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

Good morning. I'm Steve Baxter, the health care services analyst at Wells Fargo. Really pleased to have Cencora with us today. Cencora is one of the largest drug distributors in the U.S., also operates pharma services business as well as an international portfolio of businesses. From the company, we have got CFO, Jim Cleary; and Head of IR and Treasury, Bennett Murphy. Did you want to make any kind of opening comments? Or should we just kind of hop into it?

Well, we just want to thank you for having us here today. A great conference that you have, and we're very much looking forward to our time with you. So...

Great. Yes. We really appreciate you coming. So -- all right. Well, maybe we could start out with the update that you guys put out yesterday, making updates to your fiscal 2024 guidance, giving us some initial thinking on 2025. I guess as we start maybe with fiscal 2024, obviously, good to see the increased guidance. Can you give us a flavor of what's driving that, where the strong performance is coming from?

Sure. Yes. In fact, as you all saw yesterday morning, before the market opened, we issued an 8-K with really kind of 3 items. And the first thing that we did, as you just asked about, is increased our guidance for fiscal year '24. We increased our adjusted EPS guidance. And it was a small increase. We increased it by $0.05 at the low end of the range and $0.05 at the top end of the range. So our current adjusted EPS guidance for fiscal year '24 is $13.60 to $13.70 a share. And really, the reason for the increase is just continued strong performance in our U.S. business for the same reasons we've been talking about for quite some time, strong utilization trends, strong sales of specialty products to physician practices and health systems. And overall, just broad-based, really good execution in our U.S. business. And then the second reason was some continued favorability in net interest expense.

Okay. Makes perfect sense. And then to move to the 2025 commentary, I think generally it made a lot of sense, at least how we were thinking about the business. Obviously, you flagged with the previous quarter that COVID vaccines were going to be potentially a bit of a swing factor. So as you think about EBIT growth at kind of the lower end of the long-term range, I mean, again, not a surprise, but as we think about the moving parts there, would love to get a sense of kind of like the materiality of each one of these things? You've been more helpful than a lot of companies with quantifying it, but wondering how you're thinking about the step back in COVID vaccines for fiscal 2025?

Yes. Yes, sure. And so the second thing that we did in the 8-K that we put out early yesterday morning before the market opened was we indicated that for fiscal year '25, we expect our adjusted operating income growth and our adjusted EPS growth to be at the bottom end of our long-term guidance range. And our long-term guidance for adjusted operating income is 5% to 8%. And our long-term guidance for adjusted EPS is 8% to 12%. And so again, we expect in fiscal year '25, we'll be at the bottom end of those ranges. And we indicated that really the principal driver there is COVID related. And COVID has had a meaningful impact on our business, and we're really pleased about the work we've been able to do with COVID vaccines and therapies, and in that it has had a meaningful financial impact. As you were saying, we've, I think, done a really good job on disclosure over the past couple of years and provided a lot of insights. And one of the things that we indicated last year is during the first 6 months of -- and when I say last year, excuse me, I'm referring to fiscal year '24. During the first 6 months of fiscal year '24, we -- our U.S. segment grew operating income by 16%. And ex COVID vaccines, that growth would have been 8%. And so that -- we really wanted to kind of size it and give an order magnitude of the operating income growth we were getting from COVID vaccines. And then also in the first quarter of the fiscal year '24, we had $0.06 of contribution from exclusive COVID therapies. And of course, COVID therapies are no longer exclusive, so we don't have that contribution. And so we expect our contribution from COVID vaccines and therapies to be meaningfully down in fiscal year '25 versus fiscal year '24. And so that was kind of the key driver of indicating that our operating income growth would be at the bottom end of our long-term guidance range.

Yes, it makes perfect sense. And disclosures have been very helpful. I think we were -- I think the math you did was the first half math. I think the full year math we were getting to 4% or 5% of segment EBIT was coming from the commercial vaccines. I guess as you fill your forecast in your initial commentary for 2025, how are you thinking about how much that declines? And I guess what's informed that decision? I guess like what are you basing that decision based off of?

Yes. I think it's a combination of mix, product mix, right, less complex products now going through that now being utilized for the vaccine and just some different expectations on how much share go through the retail channel or how much volume in total will kind of go in. But there's a number of factors in there that are all really factors that tie back to how we talked about COVID vaccine as being above our expectations and being a bigger contributor in 2024. So I think it all ties back nicely. What we're talking about now is somewhat intuitive or understandable relative to how we talked about it throughout the year.

