ENDP Likely to See Further Pressure; Why the Underlying Patterns May Be Good for Wholesale / Retail JVs

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SEE END OF THIS REPORT FOR IMPORTANT DISCLOSURES

Richard Evans / Scott Hinds / Ryan Baum / Hardy Evans

203.901.1631 /.1632 / .1627

richard@ / hinds@ / baum@ / hevans@ssrllc.com

@SSRHealth

May 16, 2016

ENDP Likely to See Further Pressure;

Why the Underlying Patterns May Be Good for Wholesale / Retail JVs

  • Our bearish ENDP stance is centered on the risk of US brand prices falling to the level of cheaper substitutes. Much like VRX, 24% of ENDP’s US Rx net sales are in products with much cheaper A-rated generic alternatives; 54% of US Rx net sales have therapeutic alternatives
  • Yet ENDP’s 1Q16 miss has practically nothing to do with US brand pricing pressures – so despite the fall in share price and expectations, this major risk still remains
  • ENDP’s miss comes mainly from the US generic side; of the 718 products where we have complete pricing data in both 1Q16 and the year prior quarter, prices fell for 478 (by an average $0.16 / unit)[1] and rose for just 240 (by an average $0.13 / unit)
  • ENDP points to newly approved competitors and increased consortium (wholesale / retail JV) negotiating pressure, and the evidence supports both causes. The number of manufacturers competing rose for 369 of ENDP’s products, and fell for only 211. Certain products with large price drops saw sharply increased concentration of sellers’ market shares, consistent with large blocks of demand being won or lost at bid
  • Wholesalers’ margins benefitted in the late 2013 through early 2015 period of generic inflation, because the prices at which wholesalers sold to end-users grew faster than the (also inflating) prices at which wholesalers purchased from manufacturers. Generic deflation also can be beneficial to wholesale margins – if prices paid to manufacturers fall more rapidly than prices paid by end users
  • Of note, wholesalers’ margins generally rose for ENDP generic products whose Average Manufacturer Prices (AMPs) were falling. If these margin gains prove durable, this would indicate that ‘JV’ed’ wholesalers (ABC, CAH) and their chain pharmacy partners (WBA, CVS) benefit from the type of generic pricing pressure that befell ENDP
  • Despite the potential for sourcing margins gains, chain pharmacies face immediate selling margin pressures as retail networks are narrowed – and this keeps us from taking a positive view of retail pharmacy. Wholesalers face less immediate selling margin pressure from narrowing retail networks; however if narrowing retail networks force significant numbers of independent pharmacies out of business – a very real risk – wholesalers would see significant selling margin pressure in the mid- to longer-term

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. ABBV, BMY, GILD, SHPG, SNY, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ACAD, ADMA, ALIOF, BIIB, CHMA, CLVS, CPRX, CTIC, GILD, ICPT, JAZZ, LLY, LPCN, MRK, NVO, OCUL, PTCT, SRPT, TEVA, ZSPH); SNY on sales potential for Praluent (alirocumab); CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); ENDP on risks to branded Rx price premia; Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

ENDP’s 1Q16 miss and lowered guidance has implications for a number of healthcare sub-sectors – namely specialty pharmaceuticals, generic manufacturers, drug wholesalers, and drug retailers

ENDP’s US business spans both specialty pharmaceutical brands and generics. Our bearish stance on ENDP has been anchored on the company’s US branded specialty business; specifically, we’ve shown[2] that 24% of ENDP’s US Rx brand sales come from products with A-rated generic alternatives, and that 54% of US Rx brand sales come from products with therapeutic alternatives[3]. If formulary managers choose to force the issue, these products’ prices can be lowered toward the prices of substitutes, and ENDP’s products on average carry substantial premia relative to substitutes. Completely eliminating these premia would reduce ENDP’s US brand Rx sales by as much as 35%, and global sales by as much as 12%

