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

Great. Good morning, everyone. Welcome to this session of the Leerink Global Healthcare Conference. I'm Mike Cherny, the health care tech distribution analyst. It's my pleasure to have with us the Cencora management team, Jim Cleary, CFO; Bennett Murphy, who heads up IR as well as Treasury.

I got a ton of questions. Obviously, if anyone in the room has anything at any point, let us know, raise your hand. But for now, maybe I'll just start. Jim, you had an 8-K this morning, increased guidance about $0.05 at the top and bottom of the range, called out U.S. Healthcare Solutions. Maybe just go into a little bit more detail about the drivers behind that and maybe use that as a framework for what you're seeing across the market, obviously, building off of a strong 1Q as well.

Yes. As I'm sure you all saw, we put out an 8-K this morning, and we increased guidance for adjusted diluted EPS to a range of $15.30 to $15.60, so $0.05 at both the bottom and top end of the range. And we said it was specifically as a result of continued momentum in the second quarter in our U.S. Healthcare Solutions segment. And so we're seeing really the same things that we've been seeing for some time now that's benefiting our core business in the U.S., just continued strong utilization trends, continued strength in specialty sales to both physician practices and health systems and really broad-based growth across the segment. And so we thought as a result of that, it was appropriate to do this increase in guidance and attribute it to the continued momentum we were seeing in the second quarter. And so we are just really pleased by that. And of course, it's in spite of a COVID-related headwind that we've had for some time now. And so we're overcoming that like we did in the first quarter. And as I'm sure you saw in the first quarter in the U.S. segment, we had operating income growth of 10%, which was in spite of that same COVID-related headwind in the first quarter.

And maybe just to dive in a little bit more, you mentioned specialty, I'll start there. Cencora has a long history of being a no pun intended core specialty provider. You've always performed well in specialty, but we've seen what appears to be elevated market growth as well. As you think about the dynamic, especially flipping the calendar from second half of last year, calendar-wise to the first quarter, you mentioned both provider and bulk dynamics. Anything else you're seeing, anything on the condition states, anything else you can call out relative to the specialty growth and particularly your ability to gain share with your current customer base?

Yes. So I'll start, and I'm sure that Bennett can add. So as you know, specialty is a real area of strength for us. And as I said earlier, we've seen very good performance in sales to both physician practices and health systems. And again, I could call out really a number of different things. We see very good performance in Part B. We said we see very good performance for us in both the oncology space and the retina space. We see good performance in distribution. We see good performance in our wraparound services like our GPO services. One of the several things that's benefiting us also in the space is the biosimilar trends, and we've had good performance, we've called out for quite some time in the oncology space, and now also in the retina space.

And as you think about biosimilars in particular, the last year, the biggest focus has been on Humira, Stelara, as biosimilar introductions, which my understanding is that they're not huge differentiated growth drivers for the distributors. So what are you seeing from a biosimilar adoption dynamic for your customers given that especially for drugs that fall into the provider channel, that seems to be like a later in the decade opportunity for maybe upsized growth given some of the patent expiries we're expected to see?

Yes, I will start. And this is something, of course, that we've mentioned for quite some time. With biosimilars, we principally benefit in Part B, where we not only do the distribution, but we also do a number of the wraparound services like the GPO services. And I said earlier, we really benefited with -- from biosimilars in oncology for quite some time in Part B and now in retina also. In Part B, and you mentioned Humira, those are, of course, good for patient care and patient access. but they're lower margins for us, and so don't have nearly as much impact, they're largely mail order. So we're doing pallet size shipments to relatively few locations. And so as you can imagine, that's a lower margin business for us, but of course, still very good for patients. Bennett, anything you'd like to add?

Yes. I think that kind of setting aside the recency bias, right, if you kind of take a longer-term picture, you see that several years ago, we started to see the Neulasta Avastin, Herceptin, Rituxan biosimilar come in, and they are in that Part B space, and we saw quick, fast adoption as the doctors got comfortable with the therapeutic comparability of those products, and we saw them get into our numbers pretty quick. The more recent experience has been those Part D products, which is what Jim is talking about or clarifying. I think that's the part of the market we've always known is going to have a little more challenges given the structure of that market going through the payer. And I think what you're seeing with those products now that there are the private label products, you've seen it's more calendar-based as opposed to doctor comfortability, right? So as the new plan year started in January, you saw some of the biosimilars or some of the reference Humira volume switch over to biosimilar. And we'll probably see that continue to play out on the mail order side. And then to what you're talking about later on, we ideally will experience a very similar experience we had in like the 2020 to '22 where we saw the Part B biosimilars pick up as some of those patent expirations occur.

