AmerisourceBergen (NYSE:ABC) is a pharmaceutical company that operates in the downstream business of drug distribution. The company has gained a solid reputation over the years as a great long-term value investment. AmerisourceBergen's stock has, however, been rapidly building another reputation of late -- this time as a growth stock.
AmerisourceBergen's 10.81% yearly revenue growth is almost double the industry average of 5.51%. The company's 7.72% expected revenue growth is also considerably higher than the industry average of 5.86%. The drug distribution business is quite naturally not geared for high revenue growth, but, rather, slow but steady returns. AmerisourceBergen is, however, now proving that high growth is quite possible in the industry. The company's recent deal with Walgreen (NASDAQ:WBA) should accelerate its revenue growth to a whopping 30% in 2014.
AmerisourceBergen together with its two archrivals, McKesson (NYSE:MCK) and Cardinal Health (NYSE:CAH), are responsible for the distribution of more than 90% of the $325 billion-a-year prescription drugs in the U.S. These companies act as middlemen between drug manufacturers and end distributors such as hospitals, doctors, pharmacies and so on, distributing both brand name as well as generic drugs.
The sheer volume handled by these behemoths helps them create significant value for consumers, by negotiating lower prices with drug manufacturers, and then passing on the benefits to the end users.
Consolidation changes the name of the game
AmerisourceBergen signed a huge 10-year agreement worth $400 billion in March this year with drug store Walgreen. The company became Walgreen's official distributor on Sept. 1, thus ending Walgreen's relationship with Cardinal Health. Walgreen invested a 45% stake in Alliance Boots, a drug, health and beauty products retailer in 2012. Walgreen's alliance with Alliance Boots gives the two pharmacy chains a 7% stake in AmerisourceBergen, with an additional option of up to 23%.
Walgreen was quick to learn a vital lesson from its 2011 showdown with the leading Pharmacy Benefit Manager, Express Scripts, after Walgreen CEO Wasson was forced to acquiesce to Express Script's terms. Despite its extensive 8000-plus store network, Walgreen simply wasn't big enough to trade punches with a PBM of Express Scripts' size.Express Scripts handles more than a billion customer prescriptions per year.
Walgreen has since then moved fast to take the other side of the play by building scale. Walgreen is not the only company trying to gain some heft. Other hospital chains are busy bulking up through acquisition, as physicians groups merge and join forces with hospitals. Investors can expect even more deal-making in the space, as more firms start appreciating the critical importance of size in the drug distribution business.
Benefits of the deal
The deal is hugely significant to both Walgreen and AmerisourceBergen in a number of ways. The agreement is expected to boost AmerisourceBergen's sales by a whopping $25 billion next year alone, about 30% of its annual sales. The firm now has a chance to expand rapidly, after gaining access to Alliance Boots' 11,000 European stores located across 21 countries. AmerisourceBergen will also gain access to Alliance Boots' generic as well as other more expensive branded medicines.
The agreement provides a multiyear run of predictable sales for AmerisourceBergen. The firm usually faces stiff competition from better-heeled rivals Cardinal Health and McKesson, and the risk increases considerably when its contracts expire and it has to renew them. With the Walgreen deal, AmerisourceBergen now has close to 30% of its annual sales covered for the next ten years, and this removes a big competitive risk element from the picture.
AmerisourceBergen derives about 80% of its revenues from the low-margins drug distribution business. The company, therefore, relies heavily on volume sales, and the Walgreen agreement will no doubt be a hugely beneficial in growing its sales volumes.
Walgreen will of course be only too happy to avoid a repeat of the Express Scripts fiasco, since it now has the scale to throw its weight around and make its presence felt. Its huge volume purchases from AmerisourceBergen will boost asset utilization and its profitability. Suppliers might be forced to lower their prices leading to lower wholesale costs for Walgreen.
With the deal, Walgreen will be better able to access specialized drugs such as popular cancer medicine and expensive injectable drugs since AmerisourceBergen trucks will now arrive at Walgreen's more than 8,000 stores daily, rather than the previous weekly arrangement the firm had with Cardinal Health.
The deal is also widely seen as a hedge against the United States Government's rapidly growing position as the country's largest buyer of prescription drugs. The Affordable Care Act, aka Obamacare, will help to further cement U.S.' status as a leading buyer of medical-care services.
Many analysts expect Walgreen's rivals such as CVS Caremark to take a cue from the AmerisourceBergen/Walgreen deal and attempt their own distribution arrangements as well. But Walgreen and Alliance Boots are confident that their alliance, hailed as the largest drug distribution deal in the world, will give them a leg up their competition for a few years at the very least.
Although AmerisourceBergen is already experiencing some degree of margin compression due to the Walgreen deal, the benefits thereafter will more than offset the short-term costs. The deal provides the company with a good hedge against its competitors, grow its revenues rapidly, and a great way to access the European market. Investors who are spooked by the effects of Obamacare, but would still love to gain exposure to the health care industry, should definitely consider AmerisourceBergen.
Fool contributor Anthony Maina has no position in any stocks mentioned. The Motley Fool recommends McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.