Labor Will Be Less of a Drag on Drugstores
Pharmacist-wage inflation has been a meaningful earnings headwind for drugstores over the past decade, but structural changes in the labor market should provide significant relief going forward.
Our proprietary analysis suggests that pharmacy-wage growth should sharply decelerate and could flatline in the near future, allowing the drugstores to better leverage selling, general and administrative costs (SG&A) and accelerate earnings growth. We believe this benefit is largely underappreciated by the market and represents another reason to be positive on the group. We maintain our Outperform rating on Walgreen (ticker: WAG) and CVS Caremark (CVS).
Pharmacy-labor inflation has been a large earnings drag for drugstores. We estimate that mid-single-digit inflation in pharmacist wages over the last decade has stolen 5% to 7% of earnings growth annually from the drugstore industry, including a 2010 earnings-per-share hit of 13 cents (6%) at Walgreen, seven cents (3%) at CVS, and 10% to Rite Aid’s (RAD) earnings before interest, taxes, depreciation and amortization (Ebitda). Investors may be surprised to learn that pharmacy labor represents the largest operating expense for a drugstore at 35% to 40% of SG&A. Rapid inflation in wages has been driven by a shortage of qualified pharmacists, a period of aggressive pharmacy-counter expansion, and historically strong script growth.
The supply/demand dynamic of the pharmacist labor market is undergoing a major change, in our view, as the number of graduates is poised to sharply accelerate as pharmacy-counter growth slows and companies roll out productivity initiatives. We believe pharmacy labor-cost inflation will decelerate and could even flatline in the near future through various cost-containment initiatives, which should result in a deceleration in overall expense growth and a higher incremental margin on sales growth.
We believe the drugstore industry currently represents one of the most compelling sectors in the consumer landscape. It has a unique industry catalyst in the generic wave, positive leverage to product-cost inflation due to the channel’s price inelasticity, insulation from rising gas prices, and now an improving labor-cost outlook. Company-specific turnarounds at Walgreen and CVS provide additional upside opportunity.
We are raising target prices for Walgreen and CVS. We believe both stocks still have 15%-plus upside despite recent appreciation. We raised our target price to $51 from $46 on Walgreen and to $44 from $42 on CVS.
Research-Based Pharmaceutical Industry Presentation in Geneva
As one of the 189 nongovernmental organizations (NGOs) in official relations with the World Health Organization (WHO), and in line with WHO principles governing relations with NGOs, representatives of the International Federation of Pharmaceutical Manufacturers & Associations (IFPMA) will be present to listen to the proceedings of the 64th World Health Assembly (WHA).
The IFPMA will follow with particular interest decisions made by member governments on global health challenges directly involving the research-based pharmaceutical industry, such as pandemic influenza preparedness and fake medical products. The IFPMA will be taking particular note of the outcome of the World Health Assembly’s discussions on the health related Millennium Development Goals (MDGs) and non communicable diseases (NCDs); as both demonstrate the need for global leadership and partnerships. The federation will also be interested in discussions on specific disease areas such as HIV/AIDS, malaria, and cholera.
The World Health Assembly agenda includes a review of the report of the WHO Open-Ended Working Group of Member States on Pandemic Influenza Preparedness (OEWG/PIP) which scopes out a global system to prepare for future pandemics. Recognizing a shared responsibility to help secure the world against future pandemic influenza outbreaks, the research-based pharmaceutical industry has engaged constructively in the OEWG/PIP process and stands by the collaborative commitments it has made to address this challenge. The Assembly will also consider the report by an external panel to review the “Implementation of the International Health Regulations (2005)” and the response to the 2009 H1N1 pandemic. The findings of the report and its recommendations together with the OEWG report represent an important basis to prepare and fight future pandemics and underscore the essential need for close collaboration between many different stakeholders.
The issue of substandard/spurious/falsely-labelled/falsified/counterfeit medical products is on the WHA agenda. The WHO has a crucial leadership role to play in helping to ensure that medicines everywhere are of high quality, safe and efficacious, and that they are also what they purport to be. The IFPMA supports the global effort to secure high quality medicines, and also hopes there will soon be consensus around priorities on fake medical products. The IFPMA’s “Ten Principles on Counterfeit Medicines” are based on the belief that the production and distribution of deliberately falsified medicines are an important threat to patients’ health and a serious global crime which calls for a global course of action to be taken.
The IFPMA believes this 64th WHA is an important milestone in shaping the global approach that seeks to address the millions of deaths that are caused every year by non communicable diseases — 14 million of which are premature and could be averted or delayed. Given the sheer enormity of the challenge, in particular in low income and emerging countries, the approach needs to involve not only governments but also the private sector, nongovernmental organizations and each of us as individuals. Governments can have a direct impact by introducing or reinforcing fiscal and legislative measures to discourage, for example, the use of tobacco, by imposing restrictions and bans. At the same time, awareness-raising and communications campaigns are a key factor for prevention.
