We have updated our generic drug market tracking files to reflect February data. Overall, generic sales decreased 1.7% y/y in February compared to the 2.7% increase in January, with lower volume growth more than offsetting moderating deflation. Deflation on mature generics improved for the second consecutive month following the higher rate of price deflation that we noted with the December data, possibly driven by COVID-19 disruption and / or stocking activities. So far in Q1 our data suggests chain store acquisition costs have declined faster than independent pharmacy acquisition costs, which implies that distributor margins for independents are expanding.
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Given the highly uncertain outlook for earnings and cash flow this year as a result of COVID-19, we wanted to assess each company’s comfort level vs. financial covenants where applicable and benchmark liquidity vs. recent cash flows. In short, liquidity is 2-3x annual cash flow and the CROs average a ~45% EBITDA buffer vs. covenants.
Distributors have outperformed the S&P 500 by 6% since the equity market sell-off kicked off on 2/24/10 but have underperformed the XLV by 2%. ABC has outperformed the XLV by 5%, while CAH and MCK have unperformed by 5% and 6%, respectively. We see ABC’s outperformance as a function of having the lowest leverage in the group and also the most exposure to the core U.S. Pharma distribution business. As we looked back at prescription trends during the financial crisis, we were surprised to see how well total prescriptions held up – total prescriptions never declined on a quarterly basis during 2008, 2009, or 2010. While the uncertainty introduced by COVID-19 is a completely different challenge vs. the financial crisis, we would expect prescription trends to hold up much better than other areas of health care utilization – likely boding well for distributors over at least the next couple of quarters.
On Friday (3/13/20) the New York Times provided an update on opioid settlement negotiations. The disagreement among state attorneys general continues, but the article included some notable details on potential settlement structure and the issues holding up the local governments from reaching a settlement. Based on a deal proposal outline obtained by NYT, distributors would only pay out 55% of settlement % until a state can confirm that its local govts are on board with the deal – this structure is referred to as a “cramdown”. Interestingly, Paul Hanley (a lead MDL attorney) suggested that the proposed payment amount of $19.2B would be acceptable “if it were paid over one, two or three years. But over a generation is too little, too long.”
We are updating our MCK estimates to reflect the split-off of the company’s investment in Change Healthcare (CHNG, not covered). Our adjusted net income estimates are unchanged beyond removing the Change Healthcare equity income, which is already after-tax. We note that our CFO / FCF estimates are entirely unchanged given that there has not been any cash inflow to MCK from Change Healthcare equivalent to the equity income – it is entirely a non-cash income statement item. As MCK’s market cap moves lower post the share count reduction, FCF yield will improve by approximately 120bps. Our fiscal 2021 EPS estimate decreases by 0.7% to $15.77, but our fiscal 2022 estimate increases by 0.4% to $16.94 as we lower the assumed share price for MCK repurchases to reflect the recent sell-off. See Exhibit 1 on Page 2 for a summary of the changes.
Early this afternoon (03/10/20) Law360 reported that the upcoming New York opioid trial scheduled to start on 3/20 will now be delayed as a result of COVID-19. A status conference has been scheduled for 4/14 to see if a trial can begin shortly after that time. Recall that last week a New York appeals court rejected a request (unrelated to COVID-19) from various drug industry defendants including distributors to delay the trial. This trial combines cases brough by the New York attorney general, Nassau County (NY), and Suffolk County (NY). While the ongoing COVID-19 situation may also limit the opportunity for key stakeholders to come together and negotiate, this delay does in theory provide some additional time to continue discussions around reaching a global settlement ahead of the trial. However, we continue to see reaching a settlement specific to these plaintiffs as more likely than reaching a global settlement given 1) ongoing disagreements among state attorneys general and 2) discord between state AGs and local government plaintiffs. We note that we have not seen any reports or comments indicating NY AG Letitia James’ willingness to settle the case.
Yesterday a trial date was set for the opioid multidistrict litigation (MDL) Track 2 bellwether case in West Virginia following a status conference. Recall that the Track 2 bellwether case consists of Huntington, WV and Cabell County’s cases against ABC, CAH, and MCK. The trial is scheduled to begin on 8/31. Both the plaintiffs and defendants will have 6 weeks to present their cases, and inclusive of breaks in the schedule the case would run through the week of 12/14. Plaintiffs wanted the trial to start almost immediately, the and defendants had argued that a trial before the summer of 2021 “would be rushed”.
Last night (03/04/20) Reuters reported that a New York appeals court rejected a request from various drug industry defendants including distributors to delay an upcoming opioid trial. This trial combines cases brough by the New York attorney general, Nassau County (NY), and Suffolk County (NY). The trial is scheduled to begin on 3/20 and now appears likely to do so absent a settlement. At this point we think reaching a settlement specific to these plaintiffs before trial start is much more likely than reaching a global settlement given 1) ongoing disagreements among state attorneys general and 2) discord between state AGs and local government plaintiffs. We note that we have not seen any reports or comments indicating NY AG Letitia James’ willingness to settle the case.
We have updated our generic drug market tracking files to reflect January data. Overall, generic sales increased 2.0% y/y in January. Both volume and pricing improved relative to December trends, although we note that the higher rate of price deflation on mature drugs that we noted with the December data only appears to have moderated slightly in January. For the second consecutive month, our data suggests chain store acquisition costs have declined marginally faster than independent pharmacy acquisition costs, which implies that distributor margins for independents are expanding modestly. See Slides 3-10 for visuals illustrating the trends discussed below.
Yesterday (3/1/20) The Herald-Dispatch (WV) reported that plaintiffs lawyers have proposed a $1.25B “take it or leave it” settlement across all opioid defendants to resolve local government cases, paid immediately. The news follows recent pushback from >20 state AGs against the global settlement framework proposed by a group of 4 state AGs in October that would have seen the distributors pay $18B over 18 years. West Virginia was particularly opposed to that framework because it would have treated WV local govt lawsuits to have been resolved by the distributors’ previous settlements with the state, meaning that WV would have received very little incremental settlement $. WV’s AG would be able to pursue state settlements for companies that have not already settled that would be incremental to the $1.25B.
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