We are lowering our distributor target prices to reflect a worse than previously contemplated opioid litigation settlement. While there has been significant news flow for opioid manufacturers over the past several weeks, we continue to see the Bloomberg report from early August on distributor negotiations with state attorneys general ($10B opening offer made by distributors, $45B demand from AGs) as the best data point from which to start thinking about exposure. If that report is credible, it would seem to suggest $15B as a more reasonable settlement “floor”. We now explicitly assume a $20B total headline settlement for the distributors, with a NPV approximately 2/3 that amount after considering potential offsets.
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Late this evening (9/11/19) Judge Polster of the U.S. District Court for the Northern District of Ohio certified the creation of a nationwide negotiation class in the ongoing opioid multidistrict litigation (MDL). As discussed below, the creation of the negotiation class could potentially make it easier to arrive at a global settlement. We are not surprised given Polster’s apparent support for the idea in an early August hearing and more recently a supportive brief filed this week by one of the special masters in the case tasked with evaluating the proposal. Clearly this gives local governments more leverage in negotiations to reach a global settlement, but it could also complicate discussions further given a clear desire by state attorneys general to control the process – 37 states the District of Columbia objected to the proposal. We note that the state cases against opioid defendants remain outside of both the MDL and the negotiation class.
We have updated our generic drug market tracking files to reflect July data. Overall, generic sales increased 3.7% y/y in July – an acceleration from recent trend that was partly driven by a pickup in y/y volume growth. Deflation has remained quite stable. Our analysis now suggests stable margins for independent pharmacy customers in July vs. modest margin pressure in calendar Q2. See pages 2-5 for visuals illustrating the trends discussed below.
Today (8/26/19) after market close an Oklahoma judge ordered Johnson & Johnson (JNJ) to pay the state $572M following a bench trial in the state’s lawsuit against opioid manufacturers. The judgment is available here. JNJ has already said that it will appeal. Importantly, we note that the $572M payment is “the sum necessary to carry out the Abatement Plan in year one”. While witnesses testified that abatement will take at least 20 years, the state did not present sufficient evidence of the amount of time and cost necessary beyond year one. It is unclear to us whether this leaves the door open to additional payments in future periods. See Page 2 for the excerpt. Recall that Purdue Pharma ($270M) and Teva ($85M) reached settlements in this lawsuit before going to trial. If $572M is the total JNJ payment amount, we see the outcome as better than expected / feared. However as discussed below, we note that extrapolating nationally and considering both state and local government lawsuits woul
On Thursday (8/8/19) CAH reported fiscal 4Q19 results that were above estimates / guidance and issued fiscal 2020 guidance. EPS guidance was generally in line with our estimate and buy-side expectations but was below consensus. Following guidance and the earnings call our estimates change only slightly, and our expectation is that we will be generally in line with consensus over the next couple of years once consensus is fully updated. With our thesis on 2020 #s having largely played out, the rationale for an Underperform rating is now increasingly predicated on CAH’s higher relative exposure to opioid litigation and a relatively greater potential EPS growth headwind from reduced share repurchase post settlement. We maintain our year-end 2020 target price of $47.
This morning (8/8/19) CAH reported fiscal 4Q19 adjusted EPS of $1.11, above Wolfe/Consensus EPS of $0.95/$0.93. Operating income was 1% above our est, with EPS favorability driven by lower interest expense and tax rate. Segment results deviated widely from prior full-year guidance – with Pharma significantly exceeding our est and Medical significantly below. CAH issued fiscal 2020 EPS guidance of $4.85-$5.10, in line with our $4.97 est but below consensus of $5.09. As we mentioned earlier this week, our sense is that buy-side expectations were $4.75-$5.00. On that basis guidance is slightly better, but may be somewhat offset by concerns around the degree of apparent forecasting error in Q4.
This morning (8/6/19) Bloomberg reported that ABC, CAH, and MCK have been engaged in settlement discussions with a group of state Attorney Generals and have proposed paying $10B to settle claims related to the companies’ role in the opioid crisis. Given this news we are updating a scenario analysis we believe is helpful to frame a range of potential outcomes for the group given uncertainty around potential opioid liability and earnings power. Starting with our estimates, the scenario analysis allows the user to make revisions to each company’s earnings base by segment as well as input assumptions on potential opioid liability. We then show the return implied by each permutation of earnings and opioid liability scenarios across a range of "core" multiples for both P/E and EV / EBIT.
This morning (8/6/19) Bloomberg reported that ABC, CAH, and MCK have been engaged in settlement discussions with a group of state Attorney Generals and have proposed paying $10B to settle claims related to the companies’ role in the opioid crisis. The report says that the state Attorney Generals countered with a demand for $45B, with the settlement paid out over “decades”. It is unclear whether the proposed settlement is meant to also resolve the cases brought by cities and counties that currently make up the ongoing opioid multidistrict litigation (MDL), but given the size of the settlement being discussed we would assume the goal of the discussions is a global settlement. While we don’t see the $10B proposal as significantly different than buy-side expectations (although expectations vary widely), the magnitude of the $45B counterproposal is clearly causing weakness in the stocks today.
We are downgrading MCK to Peer Perform from Outperform, driven primarily by MCK’s outperformance since our 4/1/19 launch. Continued signs of stabilization in MCK’s U.S. Pharma results have driven an improvement in relative valuation to near-parity with ABC on an EV / EBIT basis. Given ABC’s historical valuation premium vs. MCK/CAH, which we think is justified, we believe it will be harder for MCK to outperform from current levels. We maintain our Market Weight on the Distributors group.
This afternoon MCK reported fiscal 1Q20 adjusted EPS of $3.31, above Wolfe/Consensus EPS of $2.94/$3.03. The beat was driven by U.S. Pharma, Other/Change HC, and Corporate costs, partially offset by weaker results in Europe. MCK increased fiscal 2020 EPS guidance by $0.15 to $14.00-$14.60.
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