McKesson (Excerpt From Our Upcoming Letter)
The following is an excerpt from our spring 2025 investor letter. As a reminder, premium subscribers will receive a full copy of our investor letter, including a description of every investment we own and why we own it, 45 days after our investors receive it (so on or around April 15).
McKesson is the largest of the three American pharmaceutical distributors. It distributes one of every three pharmaceuticals in the country. Without McKesson, the American medical system would grind to a halt. We view McKesson as a royalty on the US pharmaceutical industry, which we think is virtually certain to grow.
McKesson continues to report strong results. Year-over-year revenue increased 18%, operating profit increased 16%, and earnings per share (EPS) increased 4%. EPS growth was hampered by higher taxes, driven by one-off items. Trailing nine month pre-tax EPS increased 14%, which is more representative of McKesson’s true performance.
McKesson’s US Pharmaceutical segment is the company’s largest and most important. It continues to drive the lion’s share of growth. Sales increased 16% and operating profit increased 10% over the last nine months.
Growth was driven by higher volumes and a new retail partner. In April 2024 McKesson won a $31 billion contract to distribute non-specialty bulk shipments to OptumRx's mail dispensing facilities.
A formulary change at several health insurance plans partially offset this. Humira lost patent protection in 2023 and insurers have been switching coverage to biosimilars. Biosimilars are cheaper, a headwind to revenue, but carry higher margins (4-5% vs 1-2%), a tailwind to earnings. COVID-19 vaccine volumes continue to dwindle, as expected, providing another headwind.
Surging sales of GLP-1s helped drive revenue. GLP-1 sales increased 45% last quarter to $10.9 billion. GLP-1s require cold-storage through the supply chain, which increases costs and decreases margin. McKesson makes back some of that margin through its prior authorization services, which are part of its Prescription Technologies segment.
Prescription Technologies grew revenue 14% and operating profits 22%. This segment includes third-party logistics services (50% of revenue), access services (25% of revenue), and affordability solutions (25% of revenue).
Third-party logistics (3PL) services support pharmaceutical manufacturers through their product’s entire life-cycle, from pre-launch preparations to ongoing distribution and logistics support. It allows biopharma companies to focus on their core competency of developing therapies instead of the complex logistics of distribution and supply chain management. Unlike its core US Pharmaceutical distribution business, McKesson 3PL business does not take ownership of drugs. Revenue is lower but margins are significantly higher. Services include warehousing and transportation, inventory management, cold chain management, controlled substance handling and distribution, track and trace (serialization) to meet regulatory requirements, quality control, and compliance support.
Access and Affordability Solutions are high margin software businesses. They connect 900,000 healthcare providers with over 50,000 pharmacies. Deep integration on both sides makes this a differentiated and sticky business.
Access for More Patients (AMP) is a key program in McKesson’s Access Solutions business. AMP aims to get patients access to their specialty medications faster and remove barriers to increase adherence. AMP integrates into physician’s workflows to streamline and automate the prescription process. It captures patient consent in the provider's office and enables real-time enrollment into biopharma-sponsored support programs before the patient leaves the office.
Affordability solutions include Rx Savings Solutions (RxSS) and CoverMyMeds. These programs provide electronic, automatic copay coupon programs. They also handle prior authorizations. Prior authorization is a process used by health insurance companies to determine if they will cover a prescribed procedure, service, or medication before it is provided to the patient. Healthcare providers must obtain approval from the insurer before delivering certain services or prescribing specific medications. GLP-1s require prior authorization and booming sales have been a boon to McKesson’s Prescription Technologies business.
McKesson’s Medical-Surgical Solutions business distributes medical supplies, like personal protective equipment, diagnostic equipment, surgical instruments, lab testing supplies, and pharmaceuticals. McKesson has a leading market share in alternative-site medical centers, such as ambulatory surgical centers, long-term care and skilled nursing facilities. These facilities are often lower cost than hospitals and continue to take share. Revenue decreased 3% last quarter, but operating profit was up 4%. Revenue declined as a result of a light flu season. Operating profit increased as a result of a cost efficiency program.
On the capital allocation front McKesson repurchased 5% of shares over the last year, made two acquisitions, and closed the previously announced sale of its Canadian business.
In August McKesson bought 70% of Florida Cancer Specialists for $2.5 billion and in February it acquired 80% of PRISM Vision for $850 million. These acquisitions build on McKesson’s prior acquisitions. In 2007 McKesson acquired Oncology Therapeutics Network (OTN) which is a major U.S. distributor of specialty pharmaceuticals, particularly oncology drugs. This acquisition strengthened McKesson’s position in the rapidly growing specialty distribution space. In 2010 McKesson acquired US Oncology, which included over 1,000 oncology providers. US Oncology treats one in five US cancer patients. It also included technology, like the iKnowMed electronic health record system, and the capability to conduct and manage clinical trials. iKnowMed is now a part of Ontada, McKesson’s oncology technology and insights business
Florida Cancer Specialists will give US Oncology even more scale. After the acquisition closes, McKesson will have 2,750 oncology providers, all operating on the same iKnowMed electronic health records system. This produces valuable data because it includes real-world data and real-world evidence.
Ontada generates real-world data (RWD) and real-world evidence (RWE) on 2.4 million patients across more than 80 tumor types. McKesson leverages the data to fuel discovery by helping patients participate in cutting-edge clinical trials through its joint venture with Sarah Cannon Research Institute. Enrolling a patient with a clinical can generate $200,000 to $400,000 of revenue per patient. When biopharma companies develop new drugs, it improves patient outcomes and drives volume through McKesson’s US Pharmaceutical distribution business.
Ontada also integrates its data into iKnowMed and its Practice Insights analytics tool, which help doctors provide better patient care. It is a virtuous cycle that deepens McKesson’s relationship with biopharma companies and healthcare providers while benefitting patient outcomes and distribution volumes in a positive feedback loop.
McKesson’s PRISM Vision acquisition will work in much the same way as McKesson’s oncology business. PRISM Vision is a provider of general ophthalmology and retina management services. It includes over 180 providers, 91 offices, and seven ambulatory surgery centers. Buying healthcare providers and managed providers is generally a tough business, but oncology and retinal care stand out because they’re seeing more drug innovation, more drug investment and increasing levels of drug spend. This makes McKesson’s real-world data and real-world evidence particularly valuable to biopharma companies researching the field. If biopharma companies succeed in developing new drugs, they’ll be distributed through McKesson’s higher-margin specialty distribution channel
McKesson has reiterated its expectations for 12-14% long-term EPS growth. That’s driven by high single digit revenue growth and a mid-single-digit buyback yield. Fiscal 2025 is likely to be even better. At 18x earnings, McKesson’s is valued at a discount to the broad market. We consider its valuation within a fair range, and expect the stock to earn returns in-line with the underlying business. We like that McKesson’s business has a low economic sensitivity and a wide and widening competitive advantage.
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