Yes. And actually, Bennett called out something there, which is really key and in '24, one of the vaccines was an ultra-frozen product, and it no longer is. And so the fee that we earn is somewhat less.

Okay. Makes sense. Okay. And then if we were to set these headwinds aside, like how would you characterize the underlying growth ex the headwinds relative to your more normalized levels of performance you'd expect in [ LRP ]?

Yes. And we continue to see kind of quite good trends across our core business. And we talked about this for quite some time that we see really good utilization trends across the core business. We see very good growth in sales of specialty products to both physician practices and health systems. And then really kind of a number of the other kind of macro dynamics are consistent with what we've been seeing and talking about for quite some time in terms of the fact that generic deflation has moderated and really kind of branded price increases are, we think will be in line with our expectations. And actually, we just finished 2 full days this week of business planning meetings, where all of our business units present to the executive management team and present on their fiscal year '25 plans. And so kind of in terms of the dynamics, both the macro and business dynamics driving the business, we feel quite good about the business.

Okay. Got it. And I think the one other item that we didn't maybe touch on from the update yesterday as I think you flagged, hey, there's potentially a customer loss. I think the timing maybe would be pretty late in the fiscal year. So maybe it seems unlikely that it would have much of an impact. But any sense you can give us of how do we think about, hey, the run rate of that transaction potentially going through, what that could mean maybe on a more run rate basis?

Yes. So we -- when we indicated that we'd be at the bottom end of the ranges for fiscal year '25, we called out COVID. But then we also talked about to a lesser extent, it was impacted by factoring in the potential loss of a customer, which would happen in the -- in June of 2025, a customer that's in the oncology market that recently went through and announced impending M&A event. And so that's a business which is a -- it's a good business for us, the oncology business and one that we are quite focused on and really want to continue to grow in, and we're really pleased with our investment in on OneOncology that we made in June of last year, which we have put call to own the full business within 2 to 4 years, and we think will be a very good growth platform.

Yes, we're going to come back to that. All right. And then just to maybe close out the 2025 discussion. How should we think about the international expectations that are factored in? I know it's a smaller part of your business, but there were some headwinds this year. So trying to think about what that means for growth into next year.

Yes. Yes, sure. And so if you look at Cencora overall, 80% of our operating income is from our U.S. business, 20% is from our international business. And if you look at our international business, it's a higher-margin business than our U.S. business. It has kind of a core wholesale business, but then it has a number of higher-margin services businesses, including 3PL and global specialty logistics and the PharmaLex Consulting business. And we've had a softer quarter in the third quarter that we had talked about. But the business is positioned for growth in fiscal year '25, and we expect to see growth across that portfolio in fiscal year '25. And of course, our long-term guidance for the U.S. business is 5% to 8% operating income growth and our long-term guidance for the international business is also 5% to 8% operating income growth.

Okay. That's great. And then we obviously try to do our own work to track your end markets and demand trends. We thought that maybe this most recent quarter, we would see maybe a bit of a deceleration in the revenue growth that you reported in your U.S. business and said, you accelerated, I think, ex GLPs from 6.5% year-over-year growth to 10% year-over-year growth. So going the opposite. I would love to hear a little bit about what drove the acceleration in the growth rate, especially compared to the prior quarter, which is maybe a little softer?

Yes. I think we -- in the quarter, what we talked about is that we had really good growth in health systems and specialty physicians in those -- inside of that customer base. It's an important customer base, and the classes where we saw the most growth was like oncology and ophthalmology. And those would be the areas that were really probably a bigger driver of the growth in that quarter versus prior quarter. But still good in the other quarter, and you just have -- quarter-to-quarter, you're having these dynamics, but not big moving pieces in the grand scheme.

Okay. Got it. And you've mentioned seeing more stability on the generic side, which obviously isn't very helpful for the industry. As you look at that over the next couple of years, I think like one concern that comes up still, there's been lot of tension on generics. But one thing that still comes up is, hey, if things have been stable for a while, does that mean that at some point, we could see maybe a reacceleration of competition or things like that. How do you guys see it from your position at the top of the perch?

Yes, sure. And so, of course, a few years ago, we had gone through a period of accelerated generic deflation, and we've been talking about for some time now that generic deflation is moderated, and that continues to be the case. There still is generic deflation. So that is a headwind for us. But it continues at that moderated level of deflation. And that's something that we have -- one of our -- it's one of our expectations. And I think it's occurred because generic manufacturers have prioritized their portfolios. I think it's also occurred probably because there's been increased FDA inspections of generic facilities post COVID. I think maybe it's also been impacted by some spikes in demand and some product categories also. I'll also say that as we've gone through our planning process, we also do analysis that what happens if generic deflation increased by 1% or 2%? Or what happens if deflation moderates by 1% or 2%? And I'll just say that, that's very manageable also.

