmerisourceBergen is always our March strategy meeting. And I like the 5 imperatives that we've laid out, and they have not really changed, which is leading with market leaders. If you think about the customer portfolio we have, most familiar here with the U.S. companies like Walgreens, with Kaiser, with Express Scripts, Cigna, those are our marquee customers, but also have incredible relationships with pharma manufacturers. And our services businesses have some long-standing clients on the reimbursement access side. We are very proud and we continually find ways to leverage our infrastructure to increase efficiency and support our customers. We want to expand on our leadership in specialty, very important for us to do that. We want to contribute to pharmaceutical-driven outcomes, working collaboratively with our partners, both up and down the channel. And finally, and this really is a great proof of point with PharmaLex acquisition, which we announced on Monday this week, is we are investing in innovation to drive further our differentiation, both in specialty but also in core distribution services and including services to manufacturers. So we did announce this acquisition this week. We've had some -- we've been in a couple of one-on-ones. We're getting questions about why at this time, why invest more in Europe. We don't know what's going to happen with exchange rates, but we weren't driven by that. What interested us was the high level of growth of this business, the high level of services, the differentiation they had. So PharmaLex has a well-developed competency and developmental consulting, regulatory affairs, pharma-economic vigilance and quality management and compliance. And all of these, we think, will up the game. We will be practicing at a higher end of our license in Europe as we integrate this acquisition. And it's about 65% to 70% of the revenues and earnings are from Europe. But not to be overlooked, about 25 to 30 -- about 25% in the U.S. and then 5% in Asia. So really a nice complement. AmerisourceBergen, we're not obsessed with international. We're very proud and we'll continue to invest with strength in our U.S. business. But we do believe there's something to this global thesis of being partnered with large providers and large manufacturers. We have a strong understanding of the European health environment. And we are also doing really well as we've completed our first full fiscal year with our Alliance acquisition and have done well for over 10 years since we acquired World Courier. So we believe we know how to do international. We keep our teams pretty busy, but we believe we're positioned very well. And the other thing I'd like you to think of when you think about AmerisourceBergen is resiliency. We're dealing with a pretty inelastic pharma demand curve. And one should argue that if you look at health care outcomes, there's no better leverage to those health outcomes than pharmaceutical compliance and adherence and patients staying on therapy. So when you think about AmerisourceBergen, hopefully, you'll think of some of those themes. I'm going to come and sit next to Erin and Jim so we can talk about that in Q&A.

Great. And that was a great introduction. And let's go into a little bit of the acquisition you announced this week of PharmaLex, and I think you gave a little bit of the rationale of why kind of PharmaLex and why now. It's a sizable deal for you. But can you talk a little bit about some -- and maybe, Jim, you can respond as well, but some of the financial profile? Is it a high single-digit, low double-digit grower, the margin profile of the business? And then is it actually accretive to your initial or implied kind of 2023 guidance? I guess there's capital deployment in there, but if you could comment on that as well.

Yes, sure. From a financial standpoint, we think it has a very good profile for us. It is a consulting business, as Steve talked about. So it has higher margins, and so it definitely helps our goal of complementing our Pharmaceutical Distribution business with higher-margin, higher-growth businesses. So it's a meaningfully higher margin, has an operating margin, say, in the mid-20s and should grow at a low double-digit rate over time. And we're indicating that in fiscal year '23, during the last 7 months of the fiscal year, it will bring about $0.15 of accretion. And that's for the 7-month period. And it's not a seasonal business, and so you can kind of annualize that or look at it first 12-month run rate, and then it should grow from there. And so we feel very good about it financially. We also feel really good about it strategically, as Steve talked about. It's just highly aligned with what we talked about during our Investor Day. If you look back at our Investor Day presentation, it really kind of aligns up, as Steve talked about, with our strategic imperatives of expanding our leadership in specialty and contributing to Rx outcomes by working closely with our upstream partners and by expanding our differentiation by investing in innovation. And it really kind of increases the depth and breadth of our global biopharma manufacturer services businesses. These manufacturer services businesses are some of our higher-margin, higher-growth businesses. And PharmaLex adds to our existing significant platform in that area and really increases our depth and breadth of the services that we can provide to manufacturers.

