A couple years ago, pharmaceutical manufacturers moved to a just-in-time inventory system, which cut into the margins of pharmaceutical distribution companies like AmerisourceBergen (NYSE:ABC). These distributors – Cardinal Health (NYSE:CAH) and McKesson (NYSE:MCK) are the other big ones, controlling (with ABC) 90% of the business – had to make changes to their own models to maintain profitability.
After a couple years, it looks like AmerisourceBergen is back on track. Revenues for 2006 have shown steady growth, and the company has announced it is raising its expectations for the rest of the year. Many analysts have expressed concern about the impact of having extra cash on hand as a result of diminished inventories, but ABC has announced a $750 million stock repurchase plan that should help the stock.
Meanwhile, the company just signed a letter of intent to undergo a merger with Kindred Healthcare (NYSE:KND) that will result in a new institutional pharmacy company. They expect this to be finalized in early 2007. This deal received a positve response on Wall Street, as it is likely to let ABC focus on its core distribution business while shedding one of its less profitable divisions.
If ABC has in fact figured itself out and is returning to profitability, I think it has real potential for sustained growth. Beyond distributing pharmaceuticals, the company distributes over-the-counter healthcare products and other healthcare equipment, and it also provides supply-management software, packaging, and other logistical services. With the aging boomers about to create an enormous demand for health care, ABC should see increasing demand for its services in the coming years. Additionally, the steady growth of generic drugs, which offer higher margins to distributors, will continue to help its margins.
A stock like this may be especially valuable in the coming years, as demand for pharmaceuticals doesn’t depend on the health of the economy. While the manufacturers face stiff competition for their drugs, and enormous research costs, a large distributor like ABC tends to have less risk, especially since it has only two major competitors.
Type of stock: A large pharmaceutical distribution company that stands to benefit from the demands of an aging population, without facing the risk and competition faced by pharmaceutical manufacturers.
Price target: At $44, ABC isn’t far off its 52-week high of nearly $49. I think this one is likely to keep going up from here, and it’s not a bad buy at the current price. But if you can hold off and grab it in a dip into the low $40s or high $30s, you’ll be glad you did. Either way, I’d hold it for a bit, as this company is just getting started.
ABC 1-yr Chart