Got it. That's good to hear. And you mentioned OneOncology. It's been about a year since the close of the transaction, you've minority stake in the transaction. Obviously, we can't see the results in your P&L. Can you give us an update on how the business is performing, and what we should know about where the business is today versus where it was a year ago?

Yes, we feel very good about the business, and we feel very good about the long-term opportunity. As you know, in a little over a year ago in June of '23, we made an investment and have 35% of the business. But as I said earlier, we have a put-call structure in place to potentially own 100% of the business in 2 to 4 years. We just feel very good about the business and the way it's executing. From a business standpoint, feel great about the work it does for patients and feel very good about the management team. And so we just are very optimistic about the growth prospects there. And of course, specialty has been a very good business for us for quite some time. And the business is growing nicely. It did -- in the last month, announced that it will be making an acquisition of United Urology, which is the #1 player in that market, and they are in nice synergies between the 2 businesses. And overall, we feel very good about the scale of the business prior to the United Urology acquisition. It's over 1,000 providers in 16 states. So it's a very nice growth platform for us.

Yes. So as we think about the growth, I mean, can you speak a little bit about what are the key differentiators for OneOncology that's going to allow it to compete against other competitors in the market effectively?

Yes. It is -- I think kind of one of the kind of key things about it is the MSO was formed in 2018. And so it has kind of 6 years' of experience. So it's very well established in its business, very well established in its business model. And it's -- and so it's -- just from an organization standpoint, it's well positioned for growth. And obviously, very importantly, it's very well suited to provide very important treatment for patients.

And there's a good physician leadership in there, right? We've had a relationship with the key anchor physician practices that are in that business for a decade, and many of those business leaders are on the leadership board of OneOncology, and I think that physician leadership helps as well.

Okay. And then you mentioned, obviously, the strength from the health systems was something that was notable. As we think about maybe the other side of the customer base, obviously, there's been a lot of focus on what's going on with retail pharmacies. I guess maybe if we start with independent retail pharmacies. There's been some pressure points that seem like they're emerging maybe on things like Medicaid reimbursement benchmarks, potential pressures to their model maybe from IRA. I guess as you think about the needs of your small customers, like what are you hearing from them? What are your expectations for how that plays out over the next couple of years?

Yes. I think that the independent pharmacy customer base is our exceptional business operators. The challenges that are outside of their control are frustrating. The DIR reform is a big help to then they can actually see what their reimbursement is more live as opposed to a 6-month, 12-month look back surprise invoice. So that piece was helpful. As you look at what's happened with the NADAC data, like the volatility there is just really unfortunate because you are -- they're impacting -- they're being impacted. There's not a lot of clarity what's happening in the survey side. And I think we need -- we continue to advocate for the pharmacist because, at the end of the day, it's important that those pharmacists are paid fairly, reimbursed fairly. All pharmacists are reimbursed fairly because it's a really important site of care. If you're a patient and you're managing multiple prescriptions, the pharmacist is the one person that can't hide from you. You don't have to try and wait 4 weeks for an appointment. You walk in, you have a personal relationship. And for a lot of the community pharmacists, they have lot of overlap because they're typically leaders in the community. So there's a really good relationship there. It's important that they get reimbursed fairly, and they're a really important part of the care team for a patient, particularly ones that are managing 3 to 5 prescriptions.

Okay. Got it. I know this is probably a harder question to answer, but obviously, a large customer of yours is struggling a bit, plans to shrink. I guess, how should we think about your company's ability to help them through the challenges that they're having, and what's the right set of trade-offs to make for somebody to make such an important partner for you?

Yes. And let me say kind of couple of things there. One, with regard to the store closures, which will happen over an extended period of time, I think that Walgreens has terrific experience and expertise in doing that, and I expect it's some of the lower-performing stores that are being closed. And of course, they have a lot of expertise in shifting the scripts. And I believe they intend to keep their teams also and have them shift over to other stores. And so that's something that we expect to have a minimal impact on our overall business and have a lot of respect for their capabilities to execute on those sorts of things over a period of time. And then really the -- just the other thing I'll say is that it's, of course, an extremely important customer and partner that we've had for quite some time. Our businesses are integrated to a very high extent, and we'll always be looking for win-win opportunities with our customers, in particular, our key partners.