Okay. Great. And so I think also what I was getting at, too, is as we think about 2023 and the key drivers that are embedded in your underlying 8% EPS growth, that's excluding the COVID dynamics. Is that target still intact even with PharmaLex? I just wanted to clarify.

Yes. So as we said during our Investor Day and then we reiterated in August on our third quarter earnings call, our initial guidance for fiscal year '23 is organic operating income growth of approximately 5%. That's excluding COVID impact and then growth from capital deployment of an incremental 3%. And so that's 8% EPS growth excluding the COVID impact. And the PharmaLex acquisition is part of that 3% growth from capital deployment. And then, of course, the rest of that growth would come from other capital deployment during the year such as share repurchases.

Okay. Great. Let's take a step back, and let's talk about core supply chain fundamentals right now. So can you comment on the underlying volume environment from a prescription utilization perspective excluding COVID? And can you speak to the overall kind of durability of your business also in varying economic environments? And yesterday, we did hear from one of your competitors that there was a weaker July experience, but then maybe some improvement in August. Is that consistent with what you're seeing as well?

I think July was a month that we became a bit like Europe in the U.S. Everyone's on vacation. And -- but honestly, we -- over a long period of time, we, of course, monitor the IQVIA trends and -- but some of those prescriptions are not as overall economically impactful, particularly when you look at like flu vaccine and COVID therapies, we obviously are well understood. And that comes in and out a bit, and July was, I think, quite a weak census month. So we're not seeing anything that we're concerned about so far in this quarter. We are really encouraged. And if -- I get the question often and including this morning, what is the most unappreciated aspect of your business. And I would say it's our resiliency. If you think about -- the first year I was running our core drug business was 2009, and the whole world was collapsing, right? And we had, I think, $4 million in bad debt in the drug distribution business. And also our demand remains fairly inelastic, and it's the same in Europe. And as I said, there's no better path to productive health care outcomes than prescription benefit and management. So we strongly believe in that. And I think people really need their medicines. And it's just a core tenet of our business. And we feel like the company is really well positioned. The leading with market leaders is a fact. And also I'd say we have market-leading portfolio companies. We got asked the question earlier, why did we divest our specialty pharmacy business and was based in Dallas. And the reason we did that is we didn't see a path to become a top 3 player in that space. And then that means that you can't quite attract the talent and capabilities and customers that you want. So in those cases, it makes sense for a company, a mature company like us with a large revenue and economic base that we have to really be focused on where we can be successful. And that's a lot what we think about and along with those 5 strategic imperatives. So we believe we can be successful in specialty without owning a specialty dispensing pharmacy. So...

Where do you think we're at now in terms of underlying utilization relative to pre-COVID levels? And do you think that there's any sort of structural change in utilization trends at all?

I don't think so. I don't think so. I think there's more resources for those patients that need access to financial assistance, including programs that we run at our Lash Group. But there is just generally more resources. I think the Affordable Care Act and Obamacare were very helpful to that as well. In Europe, of course, we're often dealing with single-payer systems. And I think manufacturers are very thoughtful about how do they keep patients on therapy and how do they get patients on therapy. And we also are tremendously encouraged by the innovation that's taking place, whether it's in weight loss products or cell and gene therapies or potentially Alzheimer's drug. So it's a tremendously exciting space to be in. AmerisourceBergen is, as we said, focused on the innovation aspect. So our World Courier business has been a leader in cell and gene therapy. And before we bought that business, we had those therapies on the landscape. We're worried about them because often they get distributed straight from the laboratory to the academic medical center, and that's what the model we saw with CAR T cell. But usually, it's been transported by World Courier because not many other people have the expertise to do that. And we're building additional capabilities around that.

Okay. Great. And then speaking to drug pricing, I feel like -- and it's been a little bit of a timing between since we've spoken, but I do feel like we're in a stable environment from a drug pricing perspective at least relatively speaking. And is this the new normal? Is this sustainable and to what degree? Is your model even sensitive to the generic pricing dynamics as much as they used to be and how has it evolved because I think it has.

