Amerisource Stung by Cutback

A major industry transition continues to cause painful side effects for AmerisourceBergen (ABC).

With inventories -- and the profits they once generated -- falling, the drug distributor foresees a "difficult" year that will leave results far below Wall Street expectations. The company warned on Monday that inventory levels could plunge by roughly $1 billion, or 20%, this year and drag earnings down with them.

"We expected ABC to cut guidance," wrote Baird analyst Eric Coldwell, who has an outperform rating on the stock. "But the cut was worse than expected."

AmerisourceBergen slashed its full-year profit forecast from between $4 and $4.10 a share to between $3.10 and $3.50 a share. It also issued preliminary 2006 guidance that fell short of expectations.

Still, the company continued to portray 2006 -- and the years that follow -- as quite promising.

"We are very disappointed in our earnings performance during this tough transition year," admitted CEO David Yost. But "as difficult as this fiscal year is, I remain optimistic about fiscal 2006 and beyond."

Industry Shift

For now, however, a shift away from huge inventories -- which historically allowed distributors to profit when drug prices rose -- continues to hurt results.

In the past, drug distributors would often stock up their inventories ahead of seasonal price increases and then profit by selling the drugs at the higher rates. But some critics felt the practice, known as "speculative buying," actually fueled the regular growth in drug prices. So the entire industry has shifted to a straight "fee-for-service" strategy, charging manufacturers a set fee for delivering drugs instead.

In the end, AmerisourceBergen believes the current sacrifices will pay off. Specifically, the company says the change will bring "more stable and predictable operating margins" while lowering its capital requirements. Indeed, the company has already seen its cash picture improve during the transition period.