Got it. We'll probably circle back to specialty a bit more as we go. But maybe just thinking about the more traditional side of the world, the comments we always use on pricing are competitive but stable. I think that's -- it's a very common term, I think we hear from you and your peers. As you think about the recent set of customer renewals, especially as you've got -- you expanded your service offering, additional capabilities, how does that factor into the pricing dynamics? And where do you see the -- I guess, a, can you confirm the competitive and stable pricing? And then b, how much of upsell opportunities do you have given that maybe versus the last time you went through an RFP, your service offering has expanded?

Yes. So I think competitive but stable remains true. And as it gets -- as we look at our customer base, what we're really focused on is partnering with or finding customers that want partners right? It's more than just that transactional basis. So across our portfolio of customers, we're really focused on those ones who want to do more with us, who have long-term strategic goals that they're trying to hit and they are pharmaceutical centric, and we're focused on targeting those customers, working with those customers and then making sure that we're helping solve those problems and lay that groundwork. I think that the changes we've made or the investments we've made are just to either expand our capabilities or enhance some of the solutions that we provide and then just make sure that if we're doing those things that our customers view us as that partner and want to be with us for the long term.

And Bennett, just one thing I'll add is we are renewing customers all the time. And typically, these are just things that we don't need to call out because we're doing it all the time, and we've rebalanced contracts over time very well. So there just isn't a need to call out any sort of change typically when we do a renewal now.

I just have a question. Walgreens going private, does that have any impact on you, are you guys worried about store closures and things like that as you go forward? Or is that...

So just to repeat, the question was about the Walgreens announcement from last week and what it means for Cencora's relationship and the potential for store closures.

Yes. And so there are really a couple of things there. One, we were pleased to see Sycamore's positive commentary on Walgreens pharmacy-led business model here in the United States. And we've had, as you know, a relationship with Walgreens and WBA for quite some time. We started our relationship in the U.S. in 2013, and we presently have a contract here in the U.S. with Walgreens through 2029 and in the U.K. with Boots through 2031. And we have a very good relationship and actively partner with them, and we are looking forward to continuing to partner with Walgreens. And with Sycamore also to look at ways to pursue strategic initiatives with them and add value in a way that's win-win for both companies. Now I'll get on to the store closure question you asked. What we're seeing is they've announced store closures at this point in time. And of course, typically, they are closing stores that are less profitable or have less volume and then also where they can ship prescriptions to other nearby stores. And so that's something that we'll see what the impact is over the long term. But overall, I'm very pleased to see the news because I think it creates an opportunity for Walgreens to continue their turnaround plan and be able to do it with a lead investor that's very smart and very experienced in retail. And I think they'll have a very good chance of achieving their objectives as a private company.

And the change in control, does that open up contract terms or anything or contract discussions or it does not?

Yes. Let me just say we have a very good relationship, and we have contracts that are in place that are through 2029 in the U.S. and 2031 in the U.K.

Maybe to use that as a backdrop, Walgreens is not the first of your customers that's closed stores. Clearly, the U.S. pharmacy channel is one that's been in years of flux. As you think about your role as a partner for all these pharmacies, especially pharmacies going through those store closures, how does the typical relationship work where you can make it win-win for those customers where you can help them on store closures, inventory management, making sure that they're not falling short on those script transfers. You don't want to transfer to a store and then they don't have enough volume. And maybe just give some specific examples, but this isn't the first time where you've seen companies like this going through some level of store disruption.

