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

[Audio Gap] the Cencora fireside chat here at the Citi Global Healthcare Conference. My name is Daniel Grosslight. I'm the health care technology and distribution analyst here at Citi. I'm very pleased to have Cencora's CFO, Jim Cleary with us today; as well as Head of IR and Treasury, Bennett Murphy. Bennett, anything you need to read from a forward-looking statement perspective or...

No, we're good to go.

Okay. Just some housekeeping, too. You should have QR codes on your table. If you want to ask a question, scan the QR code, you can type it in. It will beam up here to me and it's completely anonymous, and I'll make sure to ask those as well.

So maybe if we can just kick off with a political question, given we're just a month out from the election, and we now know pretty much all of President-elect Trump's nominees to run the health care bureaucracy. I would love to just get your thoughts on how -- as we look forward to the next 4 years, how this new administration may impact your business, if at all?

Sure. I'll definitely answer that political question, Daniel. But before I do, I just want to thank you, and thank Citi for having us here today. We've got a lot of great meetings set up throughout the day, so thank you. As you know, and everyone here knows, I'm joined by Bennett Murphy, and Bennett has responsibility at Cencora for both Investor Relations and Treasury. And one good outcome in Bennett's area of responsibility this week is we had a very successful bond deal at the beginning of the week. We issued $1.8 billion in debt to finance the upcoming RCA acquisition, both we did 3, 5 and 10-year terms. It was over 5x oversubscribed and very successful and the rating agencies affirmed both our ratings and our outlook. So I just wanted to comment on that and that Bennett is on the stage with me. It was a very good outcome this week in his area of responsibility. So with regard to the political question that you asked, of course, it's still early days. And of course, we're prepared to work with the newly elected and appointed officials and well, absolutely, as we have been in the past, be part of the conversation. And we'll advocate for ourselves and then also very importantly, we'll advocate for our customers also, community pharmacies, community physician practices, health systems. And we're evaluating the potential impacts, and it's still early days, but the potential impacts that it could come about as it relates to reimbursement or tariffs or vaccines. But I'll also say that as we approach these conversations, we approach them with an appropriate level of confidence. And this, Daniel, I think gets to the key part of the question. I mean as a company, Cencora, and as an industry the distribution in the health care market, we are so efficient and we bring such value to the supply chain. And I think our gross margin structure, whether you look at it in terms of percentages or dollars, our gross margin structure is highly justifiable and defensible. And so I think as you look at periods of change, I think that distribution in general and Cencora in particular, will continue to be very resilient business models in spite of any potential change.

Yes. Yes, that makes sense. And I suppose the biggest unknown around a Trump administration right now for you guys is what happens to the IRA, what happens to drug pricing? The first go-around, we did see a proposal to link Part B drugs to an international index. So if we do see some regulation or legislation around drug pricing that could potentially lower wholesale acquisition costs, how might you respond to that? And how have you responded to that in the past?

Yes. Thanks. There's a lot there. And of course, there's a lot in the IRA. And I'll just comment, one of the things that we're seeing now and people have been talking about is the out-of-pocket caps. And of course, there's many things that are driving really solid utilization trends in pharmaceuticals now. And that's perhaps one of the many things. And so we've obviously been benefiting from the solid utilization trends. But specifically, with regard to wholesale acquisition cost, what we see from the IRA is that an impact to reimbursement as opposed to less price. So much less of a direct impact on us. If there were ever things that would reduce list price, whether it be IRA or something else, this really kind of gets back to the point that I made earlier. I think Cencora as a company in distribution in general, we are kind of so efficient in our gross profit structure, whether you look at it in terms of margins or dollars, is highly justifiable and defensible. And I think there was a good case study this past year on the insulin front where list prices came down. Of course, it was totally unrelated to IRA. But that -- in that case study, we showed that we're able to renegotiate with the manufacturers and approximately keep our gross profit dollars constant. And so I think that's just a good case study of how defensible and justifiable our gross margin structure is.

Yes. Yes. Okay. And sticking with the IRA, let's just assume that it stays in its current form. I think there's also been some concern over not just distribution, but other parts of your business, namely the MSO business, which as we'll talk about a little later, has become an important part of your overall specialty strategy. There was a report out there saying that once Part B [indiscernible] drugs come into these negotiations, we could see a reduction in physician add-on payments of about $25 billion, half of which is concentrated in oncology. I'm just wondering how you can help offset some of these inevitable pressures on your affiliated physicians and how you could potentially respond to those negotiations?

