McKesson Corporation (MCK) Earnings Call Transcript & Summary

Hi. Good morning, everyone. Thanks for joining us today on the second day of the Morgan Stanley Healthcare Conference. My name is Erin Wright. I'm Morgan Stanley's health care services and distribution analyst. I am pleased to have McKesson's CFO, Britt Vitalone, here with us today. McKesson is a leading drug distributor and IT services provider to health care providers and pharmaceutical companies. Before we get started, I do have to do some disclosures here. For important disclosures, please see the 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, Britt, for joining us today. And I'll turn it over to you for some introductory remarks.

Well, thank you, and good morning, everyone. We're really pleased to be here, and thank you for hosting us. McKesson as a global health care company, now focused mostly in North America. We can talk about that a little bit later. We are really excited about the performance that we've had over the last several years that really started with establishing a very focused strategy on really 4 key components. One is really focusing on talent and people, and we're very excited about the talent that we have that's driving the engine of our company. We really defined growth strategies around some differentiated assets and capabilities in oncology and biopharma services. We're very pleased with the development of that. Very focused on our scaled and differentiated durable core set of businesses and advancing that, and really focusing on the portfolio and rationalizing the portfolio. We believe that these are really at the core of the performance that we've had over the last several years, allowed us to put some long-term targets in place that we're -- we believe are sustainable over a long period of time, and we can probably talk about that a little bit later. So we're pleased with very solid, consistent performance now over a number of years. We believe we have great assets and capabilities in some key core growth markets, and we're really just looking forward to continuing that momentum as we go forward.

And I do want to get into the long-term vision essentially. But first, on the near term and '23 guidance, you're targeting 10% to 15% EPS growth. That's excluding the COVID dynamics. Can you speak to the key drivers? What gets you to the top, bottom end of the guidance, the risk factors you've embedded in there? And then even tracking above that 12% to 14% long-term guidance that you gave, can that sort of outperformance continue? And what's driving that?

Sure. So at our Investor Day in December, we outlined for you our adjusted operating profit targets by each segment, which called for growth in each of our 4 segments and then overall adjusted EPS growth, long-term target growth of 12% to 14%. We did update our guidance after first quarter to 10% to 15%. So it's in line with the long-term target profile that we have, but our first quarter was strong, and we tracked above our initial guidance in each of our segments. As we think about this, there's a few things that we're optimistic about. Certainly, we're seeing stronger prescription transaction volume in the first quarter. That has slowed a little bit here in July, but still tracking above prior year. So we're still seeing growth there. We're seeing good patient mobility, which is impacting and supporting the growth in our Medical-Surgical business, is supporting the growth in our -- some of our technology businesses. And we think that, that is supportive of this upside that we provided you in our first quarter. Clearly, we're watching things in the broader economies such as inflation and supply chain disruptions. We've managed through that quite well. We believe that, that is embedded in our guidance, and we don't see any risks to what's currently in our guidance, but we'll continue to watch out for that. As we think about some potential upsides, again, continuing to see stable transaction growth. We expect that to continue through the rest of the year. We think that biosimilars will continue to grow as adoption continues to grow as more products are launched in the pipeline, which is supportive of our specialty and oncology businesses and just generally just adoption of some of the products that we have within our biopharma services capabilities. Capital deployment was outlined in our long-term growth algorithm. We have good, strong cash flows. We'll continue to deploy capital in a very accretive way for our shareholders. And so overall, we think that we're in a very good, sound position that allowed us to increase our guidance after the first quarter, and we're very optimistic that the growth will continue in each of our segments.

Okay. And you commented a little bit on utilization there, but could we dive in a little bit deeper on the volume environment from a prescription utilization standpoint, excluding COVID? Given your visibility also across MedSurg as well as prescription business, how would you characterize the current state of overall health care utilization trends, especially emerging from the pandemic?