Yes. So let me start and then, Bennett, you may want to add. And I think this is one of the really great things about our company and more broadly, our industry. And this is something that we've tracked over time. Of course, there have been store closures that have happened for a number of years. But if you look at industry volume growth, industry volume growth on both the units and a dollar basis has been very strong for quite some time and has been driven by the utilization trends that we've seen for quite some time that are very positive. And so while there can be store closures, while we look at our overall business, we see very good durable top line growth. And one thing I'll add that I didn't mention earlier is that, of course, companies like Walgreens and others are very experienced at doing this and are very good at transferring prescriptions from one pharmacy to another pharmacy and retaining staff. And so it's something that we've seen for quite some time and are quite comfortable with and confident about the top line growth that will continue for our company and our industry.

And I think if you look at our industry or our company, the value that we provide on the inventory side is really high. So if you're closing stores or if you're shifting volume, the fact that you can order from us until 7:00 at night and get the next morning by 10 or 11, that gives you a lot of wiggle room or space to manage the iterations that can occur when you're trying to shift your footprint or move patients from one store to the next. So I think that's a lot of efficiency and a lot of value that we provide to help in those types of processes.

And Jim, maybe back to a previous comment, you talked about the dynamics of customers and renewals and constant renewals. I don't think there's been a press released customer you've won since Walgreens. So we don't see all of the wins. Clearly, there's been -- come to next, but a lot of consolidation of some of your customers, other customers that are ongoing in process. But maybe just talk about your win rate. It doesn't come up a lot, but what type of customers are still turning to Cencora? And when you win them, what are you offering? Because I know your net shift is not negative, which obviously be M&A driven more than anything else.

Yes. And that's -- and it's certainly evident when you look at our company growth. And there aren't -- and of course, you could pick individual examples, but there's not a lot of shifting in customers. But we've seen really good performance with health systems, and we've seen very good performance with community practices. And I would say we've seen a very good performance across the board, which is, of course, evident when you see our top line growth rate. And one of our -- one of the things we really focus on is leading with market leaders and having leading customers in every one of our business units. Ben, I'm not sure if there's anything you'd like to add.

No, I think that's right. We're very targeted in where we feel like we want to have the potential incremental exposure. And we just kind of fundamentally don't view the press release for customer contracts as necessarily a big upside.

And so maybe thinking a bit about the consolidation, let's jump into some of your provider services that continue to expand. The OneOncology investment now is at least announced almost 2 years old, Retina Consultants of America. I always have to look at what the C stands for to remind myself, but obviously, it's the newest one. Maybe give a little compare and contrast on what attracted you to both those businesses. OneOncology clearly felt right down the middle, given your historical strength in oncology. RCA, maybe analogy that's important, but a little different. But maybe give a little sense on the background behind both of those and what you hope to achieve and do better with them that they weren't doing before.

Sure. I will call out a few things. First of all, it was the natural evolution of our really successful specialty business. As you know, specialty has been a key growth driver for our company for quite some time, and we're a leader in distribution. We're a leader in GPO. And so now getting into the MSO space just was the logical next step because it's providing more services and higher-value services to the same customer group. So these are customers that we've had relationships with in distribution and GPO for many, many years. And so it was just the right next step to get into these higher-value MSO services with the same customer base. So that's one of the first things I wanted to call out. Second thing I wanted to call out is the reason why we're in oncology and retina is they're pharmaceutical-centric. And that's one thing about Cencora. If you look across all our businesses, we're pharmaceutical-centric, which makes a lot of sense where there's always going to be innovation and good market growth. And if you look at the different ologies, oncology and retina are the 2 that are pharmaceutical-centric. And so rather than get into other MSO ologies, what I would see is us growing the oncology MSO and the retina MSO because they're by far the 2 most pharmaceutical-centric ologies. And then the third thing I'd like to make is -- point I'd like to make is that the reason why we're excited about OneOncology and RCA is that they are leaders in the market. Both of them are market leaders. And so if we're going to do something like this to do this with market leaders makes a lot of sense. And our most recent acquisition, RCA is a market leader in a very fragmented market, which is a good position to be in and creates a lot of long-term growth opportunities. But both of these companies are similar, but I think there's ways where over time, they'll benefit from each other also. For instance, RCA is very experienced in being sites for clinical trials, which is one of the neat things about the business, not only from a potential profit stream standpoint, but also it's a way to really attract top doctors out of schools.