The Assembly will also review the health-related Millennium Development Goals (MDGs). In this area, IFPMA member companies have a strong track record with over 200 long-term partnership programs through which the research-based pharmaceutical industry works to improve health in low and middle income countries and make a tangible contribution to the health related MDGs, tackling HIV/AIDS and other communicable diseases such as cholera, and malaria. At the half way point of the MDGs, in 2007, IFPMA members had made available nearly USD 10 billion dollars’ worth of health assistance for access and capacity building in low and middle income countries, and over 1.3 billion public health interventions. The scale of their efforts is set to continue to achieve the MDGs in 2015. In addition, the IFPMA’s member companies have been supporting the WHO in the fight against neglected tropical diseases through major research and development investments and donations for many years, but more recently there has been a stepping up of the industry’s efforts in response to WHO’s call for help. In 2010 there were five new major donation announcements, and the number of tropical disease-related research and development projects is higher than ever before.
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Top Medical Services Picks by Fund Gurus Concentrated in the Sector
What do the top hedge fund and mutual fund gurus like in the medical services industry? This article, the 30th in a series, identifies through a research of the latest available institutional 13-F filings the gurus that are most invested in the medical services industry and the specific stocks within that industry that they prefer to hold in their portfolios. Please note that I have also included in this group managed care providers such as HMOs, pharmacy benefit management companies, clinical research outsourcing companies and operators of medical services facilities such as hospitals as well as home health care providers.
Also, please note that this article will be among the last in this series, as the latest March 2011 quarter 13-F Institutional filings are now beginning to come out. About 40% were out as of this weekendand most should be filed by the end of this week. As such, once 13-F filings are complete for all guru funds, in the next series starting the end of this week to the beginning of next week, I will bring to you the “Top New and Added Picks” of guru funds by industry/sector detailing this time not the top holdings, but more importantly what new positions they took and what existing positions they added to in the latest March 2011 quarter. Please check my article page for previous articles in this series.
A guru is defined as someone who is regarded as having great knowledge, wisdom and authority in a certain area. When it comes to hedge funds, there are a number of ways to anoint leading managers as gurus including long-term performance, low portfolio volatility and an elite reputation in the investment community.
Many of us are familiar with leading investors and hedge fund managers such as Warren Buffet, George Soros, Carl Icahn and Julian Robertson, but the hedge fund community alone includes over 9,000 funds; add in mutual funds, ETFs and other investment entities and the number is likely to be at least two to three times that number. While there is no official list of gurus, less than one percent or between 100 to 200 fund managers are commonly believed by the larger investment community to have earned the distinction of being called gurus.
The study of the investing habits of gurus can be informative as these are very savvy, well-respected investors with high personal net worth deploying large sums of capital from their funds on a regular basis. They have a long-term track record of successand while one can easily just ride their coattails, the savvy investor may want to use these lists as a starting point to conduct their own due diligence.
The total capitalization of the U.S. equity markets is somewhere in the $15 trillion rangeand the total market capitalization of medical services companies is $310 billion or 2.1% of the overall market. The table lists the top seven investment gurus whose funds have invested at least 6.3% or three times the average. The following is a list of the top medical services company picks of guru funds over-concentrated in that sector:
Managed care providers UnitedHealth Group Inc. (UNH), a provider of managed healthcare services through HMO and government contracts to over 75 million members in the U.S.; Wellpoint Inc. (WLP), a provider of managed healthcare services through PPO, HMO and POS, indemnity and other hybrid plans to 33.3 million members; Cigna Corp. (CI), a provider of managed healthcare services through HMO, PPO, POS and indemnity plans to 12.47 million member; Humana Inc. (HUM), a provider of managed healthcare services through HMO, PPO and government contracts to about 10.2 million members in the U.S.; and Health Net Inc. (HNT), a provider of managed health care services through HMO, PPO, POS and indemnity plans to 6.0 million members across the Country.
Pharmacy benefit management providers Medco Health Solutions (MHS), a provider of pharmacy benefit management services to employers, health plans, unions, government agencies and individuals; and Omnicare Inc. (OCR), a provider of pharmacy distribution and consulting services to long-term care centers and hospitals in 47 states and D.C.
Clinical Research Outsourcing Companies or CROs Charles River Labs International (CRL), a provider of outsourced preclinical and Phase I services, animal research models and associated services; and Laboratory Corporation of America (LH), a provider of clinical testing services via a national network of 51 primary laboratories and over 1,700 service sites.
Hospital companies Lifepoint Hospitals Inc. (LPNT), an operator of 52 general acute care hospitals providing medical and surgical services in 17 states; and Rehabcare Group Inc. (RHB), a provider of rehabilitation program management in over 1,250 hospitals, nursing homes and other long-term care facilities, being acquired by rival Kindred Healthcare Inc. (KND), an operator of 89 long-term acute care hospitals in 24 states and 226 skilled nursing center in 28 states.
Outpatient and Home medical services providers Lincare Holdings Inc. (LNCR), a provider of oxygen and other respiratory therapy to patients at home through 1,090 operating centers in 48 states; and Amedisys Inc. (AMED), a provider of home nursing services through 486 home health agencies and 67 hospice offices in 45 states.
Davita Inc. (DVA), a provider of dialysis services to patients with end stage renal disease via 1,612 outpatient dialysis centers in 42 states.