Sure. Well, in the first quarter, as we look year-over-year, on average in the first quarter, prescription transaction volume was up 7% for our businesses. In July, that growth has slowed from what we've seen, but it is still above prior year. And across all of the segments that we support from a transaction volume perspective, we're seeing growth above 2019 level, so pre-COVID levels. From a patient mobility perspective, as we see outpatient volumes just generally, that has been a little bit below prior year, but overall, still above the pre-COVID level. So again, that's supportive of the growth that we're seeing in our medical business specifically. And from an oncology perspective, oncology visits return to pre-COVID levels sooner than other parts of our business. They've maintained good stability, and we're continuing to see good oncology visit data year-over-year. So overall, I'd say the transaction volumes are improved over the prior year. They're improved over pre-COVID levels. A little bit softer in the second quarter that we've seen at least in July than the first quarter, but still well within the guidance range that we have for the full year.

Okay. Got it. And can you speak to the durability of your business both from a top line, but also from a margin perspective, like in varying economic environments, just to put it in perspective, given what we're seeing from a macro standpoint?

Sure. So we have scaled distribution businesses, both in pharmaceutical, in specialty health and in Medical-Surgical. We have continued to evolve our business and our pricing models with our distribution customers over a long period of time, really reflecting the economics that we're achieving with our buy-side partners back through to our supply side. That has given us good stability in our pharmaceutical distribution over a number of years. In our medical business, we have a very broad and diverse set of capabilities and assets across all of the alternate site channels. And we've developed -- continued to develop services such as lab, private brand Rx within the physician office space. And now we're continuing to develop all the way out to the home. And we've looked at home care delivery services and capabilities that just have continued to extend our Extended Care and alternate site business. So we think that we've seen, over the last few years, good stability within the business. We're well positioned and have good scale businesses. And so we think that our margin profile, again, is reflective of the long-term growth that we've provided in each of our segments.

Okay. Great. And I have to ask this, this is probably one of the bigger questions we've been getting from investors lately. But COVID dynamics, the COVID vaccine distribution moving to the private market versus CDC. What -- was this change contemplated in your guidance? Do you anticipate any changes? In your expectations for COVID contributions for the year, you recently raised it significantly, I think, to $0.35 to $0.45 for the year, up from $0.05 to $0.20. So can you talk a little bit about your COVID exposure, your expectations with the potential change in the contract here?

Sure. So the guidance that we provide is really based on the guidance that we received from the U.S. government in terms of the products, the supply, the timing and the volume. So we've continued to provide you that update as we get it. We extended our contracts both on the distribution side of the vaccine through July of next year. We extended the contract for the kitting storage of ancillary supplies to support that distribution through January. And our volumes were higher in the first quarter than we had anticipated in our original guidance. The guidance that we received from the U.S. government for the centralized model increased. We reflected that in our guidance of $0.35 to $0.45 that you referenced is vaccine distribution. Again, that's based on U.S. government volume guidance. And then we have kitting and storage, which includes COVID test kit volumes, which we provided separately updated guidance on that as well. So we have fully expected that from the beginning that at some point, that this will go from a centralized model to a normal distribution model. I think if you'd ask myself or even Brian, did we expect that it would be a centralized model for this long? We'd probably both say no. But we're happy to fulfill the requirement or the ask of the U.S. government, will continue to do this for as long as they feel as necessary. But our guidance is unchanged from what I provided at the end of our first quarter. If there's additional volume or it goes into a normal distribution channel sooner, we'll certainly provide that. But we thought it was really important to separate the COVID-related volumes from our core business so that you could continue to see the strength and the growth underneath that within our core business.

Yes. That's important. And sorry to belabor the point that on those contracts, is there volume commitments with that, that are specific?

There's no commitments. Again, we're just -- we receive volume guidance from the U.S. government of what they expect the volumes to be and then what we would expect to distribute according to those volumes. So it's not a commitment. We have a contract to fulfill a centralized role, and we'll continue to do that as long as necessary.

And on the flip side of that, opening up therapeutics to the private market, could that represent an opportunity for you?

Yes. I mean we haven't really guided on that. We'll have to see how that plays out. We don't have anything in place today that I would give you any guidance on. Certainly, we have the capabilities to do that. I mean we're a very scaled and efficient distribution model, and we could fulfill a lot of different roles as it goes forward. But there's nothing that I can provide you today that suggests that we have a larger role.

Okay. Thought I'd try. So on drug pricing, it has been a relatively stable environment from a drug pricing perspective. Do you think that this is sustainable? Do you view this as the new normal? And to what degree is your model sensitive to things like, for instance, generic drug pricing dynamics? And how has that evolved because it has over the past several years?

