Diplomat Pharmacy, Inc. (DPLO) investors took it on the chin in August after the company's management reported second quarter sales that were below forecasts. However, investors might want to focus less on the second quarter miss and more on the company's potential to win a greater share of the important and growing specialty pharmacy market.
Digging into the numbers
Unlike other pharmacies, Diplomat Pharmacy is a pure-play specialty pharmacy that concentrates its efforts on expensive indications, including cancer, which accounts for about 43% of its revenue.
In the second quarter, the company's $1.09 billion in sales may have missed analysts guess-timates, but sales were still up 34.7% year over year. While a lot of that growth was due to acquisitions, the company still delivered organic growth of 23%.
Those are solid numbers, but shares still sold off on worry that volume growth appears anemic, hepatitis C revenue is flattening out, and political pressure could crimp future drug price increases.
While top line prescription volume in the quarter only inched up 3% versus a year ago, that slight increase includes the impact of Diplomat Pharmacy exiting its low-margin compounding business. If you adjust prescription volume to take into account that change, then rising demand in oncology and specialty infusion helped boost volume by 13% compared to last year.
Hepatitis C has undeniably gotten more competitive and that's weighed down pricing in the indication, but hepatitis C accounted for only 15% of the company's 2015 sales, and new drug launches targeting less common genotypes of the disease could invigorate the category. In July, Gilead Sciences launched Epclusa, a $74,500 pan-genotype therapy that's being positioned for use in genotype 2 and genotype 3 patients.
As far as a drag on results from fewer future price increases, there's undeniably a slowing in drug price inflation due to payer pushback this year. However, price inflation is a relatively small driver of Diplomat Pharmacy's growth. A much bigger driver of growth is new specialty drug approvals, and in that respect, the tailwinds have never been stronger.
Last year, the FDA approved 51 drugs, 69% of which were specialty drugs, and 9 of the 10 top-selling medicines were specialty drugs, up from 7 of the top 10 in 2014.
As more specialty drugs win the FDA green light, Diplomat Pharmacy's sales and market share continue to climb. In 2014, Diplomat Pharmacy's owned 2% of a $63 billion market and today it owns 3% of a $98 billion market. Overall, the company's sales have grown by a compounded annual rate of 62% since 2005.
Importantly, the company's inking of limited distribution deals with specialty drugmakers is driving gross profit higher, and that's helping grow EPS. The company pocketed $143 in gross profit per script in 2014, $289 per script in 2015, and they're pocketing $339 per script this year. Limited distribution deals represented 45% of the company's sales last year and thanks to their positive impact on profit, non-GAAP EPS was $0.23 in the second quarter of 2016, up from $0.16 a year ago, and 9.5% better than analysts were hoping for.
There are 3,000 oncology and immunology drugs in development globally and the FDA has committed to speeding up its review process so that more drugs reach the market faster. A quickening of specialty drug research and development and approvals should provide plenty of opportunity for sales growth in the future. The company could also see tailwinds to sales tied to an increasing number of biosimilar approvals. Biosimilars are lower-cost alternatives to higher-price biologics that have lost their patent protection. Brand-name biologics, with an estimated $100 billion in annual sales, are expected to see their patents expire in the next five to 10 years.
This year, the company expects to deliver $4.7 billion in revenue, and given its single-digit market share and these growth drivers, sales could be much higher in a few years. Specialty drug spending is forecast to climb from 15% of total pharmacy spending in 2010 to 44% in 2020. Industry trends could make this stock a winner -- especially if a big pharmacy operator comes knocking on the company's door with an offer to buy. Overall, while growth isn't likely to come in a straight line, I believe shares in this company are worth stashing away for the long-term.