Okay. I appreciate that. Another area of focus for retail pharmacies has been whether we could potentially see something that looks more like a cost-plus reimbursement model. As you think about how that would impact your business, what are the important things to keep in mind if this model becomes potentially more prevalent over the next few years?

Yes. I think the -- I'd kind of go back to the commentary I just made earlier. There's been a lot of pressure in terms of the dynamics that play out between PBMs and retail pharmacies. Clarity and fair reimbursement is really important to supporting the pharmacist as a site of care. So however that materializes, it should be good for -- hopefully, that provides that clarity, an appropriate economics for [ pharmacy ].

Okay. So that would be good. Okay. And then a couple of biosimilar questions and maybe starting with 1 part D biosimilar question and maybe Part B after that. There's been some recent news, I think, around like formulary changes and certain biosimilars potentially moving from external distribution, it's more like an internal distribution model. How should we be thinking about HUMIRA and some of these pretty significant formulary and biosimilar shifts that we've seen really over the course of this year?

So it's not a new dynamic. I mean, in many cases, mail-order pharmacies in-house non-patent protected products. So in past discussions, it was -- product goes brand, then it goes to generic and it moves in house. So it's not overly surprising that you have that dynamic being talked about here. I think it's just different names. And I think that -- I don't think it's a very different dynamic. And I think it's -- if you go back over the last 3 to 5 years, maybe even longer, we've never talked about the Part D biosimilar opportunity being something that we thought was a big opportunity because we knew where a lot of that volume was concentrated and a lot of that procurement would be done. But for us, the biosimilar -- the Part B biosimilar market is the sweet spot, and that's the part of the market that we've been very positive about and have really good trends, quick utilization, good patient experience and good doctor comfort. And I was in the Part D biosimilar side, that's obviously been a lot slower uptick than the Part B side.

And the one thing I will add there is that if in Part D, if HUMIRA biosimilar was -- is sourced direct by a customer, that's the sort of thing that would have a pretty big top line impact on us, but a very small operating income impact on us because that's a shipment we're doing to mail order pharmacy. Those are typically like pallet shipments that we're shipping to a handful of locations. And so that is very much lower margin business for us.

Yes. Okay. That makes perfect sense. And then to bring it back to the Part B biosimilars, like as you think about the potential for these to continue ramping and building over the next few years, I guess like how kind of context can you give us about where we are in the big biosimilar opportunity? I think everyone has been excited about for some time now.

Yes. Why don't I start, but Ben, then I'd love for you to add also to this. And in Part B biosimilars are -- have been a very good opportunity for us, both in oncology and ophthalmology. It's been an opportunity for us in physician practices and in health systems. And one of the reasons why it's been a good opportunity for us is we not only do the distribution, but we have a bunch of wrap-around services that we also can offer. So it is a very attractive market for us and kind of one of those -- there are, of course, many things that move us within our guidance range, but that's clearly one of the things that moves us up within our guidance range.

Yes. I think the site of care is what matters, right, so where is it going through. As I alluded to earlier, with that Part B, Part D side that we've seen really good trends in the oncology biosimilars, some good trends on the ophthalmology side. Health systems are increasingly utilizing these products. And anything that's going through that professional physician channel or health system channel, that's going to be where we can -- we have a good opportunity to support access.

And then I asked a little bit about the IRA and Part D redesign. I guess we just got the most recent set of negotiated drug prices that have came out. I guess, as you study the impact of drugs, I guess, how are you thinking about what the potential impacts could be on your business, specifically related to the price negotiations? And then just broadly, how you think about Part D redesign, and any kind of benefits or risks that you might see to your business from that?

Yes. I think certainly, a lot of headline reaction to it. I think we'll see and pharma talks a lot about potential impact of innovation long term, but I think, for us, it's something that's really -- it's not directly linked to us given that what we're really talking about here is the government reimbursement price dynamics as opposed to some, like a wholesale acquisition change.

Good there. Okay. So you don't think on that group, majority...

The other piece is the opportunities. So the out-of-pocket caps on the Part D side, that could be good. I think one of the things that's probably underappreciated in the market, whether it's by whatever, is that a lot of prescriptions still get walked away from at the counter. And that's usually something related to sticker shock or a lot -- and then there's also a good amount of prescriptions that don't get refilled properly and once again, could be that out of pocket piece. And people not finishing out there or following the prescribed -- their prescription can have negative health outcomes and can also have readmittance cost, and it's just not good for the health care system to have that potential incremental touch point with a health care provider when if a patient had been able to adhere to the initial prescription plan, then they could have gotten back to the good health they need to be, and hopefully, some of that out-of-pocket cap. So hopefully, that out-of-pocket cap dynamic helps to have the scripts utilized as they're intended.

