This Stable Value Stock Is Built To Weather Market Storms

Here is a brief summary of the issue. Let’s say Pfizer brings a new drug to market. Its list wholesale price is $100. Pharmacy benefit management companies “negotiate” the price down to $60. A lot of dirty, nontransparent things happen in the interim with rebates. We are not going to go into that discussion, but there is a reason why we don’t own shares of pharmacy benefit management companies.

No insurer or consumer pays list price — well, kind of. The list price doesn’t matter much when many consumers have perhaps a $20 copay for any drug and don’t have health savings accounts (HSA) or high-deductible copays that are tied to the $100 (inflated) price, not the real $60 price. That $100 list price is under attack.

McKesson and other distributors are paid a fee by Pfizer to distribute the new drug, based on the $100 price. Pfizer pays McKesson a 4% fee on the $100, that is, $4. But political winds are now blowing against this ambiguous drug industry pricing. Mr. Market is concerned about what happens to the $4 if McKesson’s fee will now be tied to the $60 price instead of $100: Will the fee drop to $2.40?

To answer this question, we have to look at history, back to 2001. At that time, branded manufacturers paid drug distributors for their services by allowing the distributors to buy drugs before price increases went into effect. If Pfizer were going to raise a drug’s price by 4% next month, for example, it would sell the drug to McKesson for $100 today, and McKesson would hold it for a month and realize a $4 profit when it sold it to pharmacies for $104 a month later.

This arrangement worked well until a few drug companies started to abuse the system by stuffing drug distributors’ channels with too many drugs. Let me explain the process: Let’s say normal quarterly demand for Bristol-Myers Squibb’s Plavix is 5 million scripts. At $100 a script that’s $500 million in revenue a quarter. Now let’s say that in one-quarter sales of BMY’s other drugs fell $500 million short of what BMY promised (guided) Wall Street.

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