And when you think about growing the businesses, I mean, you have an oncology platform, obviously, with a 35% investment, you have a retina platform now. How do you think about the buy versus build expansion opportunities for both against the backdrop of making sure you keep your market leadership position?

Yes.

Easy enough.

Right. Yes. And so there's going to be both buy and build opportunities in both the businesses. They're excellent markets with growth opportunities that's going to come through pharmaceutical innovation. We just finished our 5-year planning process, which is always a great strategic planning process and financial process to go through. And there's -- one of the nice things about both these markets, oncology and retina and working with both these market leaders is there'll be a number of smaller bolt-on opportunities, we think, over the next 5 years.

And just on OneOncology, because of the investment structure, how active can you be with the business as a 35% owner versus the eventual option, assuming you're going to consolidate and obviously have more operational control?

Yes. We do have a good Board representation, good governance, and we're a close strategic partner. We both benefit from OneOncology continuing to grow.

And as you know, we have the put/call option. So it is probable that we will own all of the business in a couple of years.

And just from a technical perspective, I know cash flow is not an issue for the company, but is there anything at this point in time that would change your capital deployment priorities knowing the high likelihood of consolidating the business over the next couple of years? Or are you still on the same type of capital deployment opportunities?

Yes, that's a great question. And we will continue to have balanced capital deployment. We'll continue to do CapEx and invest in the business, a lot of which is in technology and infrastructure. And those typically have very good returns for us. We'll continue to do strategic acquisitions like RCA and buying the balance of OneOncology is also probable to happen during our planning cycle. We'll do opportunistic share repurchases, and we've done -- I think we've been very good over the last couple of years of doing opportunistic share repurchases, and we'll be growing our dividend. And what we most recently started doing is growing our dividend this year at 8%, in line with the bottom end of our long-term EPS growth guidance of 8% to 12%. Now one of the things that we have said is that after the acquisition of RCA, where we invested $4.4 billion, we are prioritizing some debt paydown for a period of time. But as you look over a planning cycle, I'd expect to see balanced capital deployment. But of course, the sorts of things like RCA and OneOncology are big parts of that.

Yes. And I think, as always, we've appreciated having a really strong balance sheet. And in our long-term growth algorithm, we've said that we're expecting 3% to 4% per year from capital deployment as we continue to strengthen our balance sheet alongside that.

And of course, one of the many really good things about Cencora is our long-term free cash flow generation, which creates very good capital deployment opportunities, which is a real critical success factor for the company and that we are such a good cash generator. Capital deployment is something that we spend a lot of time thinking about and planning.

Thinking back to last quarter, most of the businesses were at or above plan. We obviously already talked about the core U.S. pharma business. The one that was more of a little bit of a struggle is World Courier. I don't think you're immune -- you're not alone in terms of some of the clinical trial service providers having market-oriented headwinds. Maybe talk about the puts and takes right now going on with that business and anything interesting you're seeing called out from some of your manufacturer partners?

Yes, sure. I will start and then Bennett, feel free to add in. We definitely called that out and World Courier global specialty logistics business, we have seen some market softness just as other people have called out and we called out the impact of that both in the first quarter and as we said in the first half. And it's -- but it's a very -- it's a really good business. It's had great growth over the last 10 years. It's a real leader from a quality standpoint in doing logistics for clinical trial and other specialty logistics in the pharma business. So we feel very good about the business for the long term. But just as others have called out, there has been some short-term pressure there.

And has anything changed in terms of the visibility you have on that business? Again, you are far from alone in running through these issues. But are you seeing anything in terms of contracting, in terms of anything on the manufacturer side that would give pause on how well you can predict the business on a near-term basis?

Yes. I think it's predicting the manufacturer outsource or clinical trial advancement has been a little bit of a challenge. And that when you're coming down from peaks right and coming down, you're trying to find what's that new level. So I'd say it's that continued phenomenon of trying to find what's that new level to then grow from. But yes, there has been more near-term challenges of late in that business. And -- but as Jim said, it's been a really good performer. And over the long term, and we expect it to continue to be in the long term. And you're seeing our competitors say very similar things that are tied to that clinical trial space. So we're watching what they're saying, too. But certainly, we're feeling it for those businesses.