So it's a great question, and it's another aspect of the resilience of this industry. If you think about the transition we've made with the generic patent cliff and the fee for services and the transition to biosimilars, and I think our industry -- our peers as well have found really ways to participate productively for our stakeholders and our shareholders that we can increase our role in the channel. Drug pricing, the deflation is we'd like less of it, frankly. It's still a bit concerning that it's not less, but it is showing a little bit of signs of improvement. It is going to be driven by supply and demand. There is a lot of supply. There's also a lot of stable demand. And as we know, both in Europe and in the U.S., the buyers are pretty consolidated. But our thought on -- I think we want successful counterparties, and that's important to us. We want high-quality products. So on the branded side, it's kind of interesting because you heard a lot of criticism about brand inflation being above CPI. Of course, that's often ignored. That's a helpful headline maybe for some political point of view, but it's not really true when you look at the net pricing and all the rebates. And it's incredibly complex, but we believe the net pricing was pretty much where the CPI was. Now you're having the CPI going excluding labor and energy costs to above 5% and what is that going to mean for price increases. But I would suspect in the U.S., we're going to still see the sort of levels that we've seen historically, larger price increases in January, smaller perhaps in July. And I think that will even be in this inflationary environment because of the political headwinds that we see and the fact that it's undeniable that there is a differential in pricing between the U.S. and other leading countries. So I think you'll see some political sensitivity to that. And you won't see a tremendously high level of inflation in brands either. And then you've got the Inflation Reduction Act that we're keeping a close eye on. It's going to play out over many years. I believe, again, the industry will be very contemplative of that. And we're well positioned, and we'll see how it plays out. It's not clear how all the comments and all that will be implemented. But probably something that we believe we can manage through successfully. Jim, anything to add?

I'll just add a couple of things. One is on the brand side. As most of you are aware now, well over 95% of our buy-side dollars are fee-for-service. So we really don't rely on the price increases to make a profit. And then really, the second thing on pricing in -- again, this is something that we've talked about. One thing our team has done a really good job on over a number of year period is rebalance contracts. So we make a fair return on brand, specialty and generic. And there was a period of time when our industry probably over-earned on generics. But our team really spent a number of years very successfully rebalancing contracts. So again, we make a fair return on brand, specialty and generic.

And we -- just, Erin, one final point of clarification. We talked a lot obviously about buy side. Our sell side has been pretty stable as well. We've been able to be very proactive with our large customers, talk to them well in advance of contract renewals. And I think they understand very much what our economic drivers are. I think it's very hard to argue that you don't get a fair value proposition from an AmerisourceBergen if you're a large provider. I think the larger companies in the last few years, we've gotten to understand what each other's challenges are as publicly quoted companies and respect that there needs to be a certain return in order to reinvest in the business and be profitable and successful. So I think that's well understood. And we've done a good job in all sectors of our business to try upgrade the profitability and the impact of those contracts. And I'm proud of the way we've gotten through the renewal cycles.

And you continue to benefit from your market leadership in specialty and which should continue to be a driver for you. Can you speak to your -- to the various areas where you're best positioned to capture that specialty opportunity and then also what you can do to maybe even better position yourself, whether it be biosimilars or elsewhere?

Yes. So the U.S. business is reporting to Bob Mauch, who's our Group President. He was a founder of Xcenda. He really understands the specialty business extremely well. Bob, I think, was absolutely should be given a lot of credit in our industry for changing the way that specialty products got priced. When we came into the drug wholesale business, they were really a lost lead, and you didn't want to have the fastest-growing part of your core drug distribution business. We had our specialty more Part B-type businesses being very profitable and successful, but we weren't really recognizing especially with a different brand category and need to be contracted. And we've done various mechanisms, including carve-out programs in that, which all the industry has adopted to manage through that. So I think we've been very contemplative of that. And we are successfully partnered with a lot of the aggregators in oncology. We have the 3 leading aggregators for all of our customers, and we have close relationships with all of them. Our ION business is a differentiator. I made the comment earlier that when we -- when I was running our specialty business, we had about 10 to 20 contracts. Amgen was a really big partner, for example. But we've really broadened that out, and we now have over 150 contracts at ION. But a lot of our future growth and upside is really focused on other ologies as well. Oncology could not be more important, but we're trying to apply a lot of those practices and disciplines to urology, for example, ophthalmology. And with biosimilars and new product introductions, neurology is an interesting area for us. You'll see us launch more sort of ION-like companies in other ologies. And you'll see us really up our practice management skills in those non-oncology practices. There's a tremendous receptivity in AmerisourceBergen. Often, we have even higher market share in some of those markets than we do, particularly, we really helped launch EYLEA, and it's now -- now we're seeing that product cycle expire, but we'll be very involved with the biosimilar launches and carry on working productively with Regeneron. So we're very well positioned in those areas as well.