Sure. So over the last several years, if you just look at the brand and specialty environment, we've gone from a long period of higher inflation levels to where we are now, which is very modest inflation in that. We've evolved our business and our economic model to be very less -- more tied to fixed, fixed fee-for-service agreements with our manufacturing partners, so that the reliance that we had historically on not only fixed fee-for-service agreements but the inflation component is really low. It's less than 5%. So we believe that we've evolved that business to be very stable to reflect the fair value for the services that we perform on behalf of the biopharma partners. From a generics perspective, over a long period of time, generics as a whole portfolio, they do deflate whether that is just normal evolution of certain products and molecules within the portfolio, new drug launches that go through. Overall, if you look at this on a long-term basis, generic portfolio will deflate. You'll have periods where certain molecules will behave differently, and that's dependent on API supply, how many manufacturers are on a particular molecule, how difficult it is to produce that molecule. But our business is set up such that we have a very scaled and strong sourcing model, a partnership with Walmart on ClarusONE. We still believe that, that's a very strong model, and we source as well as anybody in the marketplace today. That allows us to provide our customers some surety of supply and availability of supply to keep their compliance rates high. And it also gives us the opportunity to create spread. And that has been in place now for a number of years. We think that we're well positioned to continue to create the opportunity for good supply, stability for our customers and low cost that allows us to create good spread.

Okay. Great. Moving to specialty, US Oncology. You've grown your US Oncology Network now, 2,000 providers. Can you talk about the differentiated strategy you have here, the value add for manufacturers and some of the recent investments that you've made in your oncology business?

Yes. So we're really pleased with US Oncology as an acquisition that we made several years ago, the development of that network. But I think if you just maybe just step back and look at the overall ecosystem that we've built over a number of years, the platform that we now have is quite strong and quite broad. We started in this business many years ago, really focused on building scale around distribution. The acquisition of OTN followed on by the acquisition of US Oncology, which also got us into practice management, allowed us to expand our distribution capabilities, whether that be GPO services or other types of distribution services for community oncologists. So the practice of the management allowed us to also have insight into clinical decision-making that goes on in an oncology setting. We have put in place an EMR called iKnowMed, which all of the clinicians within US Oncology use. That's quite unique. You've got over 2,000 providers all practicing on a single EMR. And that allowed us to continue to develop data and insights. And so we built this company recently called Ontada, which is really focused on taking the data that is inherent within the EMR, adding insights to that and providing insights back down to the clinicians for practice within US Oncology, but also providing insights on being able to sell those insights up to biopharma for drug development and for new indications for cancer care. Within that, we also have an organization called US Oncology Research, which is focused on clinical trials. And we've recently created a JV with HCA's Sarah Cannon Research Institute, which we believe now creates a very powerful oncology offering, which is going to advance cancer care within the community setting. So if you think about the development of a whole suite of capabilities within oncology, it's very powerful, and we believe it will advance cancer care for all.

Great. So that's a great segue. I was going to ask about the HCA JV. You established this JV, I guess, in the first quarter. Can you speak to how this positions you in the oncology arena? Can you speak to the rationale, the financials behind the deal? And when this could be material in terms of financial contributions? Or is that the right way to think about it? You also -- with this acquisition came also Genospace. And can you talk about some of the other ancillary investments that you're making with this deal?

Sure. So if you think about the US Oncology Network, they treat approximately 15% of new cancer patients each year. So it's a very scaled business. As I mentioned, US Oncology Research is focused on clinical trials as well. And so when you combine the assets of US Oncology Research and HCA, Sarah Cannon Research Institute, you really have put together a very powerful organization focused on clinical trials. And we'll get to Genospace, which is really focused on increasing matching clinical trial and patient matching. The JV is reflective of what we've been talking about, which is advancing oncology care within the community setting, which includes underserved communities. Both organizations share a commitment to advancing and providing more access to oncology care. The organization is going to come together to really focus on access and availability of clinical trials and advancing drug development at the same time, utilizing the data and the scale that we have around analytics as well as, again, focusing on expanding the reach, expanding the patient set, expanding the clinical trial offerings that both of our organizations have. And the combination of those two will create advanced data and analytics, expanded reach, expanded clinical trial offerings, and we think that this is going to really advance cancer care just generally in the community setting. Genospace is an asset that we acquired, which is focused on clinical trial matching, patient matching. And so we think that, that's going to be an underpinning supporter of the JV around clinical trial research. We've been very focused on closing this deal. It's been undergoing regulatory review, but we're really focused now on moving forward on integration activities and the mission of bringing these 2 organizations together to develop a broader set of clinical trial capabilities.