Yes. And of course, it's still early. So if we look out to 2028, there is that potential. And I do look forward to talking about our MSO strategy in a bit because we just are very confident that it's the right strategy for us and it being kind of the natural evolution of our leading specialty distribution and GPO business. But as we do look out to 2028, there is that potential. But I'll also say that it's still early and there's a lot to see, including how manufacturers respond to it. And then I'll just also say that the specialty market, whether we look at distribution or GPO or MSO, these are business models which are really going to continue to benefit from innovation that happens in the market. And we've had a terrific long-term growth rate in these markets really benefiting from things like innovation, benefiting from things like biosimilars also. And so we think kind of those underlying kind of long-term growth factors will be there.

Got it. Okay. Let's dig a bit deeper into some of those growth factors within the pharma business. Over the past couple of years, when you kind of back out the impact both on the upside and downside of COVID vaccine contribution, you've been growing above your kind of long-term operating income guidance of 5% to 8%. This year, again, backing out COVID, you'll be at the top end of that range. And that's even with a major customer rolling off in 4Q, Florida Cancer, rolling off in the fourth quarter. Can you walk us through where you have seen the most strength? And looking ahead, where do you see the most opportunity in 2025?

Yes. And so you're absolutely right. Our long-term guidance, which we think is the right long-term guidance is operating income growth above 5% to 8% a year and then another 3% to 4% from capital deployment. And so EPS growth of 8% to 12% or 10% at the midpoint of the range. But we have meaningfully exceeded that for a period of time, and we have had very good momentum in our business, particularly in the U.S. And I would say it's been broad based. But I'll be consistent in the things that I have been calling out. We've seen continued -- and what we have seen that's driven the results are around continued strong sales of specialty products to physician practices and health systems. We've seen broad-based solid utilization trends across our businesses. And then we've had sort of kind of things that have kind of been on top of that, that have really benefited us. This past year, it was COVID vaccines that really benefited us. And because of that, I think we've had a lot of transparency and really kind of called out the contribution from COVID vaccines. Before COVID vaccines, it was COVID treatments that we really benefited from. So we have a business model which is just very well positioned to take advantage of these things when the opportunities present themselves. And as we look forward to fiscal year '25, we have indicated that our guidance is operating income growth or organic operating income growth of 5% to 6.5%, driven by the same sort of things. But if you exclude the headwind we have this year from COVID vaccines, we'd be -- we would extend that range to 8%. And so that's kind of the impact of the headwind of COVID vaccines. And then the other headwind we have this year is the loss of an oncology customer in the fourth quarter. But we do feel very good about the guidance that we have in place for fiscal year '25.

Yes. And looking forward to next calendar year, there's, I suppose, nothing other than those 2 things that you mentioned that are onetime in nature, meaning the strength that you've seen, this broad-based strength that you've seen within the pharma business, those are kind of medium- to long-term secular trends that you're seeing.

Yes, yes. Kind of what we've been seeing in terms of specialty sales and what we've been seeing in terms of utilization trends, I'd have to say yes.

Okay. Let's stick with specialty because that's obviously a big part of your business. Everyone kind of defines specialty a little bit differently among the distributors. I'm wondering if you can kind of give us what's your working definition of specialty, what rolls up to that, both from a distribution standpoint and also from a manufacturing services standpoint?

Yes. So it's distribution of oncology and other physician-administered products. And so we've kind of always called out as the biggest area for us is oncology. The second biggest area for us is ophthalmology, an area where we have a particular strength, and that's why the RCA acquisition probably doesn't come as a surprise to those who have kind of listened to us talk about our specialty business for many years. And then there's the other ologies, including urology, rheumatology, neurology. And so we have -- and we have decades and decades of kind of organic and inorganic investments in these businesses. And we have the distribution, we have the wraparound services and historically, the key wraparound services has been the GPO for us. And now we are very pleased that we have the MSO business, which is really kind of the natural evolution of our leading specialty business. And so we -- most of the time, when we talk about growth in specialty, we're referring to Part B. And our specialty physician practices business is particularly strong. But then also, of course, we have a lot of specialty sales in Part D also.

