LDG, Part IV: Levering Up To Buy An Asset Headed Into A Secularl Slowdown?

Pharmacy revenue growth appears to be in the grip of a secular slowdown that has no end in sight. While the "The Aging Baby Boomers" are a source of comfort to many investors, a closer look at the individual components that drive pharmacy revenues, suggest just the opposite, a slowing demand curve.

New drug approvals, unit inflation, and insurance coverage together point to tougher times for the pharmacy supply chain. Sum of the parts calculations place the low end of pharmacy revenue growth at 1% while putting an upper limit on growth at 3.5%, under the most favorable conditions.

Using the most recent data available from the National Health Expenditures Survey of 2004, which details per capita spending on pharmaceuticals, together with the population forecast from the US Census Bureau, total prescription dollar growth will remain at the moribund rate of 1.5% or lower for the foreseeable future.

New products from the Pharmaceutical Industry have not kept pace according the FDA. Whether this is a tougher, more risk-averse FDA, or bad decisions by R&D executives, the pace of innovation has been declining for over a decade.

Prescription inflation is slowing according to the CPI (bls.gov) While generic introductions affect the shape of the curve, it appears the Pharmaceutical Industry has entered a new phase of lower pricing power. Lower unit inflation for prescriptions directly affects same store comps, but also slows the rate of change in the spread between wholesale acquisition costs and reimbursement for the pharmacy.

According to the Kaiser Family Foundation, a 1% change in the unemployment rate creates 1.1M uninsured individuals and increases Medicaid rolls by 1.0M, by law the lowest priced pharmaceutical buyer. Through 2006, the ranks of the uninsured were already climbing. With 154.6M in the civilian workforce, further increases in unemployment could represent a 50 to 100bps drag on pharmacy alone.

Tom Tobin
Managing Director
Healthcare


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