Okay. Great. On biosimilars, so this is an area that Morgan Stanley has seen a lot of work on. Your focus on Part B drugs versus Part D., how should we think about the biosimilar opportunity near term as well as longer term? What's embedded at this point in your guidance expectations from a near-term and a long-term perspective? And what are the key therapeutic areas that we should be paying attention to for you, obviously, oncology, for instance?

Sure. Sure. So we're excited about biosimilars. We think that this is a tremendous opportunity. We think of it as a win-win-win. It's a win for patients. It is providing lower-cost treatment and care. It is a win for providers because it's expanding the clinical options that they have to treat patients. And for distributors, generally speaking, it has higher margins than branded or specialty drugs, perhaps not as high as we've seen with generic drugs. The channel will make a difference. So depending on the services that are required of McKesson to support biosimilars, we will have differentiated margins. So in an oncology setting, where we have GPO services and the US Oncology Network, and we're supportive of oncology drugs through that channel. There are more services that we'll provide, and so that provides an opportunity for better economics for a distributor. In other cases, where you have a biosimilar that goes through a retail pharmacy as an example, think about HUMIRA as an example to come. There are fewer services that are required of a distributor to support that biosimilar. Now we still anticipate that the services that we provide will have higher margins than a branded or specialty drug, but they won't be quite the same if it's going through an oncology setting where we're providing more services, both for the clinician and for the biopharma manufacturer. We think the opportunity is still to come. There are approximately 38 drugs that have been approved in less than 2 dozen that have launched. So we're still on the come on this, and we think that oncology represents an opportunity in the future for more biosimilars and that will be supportive of our model. Right now, we have built biosimilars into our current guidance. There's nothing additional that I would provide here today. We're very happy with the adoption and certainly the -- what we've seen so far, and we expect that this is going to continue to be an added element to our growth algorithm.

Great. On the regulatory front, inflation reduction active locations for you, how are you exposed to new price control measures in that act? What can you do to better position yourself over the next few years? You do have some time here to prepare. And how are you thinking about the overall implications from a regulatory standpoint?

Yes, sure. So I think this gets back to a comment that I made a little bit earlier. Clearly, this is something that's going to evolve over time. This is 10 drugs that began in 2026, and then it's going to add 10 to 15 drugs a year for the next 3 to 4 years after that. So this is something that will evolve over time. Clearly, we will watch this. But as we think about our economic model, as I talked about earlier, with biopharma, we are on a fixed fee-for-service rate. So we're going to continue to be paid a fixed fee-for-service for the services that we provide. So if it's a specialty drug as an example, there could be more services that a distributor will provide, such as cold chain or special handling for those drugs and will be paid for those services accordingly. So really, the price of the drug or the inflation aspect of that drug does not impact the economics because we're really on a fixed fee-for-service that reflects the fair value of the services that we provide for biopharma.

Okay. Great. In terms of customer contract shifts, I guess there was the recent DoD contract loss. Does that have a material impact on your business? I don't think it got a lot of airtime. But any other recent or upcoming contract dynamics that we should be aware of at this point?

Yes. As we've talked about, renewals are just a normal part of our business. Historically, and I'd say going forward, as we look at this, approximately 1/3 of our book renews in any single year. So this is a normal function of our business. We serve the DoD for a long period of time. We're really proud of the service that we provided them. We think that we provided exceptional service. In this particular case, as we do with all situations, we're very disciplined in our approach to our customers and to the economics within the marketplace. We put together a bid that we thought was very fair and reflective of the services that we provide. We're very disciplined about that. And we're disappointed we didn't win the contract, but it doesn't change our outlook. There's no change to our guidance, and we're going to continue to have a very focused and disciplined approach so we can provide the best service to our customers overall. So again, not reflective of the exceptional service over a long period of time, doesn't change the guidance that we provided in the first quarter.

