This morning the WSJ reported that more than 20 states have rejected an opioid litigation settlement framework that would have led to the distributors paying out $18B over 18 years. Instead the group of dissenting states have asked that distributors contribute $22-$32B. There was nothing in the report on whether the requested payment timeframe has changed. We note that the $27B midpoint of the new “ask” is only modestly worse than the $25B we assume in our target prices, which is generally consistent with our view of investors’ line of demarcation here before today’s news – meaning that any settlement less than this amount would be viewed positively.
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Last week CAH reported fiscal Q2 EPS that was well above expectations and raised EPS guidance by ~6.5% to $5.20-$5.40. Both Pharma and Medical results were above our estimates. The revised guidance also appears to now imbed a significant amount of conservatism in the Medical segment for the second half related to potential disruption from the ongoing recall of surgical gowns and impacted kits, which could allow for CAH to outperform guidance if not entirely warranted. While results are clearly improving for CAH it is unclear to what degree core Pharma growth can be sustained into next year, and we continue to believe ABC and MCK will deliver better earnings growth over the long-term and be less cash-constrained post opioid settlement and thus deserve a higher multiple. Our 2020 EPS moves to $5.40, and our target price increases to $57 from $42.
This morning (02/06/20) CAH reported fiscal 2Q20 adjusted EPS of $1.52, well above Wolfe/Consensus EPS of $1.22/$1.23. Operating income increased 12% q/q vs. guidance last quarter for “modestly lower than Q1” and thus was 16% above our estimate. Both Pharma and Medical EBIT came in ahead of our ests. CAH increased EPS guidance by $0.32 (6.4%) to $5.20-$5.40. Roughly $0.09 (+1.8%) comes from lower interest expense / other income, with the remaining $0.23 (+4.6%) operational. Pharma EBIT growth is now expected to decline LSD % for fiscal 2020 vs. decline HSD/LDD % previously. We note that from our conversations with investors following the JPM Healthcare Conference, a guidance raise was fully anticipated although the magnitude of the raise is likely better.
This morning (2/4/20) MCK reported 3Q20 EPS that exceeded expectations, with upside vs. our model primarily driven by Corporate and Europe. The guidance raise at the JPM Healthcare Conference now looks like it was primarily driven by Q3 results, with implied guidance for Q4 appearing somewhat conservative particularly for U.S. Pharma and Med-Surg. Momentum is strong across most of MCK’s businesses at present and from here we expect stock performance to primarily driven by the sustainability of U.S. Pharma profit growth in fiscal 2021. Our 2020 EPS increases to $14.80 from $14.70 previously, the high end of MCK’s $14.60-$14.80 guidance. Our forward estimates don’t change much coming out of the quarter given that for now we are not flowing the entire lower Corporate expense in fiscal 2020 through.
This morning (2/4/20) MCK reported fiscal 3Q20 adjusted EPS of $3.81, above WR/Consensus EPS of $3.56/$3.50. We note that not all consensus estimates have been updated following MCK’s 1/13/20 $0.40 guidance raise. We had spread the raise relatively evenly between Q3 and Q4 when we updated our model, but it appears the raise was primarily reflective of Q3 upside – by comparison, consensus EPS was $3.39 at year-end. Our estimates are still under review, but this could potentially indicate some conservatism to implied Q4 guidance. Compared to our revised model, upside in Corporate and Europe drove the beat. MCK reiterated fiscal 2020 EPS guide of $14.60-$14.80.
Ahead of MCK’s fiscal Q3 earnings this morning (2/4/20), Change Healthcare (CHNG, not covered) filed an S-4 registration statement that indicates “following the Internal Reorganization, SpinCo will consummate a split-off followed, if necessary, by a spin-off”. We are still reviewing the S-4 and expect MCK will provide additional details today.
We have updated our generic drug market tracking files to reflect December data. Overall, generic sales decreased 2.4% y/y in December. The December decrease was worse than November, driven by pricing – with volumes basically flat in both months. Interestingly, our tracking indicates that the rate of deflation on mature drugs picked up in December – with chain stores appearing to drive the change. While this is somewhat surprising after several months of relative stability, we have not been able to identify any obvious anomalies or extreme outliers within the data. Following November’s data release our analysis suggested modest pressure on margins for independent pharmacy customers in calendar Q4, but inclusive of December the data now suggests independent acquisition costs and chain store acquisition costs declined by comparable amounts. See Slides 3-10 for visuals illustrating the trends discussed below.
Last week (1/30/20) ABC reported Q1 EPS that was above expectations, driven by upside in U.S. Pharma relative to our model. ABC increased FY20 EPS guidance by 3%, with almost all of the increase explained by PharMEDium and share repurchase. ABC announced it had made the difficult decision to shut down the PharMEDium business due to ongoing regulatory and operational issues. While numbers go up on this move given that losses will now be removed from adjusted earnings, this is clearly a disappointing outcome relative to potentially selling the business (acquired for $2.6B in 2015) or returning it to profitability, although the company will receive a $500-$600M tax benefit over the next few years. While the quarter was solid in absolute terms, expectations had increased following the generally positive tone from the distributors at the JPM Healthcare Conference. Our estimates increase primarily due to PharMEDium and share repurchase assumptions, with our target price of $88 unchanged.
This morning (01/30/20) ABC reported fiscal 1Q20 adjusted EPS of $1.76, above Wolfe/Consensus EPS of $1.67. EBIT was better than our est, driven by margin upside in U.S. Pharma. ABC increased adjusted EPS guidance to $7.55-$7.80 (+3%), which appears to be primarily driven by the company’s decision to exit the unprofitable PharMEDium compounding business but also positively influenced by Q1 results and a modestly lower share count assumption. The benefit from the removal of PharMEDium losses will benefit results starting in Q2, leaving Q1 upside operational in nature. Stronger than expected results will likely be well-received and are generally consistent with the positive tone from the distributors at the JPM conference earlier this month.
Yesterday (1/27/20) a status conference was held for the Track 2 bellwether case of the ongoing opioid multidistrict litigation (MDL). Recall that the Track 2 bellwether case consists of Huntington, WV and Cabell County’s cases against ABC, CAH, and MCK. From status briefs filed last week, the plaintiffs and defendants were more than a year apart in their thinking on when a trial could realistically start – with plaintiffs arguing for March 2020 and defendants arguing that any time before the summer of 2021 “would be rushed”. According to a local news report, U.S. District Judge David Faber pushed back fairly hard against the defendant’s proposed timeline: “You asked for 18 months? I’m not inclined to give you anything close to 18 months”. Judge Faber stopped short of setting a trial date and instead scheduled another status hearing in March. We suspect the ultimate timing will end up splitting the difference, leaving the trial to start in Q3 or Q4 of 2020.
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