And most of the biosimilar opportunity for you is in that Part D -- Part B category instead of Part D. And -- but how are you thinking about the potential, for instance, Humira biosimilar just given it's so near term? How do you think about kind of the relationship there that you have with your partner, but also does that relationship stay intact? And what's your exposure? Or when do you expect to have kind of clarity on that front?

Now as I heard -- we came in just 5 minutes before, and we heard the question going to J&J about -- and it's a seminal event. This is probably the biggest product consistency over the last decade or so. And so it's going to be a seminal event. There's already, as was noted, over 10 manufacturers. So we expect that there's going to be quite a rapid price benefit to the -- to stakeholders. And our view is that we need that room for innovative products. And we probably will still be net neutral on that, I would guess. I don't know exactly. We're not sure exactly how it will play out, but we'll make a higher margin, but it's going to be on a lower selling price. We don't -- the economics on that, but we don't really comment on products. But the economics on that product are -- the top line is good, but the economics on that product are not particularly compelling for us. And arguably, we could do a bit better with some biosimilars. But 11 manufacturers is a lot. And so I think you'll see some rapid price changes. But we're talking to all of our customers. And if there's a way for us to participate, we will. I don't think there's ever been a time where we are more in close touch and aligned with our large customers and issues like the Humira launch or something that really resonates. And we can try to work with it. But of course, we understand they have to be focused on their own economics as well. And -- but hopefully, that always contemplate that AmerisourceBergen is going to add a lot of efficiency to them and hopefully, even some better pricing as well.

And I want to make sure to get to international, but one last one on the biosimilar front. When we do see the proliferation of biosimilars that are more in your sweet spot of those Part B drugs, should we assume operating profit growth that can reach the higher end of that 5% to 8% long-term target that you've given?

Yes. We're never going to have 5% to 8% in all of our businesses. Certainly, we've been incredibly impressed with the last. We've had 5 wonderful years with our specialty business, 5 or 6, where the growth has been consistently higher than that. And we hope we'll continue that. Again, we are well positioned. That's the place where there's a lot of -- it's been the place to be, and we've been fortunate to have good representation there. A good part of our portfolio is leveraged to that, and that's been a long experience. It's '96 that we bought Oncology Supply, '98 that we did ION partnership. We have a lot. And AmerisourceBergen, we're just getting smarter and smarter with how we're innovating and partnering with different companies, some more on the practice management side and how do we partner and how do we adopt those. So we -- hopefully, we'll continue to benefit from that leverage because that's where the pipelines are.

Okay. So now switching to international. And can you parse out the headwinds and tailwinds from an FX perspective, Profarma, manufacturer price increases in the international segment and kind of what continues or what should we expect kind of going into 2023 as we're kind of trying to think about modeling that segment?

Yes. And so let me comment on that, and there's a lot there in the question. You mentioned Profarma. I'll just cover that one quickly. That's a business that we sold and announced in June. And that -- during the first several months of the fiscal year, I believe that contributed about $0.05 of EPS. And so -- and that business -- and it was sold because we do a really thorough strategic analysis of all of our businesses. And that was a business in Brazil where we -- other people were consolidating the market, and we didn't feel we had an ability to win. And so it made sense to sell the business. It was a very good business. But as we go through our strategic analysis, made sense to sell it. FX clearly will be a headwind, and we've talked about that internationally is really the dollar has been incredibly strong, and that's about $130 million headwind this fiscal year. We haven't specifically called it out, but a significant portion of that is offset by significant price increases in Turkey that are really based on currency devaluation there. And so that market is really set up well where there's an annual price increase, which is based on the value of the Turkish lira versus a basket of currencies. And so that offsets a significant portion of the FX headwind, but there still is an FX headwind there. What I'll say overall about the businesses, though, is they've -- our international businesses have executed very well. And we've got high teens accretion from the Alliance acquisition in the first year. Our World Courier business, that's almost 1/3 of our international segment, is really operating very well. It has -- because the value of the service it provides and doing the logistics for drug trials, it does have good pricing capability. And many of its contracts are in dollars. And it continues to perform very well. So we do have things like an FX headwind, and there is higher inflation in Europe than there is in the U.S., but we're also seeing very strong execution by our teams.