Yes. Yes. And we've referenced MSOs a couple of times at the beginning of our conversation, so let's dig in a little deeper on your MSO strategy. Obviously, you kind of got into this back in 2023 with your 35% stake purchase in OneOncology and then the 85% stake that you're taking in RCA. What have you learned via your OneOncology stake? And how do you intend to apply some of those learnings to -- as you integrate RCA?

Yes. And so we've been very pleased with our OneOncology investment. It's been about 1.5 years we bought a 35% stake, and we felt that was a prudent thing to do. It was a new business for us, and so we partnered with TPG, who has more experience in the business. We have Board seats. And so it's been a great opportunity to learn. Now this has been a long-term customer for us, and so the relationship was excellent. But it's really been a great experience for us and a great learning for us. And so this is kind of one of the things that gave us a lot of confidence as we negotiated the RCA acquisition, the experience we've had with OneOncology in addition to the very long-term customer relationship we had with RCA. And as I've said and we've talked about for quite some time, oncology is definitely the kind of the leading area for us in specialty. But ophthalmology has been that second area for us in an area where we've had very good distribution and GPO market share. And we also think that there are good synergies between the businesses, in that RCA is clearly the market leader in its space. It's very active in clinical trials and a lot of clinical trials are done at RCA side. So this is something, for instance, that could be a synergy between the 2 businesses.

Yes. Yes, makes sense. And as we think about your acquisition strategy within the MSO space going forward, are you going to kind of stick with these 2 ologies? Or is there a desire to kind of branch out to other therapeutic areas?

Yes. I think these are the 2 areas that are most complementary to our strategy. They're pharmaceutical-centered specialties. We also believe there's value in the urology space, but that can be addressed via oncology similar to how we've kind of done that or supported that through our OneOncology investment with their acquisition -- with OneOncology's acquisition of a urology MSO. So we really like that pharmaceutical-centric nature of these specialties and we like that we have a long history, as Jim talked about, decades of leadership in these spaces. So we know the spaces well. We have leading positions, and we really understand the moving pieces quite well.

Yes. Yes. So kind of having that experience with your core distribution within these spaces really is what's informing your move into the MSO space?

Yes.

That's right. And I think for Cencora, what we've been talking about pretty consistently over the last couple of months is customer centricity. And whether it's OneOncology or RCA, a strong physician leadership, and that helps us to continue to make really strong decisions and also it really improves and supports the patient care and the patient voice in the process.

Yes. Yes. And with OneOncology, you do have that put-call structure. Do you still intend to fully own OneOncology? I believe it's, what, 2025 or 2026 where you can make that decision?

Yes. It is something that is highly likely to happen in the future given the way that the put-call structure works. And I'll just say, just to give you an approximate time frame is kind of the midpoint on that put-call structure is 4 years after the deal was done in the middle of '23.

Okay. And then at that point, you would -- right now, it's not being consolidated within your financials. So at that point, you would start to report it on a consolidated basis.

Yes, that's absolutely right. We own 35%, and so we account for it using the equity method. So it's below the operating income line. But once we would -- assuming that we do move forward with the put call, we would start to consolidate it at that point in time, Daniel.

Okay. Good, good. Let's touch on some of your important relationships. We'll start with ESI. You recently noted that you extended your contract to 2029 with no real change in the economic terms there. Evernorth does have their own specialty distributor, CuraScript, which they've said they intend to drive more volume through, which I suppose could mean disintermediating some of what you guys are doing for them. Can you just comment on that dynamic, a major customer also owning a specialty distributor and how you manage some of those conflicts of interest?

Sure. It's unique, but it's a dynamic that we've dealt with throughout the entirety of the relationship. We feel really good about the relationship. It's an important customer for us. And as with any other customer, we'll continue to look for ways to do more together to create share value.

Okay. Okay. And then on Walgreens, obviously, they've kind of been pretty vocal in trying to restructure some of their supplier contracts. And I think recently, they made some comments about you guys specifically about having very constructive conversations with you. I'm wondering if you can give us some more details on what very constructive actually means. And other than pricing, which is obvious, what can you guys do to help Walgreens offset some of the pressure that they're feeling?

