Two of the biggest drug distributors --
-- need to prove they can deliver more than drugs.
They need to crank out a solid quarter to offer worried investors the reassurance that competitor
has so far failed to provide. The companies have spent the past year struggling to adopt a dramatic new business model that promises more stability but, in the meantime, has left them posting lackluster results. Late last month, Cardinal suggested that the industry's pain could linger for a while when it cut back on its own projections for 2006.
Goldman Sachs analyst Christopher McFadden is now bracing for a possible disappointment from AmerisourceBergen as well. On Monday, in fact, McFadden recommended that AmerisourceBergen shareholders buy put options to hedge against an expected drop in the stock.
McFadden offered multiple reasons for his bearish advice. For starters, he said, the stock's near-term moves will likely be tied less to third-quarter results -- which he expects to fall a penny shy of Wall Street expectations -- than to the "credibility" of the company's 2006 outlook. Already, skeptics have begun to question Cardinal's targets.
The company, in fact, found itself challenged almost as soon as it presented its future goals in a special presentation last month.
Cardinal has "put together a very powerful overview of the business with some outlooks," one analyst noted. "Unfortunately, when we strike on some of the past analyst meetings, those projections and predictions have not uniformly come to
pass. ... What gives you a higher level of confidence that the outlook you and your team are putting forth today will meet the objective you are setting?"
Cardinal's management tried to explain. It blamed the problems of the past two years on "execution issues" involving "purely inadequate management" that has since been replaced. Moreover, it said that it has "really devoted a lot of time to dig deep" into changing aspects of the industry and, as a result, now sees "a lot less risk" in its expectations for the future.
Nevertheless, McFadden maintains a mere in-line rating on the stock. And he's even more downbeat on AmerisourceBergen.
He points to disappointing news from the first company as a reason for his negative view on the second. Specifically, he says that Cardinal's reduced earnings guidance has kept him feeling cautious about the industry's transition to so-called fee-for-service agreements in 2006. Going forward, drug companies hope to make money from the services they provide, rather than banking on drug price increases. But some question whether the revised strategy will take off according to industry plans.
McFadden, at least, questions whether AmerisourceBergen can achieve its historical returns on capital going forward. In the meantime, he believes that AmerisourceBergen's stock is already "mismatched" to the company's outlook. He, therefore, has an underperform rating on the shares.
Lehman Brothers analyst Lawrence Marsh is somewhat more upbeat. On the same day that McFadden published his bearish report, in fact, Marsh raised his price target on AmerisourceBergen from $64 to $70 a share in anticipation of the company's latest quarterly results. Marsh expects the company to deliver third-quarter profits of 87 cents a share that, while down sharply from $1.02 a year ago, would beat the consensus estimate by a penny. He has an equal-weight rating on the stock.
Shares of AmerisourceBergen inched up 5 cents to $70.10 on Wednesday, topping Marsh's target price, and have rocketed more than 30% in a year.
Raising the Bar
Marsh recently raised his expectations for McKesson as well.
His new profit projection for the June quarter, while still below the consensus estimate of 53 cents a share, is now up two pennies to 50 cents. He also raised his full-year profit estimate by 3 cents to $2.33 a share in a move that put him ahead of others on the Street.
Marsh suggests that price inflation will push drug profits higher for the quarter. And he believes that a $1 billion share repurchase program will further lift results for the entire year.
Looking ahead, Marsh feels optimistic about an apparent new business win -- representing more than $1 billion in annual revenue -- as well.
"It sounds as if McKesson has been awarded the Publix business, starting either later this year or early in 2006, as we understand it," wrote Marsh, who has an equal-weight rating on the company's stock. And "Publix Super Markets, based in Lakeland, Fla., is defined as the largest and fastest-growing employee-owned supermarket chain in the United States."
Marsh calls Publix a "bouncing ball" account, won first by AmerisourceBergen and then by Cardinal and now in the hands of McKesson. He expects the new contract to offset some of the $4 billion-plus in business McKesson has recently lost.
Just after Marsh issued his comments, McKesson announced plans for an acquisition that will increase its business as well. McKesson is snatching up D&K Healthcare in a $475 million deal that, Marsh estimates, will boost the company's independent pharmacy revenues by more than 30% to some $12 billion.
"And we note that D&K has seen revenues from independent pharmacies increase substantially over the past couple of years," he adds.
Going forward, Marsh expects the acquisition to add at least 4 cents a share -- and potentially four times that amount -- to McKesson's annual earnings. With a little help from its new purchase, Marsh estimates, McKesson should be able to increase yearly profits from $2.33 in 2006 to $2.70 in 2007. Wall Street continues to look for a few cents less.
Shares of McKesson rose 40 cents to $45.95 on Wednesday, adding to a 42% gain over the past year.