AmerisourceBergen

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

AmerisourceBergen (ABC) is one of the world’s largest pharmaceutical distribution companies, connecting pharmaceutical manufacturers with healthcare providers and patients.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: AmerisourceBergen operates as a global pharmaceutical sourcing and distribution services company. It’s essentially a middleman, streamlining the process of getting pharmaceuticals from manufacturers to healthcare providers (hospitals, pharmacies, etc.). ABC’s operations are split into two main segments:

  1. U.S. Healthcare Solutions: This segment is focused on providing drug distribution and related services within the U.S. healthcare market. It’s a critical link in the US pharmaceutical supply chain.
  2. International Healthcare Solutions: This unit includes the company’s distribution business in other countries, such as Europe and Latin America. It operates in many countries with their own specific healthcare landscape.


Industry Overview and Competitive Landscape: The pharmaceutical distribution industry is characterized by several key features:

  • Highly regulated: The industry is subject to stringent government regulations regarding drug safety and distribution. This creates high barriers to entry for potential new competitors.
  • Scale matters: Given the low margins, achieving scale and operational efficiency are critical for profitability.
  • Consolidation: The industry is relatively consolidated, with a few large players controlling significant market share.
  • Dependence on manufacturers: Distributors are highly dependent on their relationships with pharmaceutical manufacturers.
  • Reliance on healthcare providers: Distributors also need strong connections with providers, who are their main customers.

The competitive landscape is dominated by three large players in the US, namely, AmerisourceBergen, Cardinal Health and McKesson. Competition, for the most part is based on price and service.

In Europe, market position is heavily influenced by relationships and partnerships with large payers such as governments or hospital purchasing groups.


What Makes AmerisourceBergen Different? While primarily a distributor, ABC has diversified its operations, particularly within the U.S. This has given it a few advantages over pure-play distributors:

  • Patient-Support Services: They offer solutions that help patients with disease management and medication adherence.
  • Data and Analytics: They provide analytical services designed to improve the efficiency and outcomes of their provider customers.
  • Speciality Distribution: They have a dedicated focus on distributing specialty pharmaceuticals, which are a high-growth area.
  • Strategic Partnerships: As discussed earlier, they have partnerships with various healthcare stakeholders.


Financial Analysis:

Revenues:

  • AmerisourceBergen is a behemoth and revenue is fairly easy to predict. Revenues are based upon the sales of drugs, where they operate as distributors to hospitals, care facilities and others.
  • The primary revenue driver is their pharmaceutical distribution segment.
  • While acquisitions have added to overall revenue, same store sales also contribute substantially to revenue.
  • In FY22 revenues have increased in International Health Solutions (from $19.18 billion to $24.77 billion), while revenue increases in U.S. Health Solutions (from $217.59 billion to $227.55 billion) have also contributed to the increased growth.

Margins:

  • Distribution businesses typically have low profit margins as companies such as ABC operate as a middleman. Companies, though, try to offset these low profit margins by higher sales volume.
  • The cost of revenue consists primarily of the purchase price of the products the Company sells.
  • In fiscal 2022, gross profit margins grew due to higher margins in branded products.
  • Operating expenses are those involved in general operating procedures of the company.
  • EBIT margins have been under stress from various factors, including wage growth and industry competition.

Earnings:

  • Operating income was around $4.27 billion in fiscal 2022.
  • Net income was around $1.88 billion in fiscal 2022, compared to $0.65 billion in 2021. This increase is primarily driven by increased operating income and improved tax efficiency.
  • Earnings per share grew dramatically in fiscal 2022.


Free cash Flow

  • The company’s free cash flow in FY22 was -1.4 billion mainly due to the increase in working capital because of higher sales.
  • They spend a lot on capital expenditures, but most of it is to maintain the business and the growth does not require excessive capex.

Risks to the Moat and Business Resilience:

While ABC has a reasonable economic moat, there are few key risks that can erode that:

  1. Pricing pressures: Pricing pressure from payers and competition between companies can negatively affect margins. Additionally, any government intervention to control drug pricing could hurt all companies in the industry.
  2. Loss of contracts: Contracts with large manufacturers are usually reviewed every three years. Loss of contracts from those can be severe.
  3. Regulatory changes: Any changes in the healthcare regulations can negatively affect distribution and profits.
  4. Acquisition risk: Many of their earnings growth can come from large acquisitions. In such a scenario, acquisition related risks like overpaying, integrating culture, etc, may come into play.
  5. Disruption from vertical integration: If hospitals or manufacturers become more vertically integrated and cut out distributors, this could pose a substantial threat.

However, ABC is also a crucial partner in the healthcare ecosystem, and its diverse segments should buffer against many of the risks in its operations.

Moat Rating: 3/5 I’m giving it a moderate moat rating. Here is the reasoning:

  • Intangible assets : they possess a very strong brand, which attracts clients to form partnerships.
  • Switching costs: The pharmaceutical supply chain is an essential operation, and it requires seamless delivery of drugs, which is not easy to replicate with new entrants.
  • Network effects: In the drug distribution space, having a large network offers great benefits, including lower costs, and better and faster deliveries.

However, pricing pressure is a looming threat, especially due to the company’s contractual based revenues, and that it faces risk from disruption. This makes their moat only moderate, not very wide.


Understandability: 3/5 The basic idea of what the company does is easy to grasp: they are a middleman. However, the nuances in the pharmaceutical supply chain, relationships with manufacturers and payers, and their operational complexity makes the business more difficult to fully understand. Their financial statements are relatively complicated due to acquisitions and complex accounting practices, such as pro-forma adjustments, various tax jurisdictions, etc., making the process slightly more difficult.


Balance Sheet Health: 4 / 5 ABC has a relatively strong balance sheet. They do have a considerable amount of debt (mainly to take advantage of low interest rates) but this is not really a concern as they have relatively stable revenue which they can allocate to repay that debt. However, the debt does have a negative effect on their earnings, but they can generate enough operating cash flows to satisfy its debt.

  • Assets are mainly driven by inventory and receivables.
  • Shareholders’ equity is around 23% of total capital.
  • They do have a significant liability in terms of accounts payable which is a natural byproduct of their industry.


Recent Developments / Controversies / Problems:

  • ABC acquired PharmaLex, a leading international pharmaceutical service company to build its global capabilities in the first quarter of 2023. They are also expanding in other areas such as cell and gene therapy logistics. This has increased revenue but also some acquisition related expenses.
  • In May 2023, they did a stock split which has not increased or decreased their business fundamentals.
  • They have faced criticism in the past regarding the role of distributors in the opioid crisis, but they have recently taken a more active role in tackling this issue. For example, in the most recent earnings call, the CEO mentioned that “the Company is working closely with our healthcare partners to advance safe use and appropriate prescribing practices, and prevent opioid misuse, abuse, and diversion”.