This morning Bloomberg Law reported on a handful of recent developments in opioid settlement talks. A group of states is pushing the distributors to add $2.3B to their previous $19.2B settlement offer, which would bring the total settlement to $21.5B - the low end of the $22-$32B range previously discussed (see below). The report provides a some additional interesting details – 1) ~18 states are seeking a larger increase (similar to previous # of holdouts) , 2) local governments also want a larger increase, 3) some plaintiffs’ lawyers are telling clients $21.5B might be the best offer that doesn’t require several more years of litigation, and 4) most states are now looking for a payout over 15 years vs. 18 previously proposed.
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As demonstrated by the Track 1 opioid multidistrict litigation (MDL) case in Ohio, trial start dates are an important catalyst for settlement negotiations. This also appears to have been true for the New York trial, with the latest update (recapped below) coming immediately prior to the originally scheduled start of the trial. New York and West Virginia are the key upcoming trials in the ongoing opioid litigation, and both have been delayed by COVID-19. The New York trial now looks likely to start in September at the earliest, and the West Virginia trial is now scheduled to begin in mid-October.
We have updated our generic drug market tracking files to reflect May data. Overall, generic sales decreased 9.3% y/y in May compared to the 8.1% decrease in April and 8.5% increase in March, which included the pull-forward of prescriptions ahead of COVID-19 social distancing / lockdowns. Interestingly, price deflation intensified in May but was almost entirely driven by inhalant molecule Albuterol – excluding Albuterol, deflationary trends remained modest compared to recent months. So far in Q2 and during Q1 chain store generic acquisition costs declined faster than independent acquisition costs, which implies that distributor margins for independents are expanding. See Slides 3-13 for visuals illustrating the trends discussed below.
Our Accounting & Tax Policy team recently published a report discussing the potential for corporate tax reform with the U.S. government’s budget deficit at a 75+ year high. We expect tax reform and the upcoming presidential election to garner increased attention in the months ahead, and our note discusses the expected impact to our coverage.
We have updated our generic drug market tracking files to reflect April data. Overall, generic sales decreased 8.8% y/y in April compared to the 8.4% increase in March, which included the pull-forward of prescriptions ahead of COVID-19 social distancing / lockdowns. Interestingly, price deflation on mature generics improved to 4% in April from 8% in March and 9% in 1Q20 – it will be important to monitor how sustainable this improvement is as the environment normalizes. So far in Q2 and during Q1 chain store acquisition costs declined faster than independent acquisition costs, which implies that distributor margins for independents are expanding. See Slides 3-13 for visuals illustrating the trends discussed below.
We are upgrading MCK to Outperform from Peer Perform and increasing our year-end target price to $184 from $161 (26% upside). We believe that the core U.S. distribution business will prove resilient as we move from a stay-at-home recession to a more normal recessionary environment, and that disruption to MCK’s other businesses will prove mostly transitory and manageable. MCK is the cheapest stock in the group after adjusting for opioid liability / costs and is now at an all-time low relative valuation despite improving results and fundamentals heading into the crisis. Further, we believe MCK will show the best EPS growth in the group over the next several years as its ability to deploy capital will be less impeded by an opioid settlement than CAH and ABC.
This morning (05/20/20) MCK reported fiscal 4Q20 adjusted EPS of $4.27, above WR/Consensus EPS of $4.12/$4.10. We note that results included a $0.14 1x bonus payment (spread across segments / corp) and $0.09 reserve for bad debt in Med Surg. The upside in the quarter was mostly driven by U.S. Pharma. MCK issued FY21 guidance with adjusted EPS $13.95-$14.75 (-4% y/y at midpoint) vs. consensus of $15.42 (includes handful of stale estimates). MCK notes that guidance reflects COVID-19 impact and investments, and that EPS is expected to grow in the second half of FY21.
This morning CAH reported fiscal 3Q20 adjusted EPS of $1.62, above Wolfe/Consensus EPS of $1.47/$1.45. Medical EBIT drove the beat, with Pharma EBIT roughly in line despite a meaningful top-line benefit from volume pull-forward in March. CAH reiterated EPS guidance of $5.20-$5.40, implying Q4 EPS of $0.79-$0.99 (down ~20% y/y). Pharma EBIT guidance was lowered to MSD % decline vs. LSD % decline previously and Medical EBIT was maintained at LDD % growth.
This morning (05/07/20) ABC reported fiscal 2Q20 adjusted EPS of $2.40, above Wolfe/Consensus EPS of $2.27. EBIT was better than our estimate, primarily driven by upside in Pharma Distribution. ABC lowered fiscal 2020 (9/30 year-end) EPS guidance by 2%, with ABC’s Other segment more impacted than Pharma Distribution. Pending more color on ABC’s guidance assumptions, we expect that the relatively small adjustment to guidance should be well received.
Last night (5/4/20) Reuters reported that ABC has approached WBA about buying WBA’s European pharmaceutical wholesaling division. ABC reportedly is willing to pay $6B for the business, which represents ~11x trailing EBIT and ~13.5x trailing earnings. The article notes that the deal would make it easier for WBA to be taken private and is another signal to us an acquisition of ABC by WBA does not appear likely. While the deal would provide an attractive level of accretion, leverage would increase meaningfully and could be >4x if the ongoing opioid litigation is settled around current expectations. It appears the discussions are still in early stages and “there is no certainty that the two companies will negotiate a deal”, according to the article.
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