Yes. And so thank you for calling out that quote. And of course, Walgreens is a strategic partner for us, extremely important, and as you all know, our largest customer. And so we're always working with them on the relationship and to look for win-win opportunities that we can do together. And we're doing that now, and we'll continue to do it so that we can provide the incredibly valuable service to WBA. And there are just kind of so many incremental things that we can do together. And just one example that we're doing now that I'll call out is work with them on their micro-fulfillment centers.

Okay. And can you explain kind of what that actually kind of means to them? How does it benefit them? How does it benefit you?

Yes. And so their micro-fulfillment centers are a way that they can fill prescriptions and deliver them to the stores. And so it helps them with the efficiency of their business model. And what we're doing is we're doing not only the delivery to the micro-fulfillment centers, but then the delivery from the micro-fulfillment centers to the stores. And so they're just kind of just always kind of things that we'll be working with them on so that we can further develop the relationship, which is, of course, such an important strategic relationship for us.

Yes. Yes, got it. Okay. Let's switch over to GLP-1s because that has been such an area of debate recently. The -- it looks like the supply constraints are easing, but I suppose there's a lot of debate around if tirzepatide and semaglutide are actually in shortage or not. In fact, there's this lawsuit outstanding against the FDA for removing tirzepatide from the shortage list. And in some other filings, the compounding pharmacy association who's suing the FDA for taking tirzepatide off the shortage list actually referenced wholesalers as showing that, hey, these drugs are still in shortage. Lilly commented last quarter that they were seeing some destocking at the wholesalers, but we talked to you guys, we talked to your competitors and no one's is owning up to destocking. So who knows what's going there. So I just want to maybe set the record straight. There's a lot of confusion out there around GLP-1s and supply constraints and shortages. What are you guys seeing specifically on GLP-1s?

Certainly, there have been some iterations of supply constraints that the manufacturers have dealt with. We are not doing anything different in terms of how we're managing these products. We are reliant on their ability to supply them to us and then, of course, their related ability to get the product to us and the timing of that. But for us, we continue to manage inventory to meet our customer needs and have the sufficient amount of product available, number of days on hand. But we haven't changed anything, and we continue to really just focus on managing that inventory efficiently as you'd expect because it is quite significant cost of capital, and it's a very, very low margin. As you talk about the supply-constrained component, that is -- that really dovetails into is it the manufacturer product? Or is it something else? Because if it's something else, then we're not in that space. The compounded stuff is not going through a distributor, the manufacturer product would be. So that is really a little bit different than what we've talked about in terms of some of the challenges on the economic front.

Right, right. And to be clear, you're not touching the compounded stuff. On the branded side of things though, and you've been clear on this that it's not -- it's good for revenue, but it's not really a needle mover on your operating income. But I suppose as supply constraints ease, as more competition comes into the GLP-1 space, the channel is going to matter. And perhaps you can get better economics as the channel becomes more important. So I'm curious, when do you think we'll start to see that dynamic start to play out where you'll start to make meaningful profit off of GLP-1s? Are we there in '25, '26? Just give us some detail around timing there.

Yes. I wouldn't tie supply constraints and supply demand as dominoes. The supply constraints are more short term and can be addressed by some of the manufacturer activity to try and boost their production availability. On the supply-demand side, what you just said, that's the key piece in our mind is new competition, new manufacturers that get the manufacturers to come to the table to get more economics into the channel, not just for us but also for pharmacies, which are very challenged by these products. And as you look at the market, they are providing really important service as so many people are on these products and the ability for them to access them at a pharmacy where they can get the medical -- the access to a medical professional quite easily. That's a really important part of supporting patient outcomes. And as we continue to see more products come to market, hopefully, there's that appreciation of the importance of that pharmacy channel and the supply chain overall to get those economics into the channel.

Ben, and then the one thing I'll add is, Daniel, I certainly don't see the economics changing for us in our fiscal year '25. But there is probably, at some point, as Bennett said, once there's more competitors on the market, there's probably some point during our long-range plan where we do see better economics over time.