And can you break down a little bit of the performance that you're seeing in the traditional wholesaling business in Europe and some of those macro dynamics that we need to be thinking about versus some of the manufacturer services businesses?

Yes. I'll start out with that. And this is really kind of a core thing about AmerisourceBergen's long-term vision is we have the foundation and pharmaceutical distribution. And then we're complementing that with our higher-margin, higher-growth businesses. And Steve talked about that in his opening remarks. And so in our international business, we have the foundation and Alliance in the wholesale business there. But a meaningful amount of our operating income internationally, even a higher percentage of operating income internationally than in the U.S. comes from some of these higher-margin, higher-growth businesses. And they're businesses like our specialty logistics businesses, World Courier that I talked about and Alloga that's a leader in 3PL distribution in health care in those markets. Then Alliance also had manufacturer services businesses. And then the PharmaLex acquisition really feeds very well into this strategy also. And so kind of what moves us within kind of a long-term growth range is kind of what's the growth rate of those higher-margin businesses. So if in Europe, if World Courier and Alloga and PharmaLex in the manufacturer services business are growing faster kind of moves us up within that operating income growth range. And it's really the same thing in the United States. Those businesses that move us up within that kind of 5% to 8% range for operating income growth in the U.S. are specialty physician services, our manufacturer services business and animal health.

Okay. Great. And then on capital deployment. And if you do have a question, please raise your hand. We have a few minutes left here. But -- and we can get a mic over to you. On capital deployment, are you on track with your debt paydown for Alliance? And can you speak to your working capital requirements and capacity for future share repurchases as well as broader capital deployment optionality post PharmaLex and opportunity to potentially purchase some of the Walgreens holdings as well.

So I'll start off. But so we've had a long-standing policy with capital deployment. Our first priority is infrastructure and internal investments. And those have been some of our best returning investments. We've got a business, AHP, which is largely self-starter, which is one of our jewels that we never really even talk about. But that's a really good example. We continue to increase the capabilities there, and that's just one that doesn't come up, so bringing that up. But AmerisourceBergen, even when we're doing PharmaLex, what we're doing is front-loading a lot of investment, which will drive the long-term synergies. Our second priority is investment is M&A. And we do put M&A ahead of share buybacks because we believe that at the end, it creates a vitality and a robustness in the business that positions you better. There is absolutely a place for dividend, share buybacks. And we've been thoughtful about that. We haven't been shy to buy back stock when we need to. We would look at Walgreens as an opportunity to collaborate if they would decide to sell more shares. And we obviously have a close and productive relationship with them. They still own 25% of the company and have a Board seat. So we obviously are very contemplated with that. Working capital and debt paybacks are all on -- I'm getting into Jim's space, but all on track. We feel very well positioned.

And if I can sneak in a selfish question here on Animal Health. If you could come in and give us an idea of volume and pricing trends, both across companion animal and production animal segments that -- or any high-level commentary on underlying fundamentals, that would be great.

Yes. So in Animal Health, and you asked about both companion and production and volume and pricing. I see in the companion animal market, we're just kind of getting back to those pre-COVID level growth rates. Of course, there was kind of a dramatic increase in growth rates during COVID as people were staying at home and adopting more pets. And then there were a few quarters where the comps were tough against the higher growth rates, but I think we're getting back to that kind of pre-COVID level of growth rates now. Of course, probably the constraint in the companion animal market is staffing at vet clinics and veterinarians being able to staff at that clinic. And then pricing is good in that market. A lot of manufacturers took 2 price increases this year. And then in the production animal market, and I'll be brief, volumes are good now. Volumes might be a little tougher next year because of the drought and a lot of animals going into feedlots now, but there might be a little culling of the herd because of the drought. But overall, both markets are very well positioned for the long term, and I think we'll perform really well in the long term, Erin.

Great. Thank you so much. I appreciate the time.

Thank you. Good luck.

Great to see you.

Thanks, Erin.

Thanks for your attention, everyone.