Okay. Great. On the international divestitures, what's left? Where are we? Norway, there was the PHOENIX group transaction, I think that closed earlier than expected with the implications there. And any sort of impact to financials relative to what you gave us in the most recent quarter?

So the exit of Europe is very consistent with the strategy that I mentioned earlier, which is to rationalize the portfolio. The PHOENIX transaction has not closed yet, is expected to close in the second half of this year. That has about 6 countries involved in that. We still expect that to close second half of this year. Norway will be the 1 country after that, that remains. We still intend to exit Norway. We'll do this in a very thoughtful and planful way. No timing that I can provide at this point, but we do intend to exit Norway as well.

Okay. And then more broadly, can you speak to labor, inflation and fuel supply chain dynamics that are impacting your business? Any sort of changes there on that front and mitigation efforts as well?

Sure. So we've been very focused, as a lot of companies have been, on just overall inflation dynamics. We think about these in 2 broad buckets. And we think about it on the labor side. We've seen some inflationary impacts to McKesson. That happened in the second half of last year. We provided that guidance to you. That was a $0.10 to $0.20 impact in the second half of the year in our North American distribution businesses. There's no incremental labor impact that's in our guidance this year. We incorporated what we thought was going to be a labor pressure, if you will, already into the guidance and no change there. On a supply and freight perspective, we've seen the same impact. I'm sure that most people have. We've been able to mitigate that through a number of efficiencies, and we've also been able to pass on a significant amount of those costs. We have incurred some clearly, but our pricing model inherently has a component in this to account for it, and we've been able to mitigate it. It's not created for us any additional pressure. There's no additional guidance that's necessary to provide on that. What we're seeing in the marketplace today is already incorporated into our guidance.

Great. Okay. And then importantly, on capital deployment. Areas of focus for future investment. Could you comment on that in addition to share repurchases and the recently stepped up dividend as well? Do investments in partnerships, for instance, like the HCA JV, does that -- should that help to explain future partnerships, future deals that you will do? Or is that more of a one-off-type partnership?

That's a great question. So if we think about capital deployment, there are really 3 components or pillars to how we approach this. First of all, the foundation for all of this is just really good cash flow over a long period of time. We've had consistent and stable free cash flow. We really prioritize growth. We want to grow the company. We've focused on 2 strategic growth pillars, one being oncology and the other being biopharma services. And those are areas of higher growth, of higher margin opportunity, but they also support where we have differentiated assets and differentiated capabilities. And so we want to support that, but we're going to be very disciplined about that. It has to be on strategy or advance our current capability that we have, and it has to have a superior financial return to other places where we can deploy capital. We -- secondly, we will look at investing in the business. This is also a component of growth. We've developed a few businesses, Ontada being one. We've developed some products within biopharma services like AMP, which is Access for More Patients. So we'll continue to focus on growth. We're also going to continue to focus on returning capital to our shareholders. We've done that primarily over the last few years through share repurchases. But as you mentioned, we've also been increasing our dividend. We increased our dividend in July, 15%. And as we've talked about, we'll continue to increase dividend in relation to our earnings growth. And so we're very pleased to not only be able to provide 12% to 14% long-term growth target, but also be able to provide increasing dividends along with that. And then the third component of this is just to have a strong, stable foundation and maintaining our investment-grade credit ratings. And we're very pleased with the balance sheet that we have. We think that it provides us good liquidity and capacity to support not only our growth opportunities but returning capital to our shareholders.

And just lastly, in the last minute here, you've really done a great job of simplifying the business. Rationally, the business is a key thing kind of in our discussion today. But are there other areas of focus that you could hone in more on your core competencies? And what's next in that evolution? And what should we be watching out for over the next couple of years here?

Yes. We've been very focused on where do we have differentiation, and that's in oncology and biopharma services. As we've talked about at our Investor Day, we think that they're very big markets. So there's still tremendous opportunities within those markets. And we'll continue to look at ways to create automation and efficiency to advance our business and help our customers in a more efficient manner. So lots of opportunities, but we're well on the way of really building out these growth pillars.

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

Thank you.