Yes, yes. And just a reminder for folks in the audience, there are QR codes on your table. If you want to ask a question, feel free to do so, and it will pop up here completely anonymous. Let's go over to Animal Health. This has been kind of a pretty -- and Jim, this is near and dear to your heart. This has been a bit volatile recently. I think we saw a spike during COVID and then coming off, it moderated a bit. Where do we stand with Animal Health? What are some of the drivers that you're seeing within the distribution space there?

Yes. So it's -- that is a really good question, and we had talked about that, very strong during COVID and then there was a period after COVID where the comps were hard. And I think that's all normalized now. And this past fiscal year that just ended and you can see it in our 10-K, we had 6% growth in the Animal Health business, and it was faster than that in the companion part of the business and slower than that in the production animal part of the business. And we -- and so I think we're kind of getting back to more of a normalized period in the market. And there have been some kind of pressures over time from staffing in veterinary clinics and those sorts of things. But overall, we're really kind of pleased with the business and very pleased with what we have been seeing in terms of incremental market share gains in both the companion animal veterinary space and the production animal veterinary space.

Got it. And we should think about this line item as kind of a mid-single-digit revenue grower accretive to margins?

Yes, it's definitely a higher-margin business than our human health business. And I do think, yes, that kind of level of revenue growth that we saw in fiscal year '24 kind of appears to be kind of more of a normalized level now.

Got it. Okay. Let's turn over to the international segment. I think this has been a source of recent volatility really because it's more oriented to manufacturer services. You bought PharmaLex, you've got World Courier in there. And the biopharma funding environment has been a bit challenged recently. It would be great if you can just give us a little bit more detail on where you are seeing pockets of strength, pockets of weakness in the international segment. And any signs of normalization there and what you can do to manage that business while we have this volatility on the biopharma space?

Yes. And so you're absolutely right, Daniel, in the way that you asked the question. So our international segment is approximately 20% of our operating income. Our U.S. segment is 80% of our operating income. But when you look at it, you'll see that the operating margins in our international segment are meaningfully higher than they are in our U.S. segment because we have a lot more of the biopharma services. We have more the commercialization services businesses there. And those businesses can be a little bit more lumpy than the core distribution business. And so we did see a softer performance from PharmaLex, and that is largely driven by the market and some of the biopharma services market pressures that you were talking about. And so as a result of that, we did take an impairment on the PharmaLex deal at the end of our fiscal year. We think it's the right business for the long term, and that will be a good business over the long term, but it was a little softer due to market pressures. Probably the top performer in our international segment has been our Canadian business where -- and I actually had lunch with the head of that business yesterday, and that's a business that does commercialization services, nursing services and related distribution in the Canadian market. And in its segments, it has just very good market share and has been very successful at winning new business. So that will probably be the -- as of late, the star performer in our international business. The Alliance business is performing well, though, I will say that overall, international will be more lumpy than the U.S. And an example of that is we had some revenue that we're expecting in the fourth quarter of last year, which will instead happen in the first quarter of this year. And -- but overall, if we look at it for last year, operating income growth on an as-reported basis was 3%. And this year, our guidance for operating income on an as-reported basis in international is 5% to 6.5% growth.

Okay. Okay. And you also called out some additional expenses within the international segment. Can you just detail what are -- what's causing that elevated level of expenses? And when do you expect that to normalize as well?

Yes. Yes, that's something we called out. And when we bought the Alliance business, there had been some historic underspending on IT. So that's something that we've been spending on for quite some time. And we called that out as one of the things that impacted earnings in the fourth quarter of the fiscal year. And now that we've built that up to a base level, it will grow now at more of a normal rate of growth. That IT spending there is now kind of at a base level that will grow at a normal rate of growth. So we won't have the same high growth rates in that spending that we called out in the fourth quarter.

Got it. Okay. Let's talk a little bit about capital deployment. Obviously, you guys generate a lot of cash flow. I think this fiscal year, you're guiding to between $2 billion to $3 billion of free cash flow. I guess the first question there, what drives you to the low end versus the top end of that range?

I would say there's always a little bit of movement around on the cash flow side, just given the fact that we have over $1 billion a day in sales. So whether it's day of the week or timing of sales or timing of receipts or sales mix between customers, there can be timing factors that move us within that range, but nothing specific that I would call out right now.