But along those lines, World Courier is not your only manufacturer services business. Can you give us a little update? I know it got probably a little lost in the last earnings call with everything else going on, but how PharmaLex is performing and the juxtaposition of PharmaLex versus World Courier, especially in the most recent quarter and where it sits competitively right now?

Yes. So we feel really good about PharmaLex and the opportunities it will create for the longer term. It is one of the businesses like World Courier, though, that will be a tougher growth business in the short term due to some of the market pressures. But of course, I'll call out that as we did during the first quarter and as you look overall, the U.S. segment is about 80% or a little bit more of our operating income and international is 20% or a little bit less of our operating income. And so while we feel very good about the International segment for the long term and the opportunities that, that will create for us and in our partnering with manufacturers, we feel like it is the right strategy. But the thing that's really been driving our growth and the 3 increases to guidance we've done this fiscal year is the very strong performance in the core U.S. segment, driven by the utilization trends and just very broad-based growth.

We're going to run out of time shortly, and so I'd be remiss not to ask about the topic of tariffs. Obviously, you have a big provider, a big inventory manager. How are you as a company thinking about planning around tariffs? What are you hearing from customers? And what are the puts and takes you're considering right now about any potential tariff impact knowing that we may have them tomorrow, we may have them in a month, we may never have them.

Yes. So of course, we have a group that studies this and is always analyzing these sorts of things. And as you all probably know, in the pharmaceutical market, the manufacturers are the importer of record. So there isn't a direct impact on us. But what our team really focuses on and really feels is really most important is product access. So always making sure that there's access in the market so we can do an excellent job on our customer service.

And relative to the manufacturer conversations, have you seen any hiccups yet on their front on product access? And anything about contractually thought process on tariff pass-through, how they're managing their pricing and how you factor that in going forward?

Yes, it wouldn't be that. It would generally be potential actions that could impact supply. So that's what we're primarily focused on is making sure that we're monitoring what we have in the channel, what customers have in the channel, what manufacturers have on the ground to make sure that if there are any disruptions that there are, there is sufficient access. And we always make sure that we understand our customers' buying, what's normal buying for them to ensure that we kind of keep -- to prevent any speculative buying, particularly as it relates to things like this. So we just lean into the communication in upstream and downstream to make sure that everyone is on the same page in terms of navigating any potential disruptions.

As we wrap, Jim, you mentioned you just went through a 5-year strategic planning. Obviously, this is the first 5-year strategic plan with new leadership, not new to Cencora in terms of Bob, but obviously, with Steve having retired. The last 5 years, I think, have been characterized, especially on an underlying basis by outperformance. I have to go back and check all of the math on this, but I'm pretty sure if you back out all the COVID moving pieces that you -- at least especially in the U.S. business, you've outperformed your 5% to 8% targets or at least right at the high end. As you think about your competitive positioning right now and eventually once we roll off of these COVID comps, how do you think about the dynamics of that 5% to 8% going forward? I'm not asking you to comment on specifically on a -- if you would change it, so to speak. But with the strong performance of the business, what are the puts and takes that at least now versus when you first introduced it about 3 years ago, get you to the upside, downside of that range?

Okay. Great question. So first of all, you talked about leadership at the company. And of course, Bob Mauch is now our CEO. Bob has been with the company for many years. He's run every business at Cencora in several different roles, and he was Chief Operating Officer for several years before becoming CEO. So when you talk about the many years of outperformance, Bob was running the businesses and/or Chief Operating Officer. And one thing I'll comment about Bob is he's extremely customer-centric and as we've been working with Bob as CEO, spending a lot of time in the field with team members and customers because he is so focused on the team and so customer centric. And we feel very confident in our -- in the long-term guidance that we have out there of 5% to 8% organic operating income growth and another 3% to 4% from capital deployment, M&A and share repurchases. So adjusted EPS growth of 8% to 12% or double digit at the midpoint of the range. We feel very confident in that. And of course, we've been able to outperform that for some time. Bennett, anything you'd add?

No.

Perfect. Well, I see red numbers, so we're going to cut it there. But Jim, Bennett, thanks much for being here.

Thank you.