Okay.

And it's just one of the many things over the long term that should cause our industry and market to continue to have good utilization trends.

Yes, that makes perfect sense. And there's obviously been a lot of focus on GLP-1s, and they've been impacting your results, obviously, much more so at the top line than at the bottom line. Does seem like this is a service that, over time, you should be able to hopefully earn a reasonable margin on? Like what has to happen between now and then to maybe see some kind of improved economics on GLP-1 drugs?

Sure. And of course, we've done a lot of disclosure on GLP-1s, and they have been a driver of our top line, and we've been consistent in our communication that they are profitable for us, but they are minimally profitable. With regard to top line, last quarter, our growth in GLP-1s during the quarter was $2.1 billion of growth. That was 38% growth over the prior year, and I believe, 30% growth over the prior quarter. And so it's clearly a top line driver for us and minimally profitable for us. So you asked, what are the things that could cause it to become more profitable over time? I think certainly, when supply catches up with demand, that would be one thing that could impact it, maybe different forms also. But I think then if there are competitive products on the market in a couple of years or so, that's the sort of thing also that could get it to closer to a normal level of profitability.

And then a couple on the international. I think you can kind of referenced this earlier in the discussion, but I think you said in the third quarter, you saw some higher IT costs and maybe a little bit of slowness in like the global specialty logistics business. What's the latest thinking on kind of those issues and how we might see them translate for the next couple of quarters?

Great. And that was with regard to international?

International.

Yes, yes. So -- we -- and once again, last quarter when we announced our results, which were overall great results, we did have softer results in the international business, which is 20% of our operating income. And we really called out 3 things. One was elevated IT expenses, and those continue in the fourth quarter, but in fiscal year '25, they go to a more normalized level of growth. Second was a down quarter in our global specialty logistics business, and that's a business that's a leader in doing things like logistics for drug trials. And it's had fantastic growth for a long period of time. It did have lower shipments in volumes last quarter. That's something that's probably been impacted by that market. But that business will turn and will be, in the future, a very good grower like it has been in the past. And then we called out some softness in the PharmaLex business, which we've now owned for about a year and 3 quarters. And I think that, that business, we have organized well now, and it's well positioned for growth in fiscal year '25. And so those are kind of the things that kind of have impacted '24, but I think we'll be well positioned for '25.

Okay. It sounds like a lot of that is happening outside of the core distribution business. Can you just talk a little about how the core international distribution business is performing?

Yes. And yes, it's performing well. And I think that if you look at it over time, our core distribution business internationally will not grow as fast as the U.S. business because it doesn't have some of the same specialty dynamics, but our international business has a lot more services businesses like 3PL business in the global specialty logistics business that I talked about in the consulting business. And those higher margin businesses will kind of get us to that same long-term growth range. Our long-term growth range is 5% to 8% in both the U.S. and international.

Okay. Great. Maybe just for the last couple of minutes, we could talk about capital. I know that, obviously, you have the buy-in for OneOncology on the horizon. But just overall, can you speak to kind of how much of your capital capacity you expect that will take? And then what will your priorities be outside of OneOncology over the next couple of years?

Yes. And so we'll continue to have balanced capital deployment. And one great thing about our business, there's so many great things, but one great thing is we have very strong free cash flow, and we have a very strong return on invested capital. And so we're fortunate that we got good capital deployment opportunities. So we'll continue to invest in the business, and that typically has our highest ROIC. Historically, we've done about $500 million of CapEx a year, a little bit less. It will probably be a bit more than that as we're investing in technology and distribution capacity. We'll continue to do strategic acquisitions. And I'll use the last 2 investments that we've done as good examples. One was in specialty, a key market for us in the case of OneOncology. And second was PharmaLex, which again, is biopharma services, higher-margin growth businesses. We'll continue to do opportunistic share repurchases. We've done $1.2 billion of share repurchases each of the last 2 years. We, I think, executed very well in repurchasing shares from WBA as they were selling down some of their shares. And then we'll continue to grow our dividend each year also. So you continue to see balanced capital deployment from us.

Okay. That's great. I think that basically brings us time. So I think we'll leave it there. Thanks so much. Appreciate it.

Thank you so much.

Yes. Thank you.