Okay. Just normal working capital days. And you repurchased about $1.2 billion of shares last fiscal year, much of that from Walgreens as they sold down their stake. Now that Walgreens, I suppose, is mostly done with those open market sales, I think there's still some prepaid variable forwards that they have to work through. But now that they're mostly done with those open market sales, how are you thinking about your capital deployment priorities between share repurchases, dividends, CapEx? And again, we've mentioned this, but the whole space has been more acquisitive recently. How are you balancing that going forward?

Yes. So if we look at it over the longer term, we will have balanced capital deployment. We're always investing in the business, which has great returns for us, and that's about $500 million to $600 million a year. This year, we'll have about $600 million in CapEx. We'll look at strategic acquisitions. And of course, OneOncology and RCA are terrific examples of that because they fit so well with our specialty strategy. We'll look at opportunistic share repurchases. Last year, we did about $1.5 billion in total. And if we look at what we did between the last 2 weeks of last fiscal year, so the last 2 weeks of September and the month of October before we announced earnings, during that about 6-week period, part of which falls into fiscal year '24, part of that falls into fiscal year '25, we did about $640 million of repurchases of what we thought was very opportunistic pricing. And then what we also did this year is we increased the dividend on our stock. And historically, we've been increasing at about a 5% rate, and we increased that to an 8% increase rate, which is in line with our long-term EPS growth guidance of 8% to 12%.

Got it. And you mentioned at the outset, you had a very successful debt raise. You got your -- the credit agencies rerated you. So I'm just curious, how do you think about debt paydown going forward? And also, how do you think about -- as I mentioned before, the M&A, what seems to be an increase in M&A activity? And on that front, where are your priorities when we think about inorganic growth?

Sure. I'll start with the debt piece, and then Jim, if you want to take the last piece. I think certainly, we've had a pretty low debt level for a while. And now we will prioritize paying down that debt as you think about some of that debt. As you look at how we finance that transaction, we did use a substantial portion of about $1.5 billion of term loans that we haven't drawn on, but we would draw on when -- if and when we close, which gives us a lot of optionality in terms of how quickly we can pay that down. So that and then as Jim mentioned, the debt stack that we did to finance the deal was 3, 5 and 10 years, $500 million, $600 million, $700 million, respectively. So if you think about the $1.5 billion term loan and then the $500 million 3-year, we do have some optionality and some ability to reduce that debt in the next 12 to 24 months, which we will do.

And then as we look over time at strategic capital deployment, my answer here will be very consistent with what we've been saying for a couple of years, and that is that the top priority is our leading specialty franchise, and you've seen us kind of execute on that with OneOncology and RCA. And of course, we have capital spoken for over the next few years with the OneOncology put call. And then a secondary priority for us is -- and this is something we've consistently been saying for some time is kind of higher-margin, higher-growth manufacturer services businesses.

Is there anything in particular as we think about upstream services that interests you more than others?

Would -- if we ever are looking at those sorts of things, it's kind of strength of the market and strength of the management team and something where we have synergy with our other offerings.

So then if you think about the position that we do have, World Courier is a leader in the space, in their space in the global clinical trial logistics side. And PharmaLex gives us a really strong global platform for outsourced manufacturer services. So I'd say for both of those, there is tuck-in opportunities that we could add to those platforms.

Yes. And cell and gene therapy has also been a big kind of area of focus for you guys and a big area of strength. Maybe if you can just, the last couple of minutes we have with you, just kind of explain what the strategy is within cell and gene therapy. And again, inorganic versus organic growth within that area.

Yes. I think that is an interesting space that's still in its nascency, but it has -- there's a lot of opportunity that we have to participate along the way as it comes into -- as the hope and the outlook comes to fruition. That's not really necessarily capital intensive. So it's really looking at -- and we've talked about this in a number of different forms, how the assets that we have and how that can make us a differentiated partner to help these products launch. So certainly, 3PL is a big piece of that, but there's a number of players in 3PL. But as you look at Cencora, because we have the World Courier asset, we have a leadership in specialty and we have 3PL both in the U.S. and Europe, we have a very differentiated suite of solutions that is not really offered by another player that can help support the manufacturer, both commercialize and actually physically get their product into the market.

Yes. I think we're just about out of time now. Jim, Bennett, thank you for joining us this morning, and thank you all for listening in.

Thank you.