As it turns out, this is not at all what happened in 1Q16. US brand Rx sales fell (Exhibit 1a, grey area), as a result of positive but decelerating net pricing gains (green line) partially offsetting improving but still negative underlying volumes (black line) and weakening mix (dashed line). However, if we back out Lidoderm (Exhibit 1b) the picture shifts to one of modest brand sales losses off of flat volumes and weakening mix, offset by decelerating but still slightly positive net pricing gains. Appendix 1 provides the positive and negative drivers of net changes to US brand sales by quarter; the largest positive drivers were Xiaflex, Lidoderm, Frova and Percocet pricing gains, plus volume gains on Nascobal, offset by quantity declines in Lidoderm, Percocet, and Opana ER, plus net price losses on Voltaren Gel

In sharp contrast, the generic portfolio came under serious pricing pressure v. the year prior quarter. Of the 718 products for which we have average manufacturer price (AMP) data for both quarters, 478 products saw prices fall, as compared to just 240 products with pricing gains. Not only did more products see AMP pressure than not, average AMP drops (-$0.16 per unit) were larger than average AMP gains ($0.13 / unit). Across these 718 products, we estimate ENDP’s net sales fell by roughly $37.6M in the aggregate (Exhibit 2). N.B. these data are for retail prescription sales only and omit other (e.g. hospital & mail) channels; nevertheless, we believe the excess of AMP declines over AMP gains seen in the retail data is indicative. ENDP attributed the generic pressure to the entry of new generic competitors, and to pressure by the consortiums (aka wholesaler / chain pharmacy JV’s) – and the evidence supports both claims

The number of manufacturers competing in ENDP’s generic products increased for 369 products, and fell for only 211 products. Evidence of consortium negotiating impacts is a bit less direct, but still fairly convincing. Using hydrocodone/APAP 10/325 as an example, we saw a sharp gain in share of units for ENDP – despite a rise in the number of manufacturers of the molecule – that corresponded to declining average AMP (Exhibit 3). In theory this could simply be a rise in the number of manufacturers driving average AMP lower; more likely however, the sudden and significant unit share gain implies that ENDP bid for and won business from a large buyer — such as a consortium

It seems reasonably likely that ENDP’s 1Q16 experience is an early indication of increased generic negotiating pressure from the consortiums, which is plainly negative for generic manufacturers. Paradoxically, this trend may actually be positive for the wholesalers participating in JV’s (ABC, CAH), and potentially also for their drug retail partners (WBA, CVS)

Wholesalers plainly benefitted from generic inflation in late 2013 through early 2015, and on a relative basis have suffered since generic inflation stalled. Intuitively this suggests that wholesalers will suffer even further if generics deflate – but this is too simplistic, and potentially even misleading. What ultimately matters to wholesalers is not whether generic prices are rising or falling, but whether their gross profits per unit are rising or falling. In the late 2013 to early 2015 run of inflation wholesalers’ average margins on the inflating products rose, to wholesalers’ obvious benefit. A crucial finding from our analysis of ENDP’s generic pricing is that wholesalers’ gross profits generally rose on ENDP generic products whose (AMP) prices fell

We estimate wholesalers’ gross profits as the spread between AMP and National Average Drug Acquisition Cost (NADAC). AMP is the average net price paid to generic companies for a given product, and NADAC is the invoice price paid by retailers (generally to wholesalers) for a given product, making the AMP/NADAC spread a reasonable proxy of wholesalers’ gross profits. Exhibit 4 plots change in AMP (x-axis) against the change in AMP/NADAC spread for the ENDP products having sufficient data in both quarters. The clear pattern is that wholesale gross profits tended to rise on products whose AMPs fell, and vice versa

The Herfindahl-Hirschmann Index, or HHI, measures concentration of market shares. Higher values signal market concentration, and classically this correlates with rising prices. However, in the context of generic manufacturers whose products are being bid by large consortia, increasing HHI might be tied to falling prices. This is because the award of large chunks of volume (for lower price) would increase HHI. It turns out change in HHI doesn’t explain change in average AMP price in the ENDP data; however, change in HHI does at least partly explain change in AMP/NADAC spread (Exhibit 5). This suggests that AMP prices are moving for multiple reasons, only one of which is consortium bids; however, when consortium bids (evidenced by rising HHI) are the apparent reason AMP is moving, the change in AMP works to the consortium’s benefit (AMP/NADAC spread rises). Yet another way to look at this is to compare the relationship between HHI and AMP/NADAC spreads before the consortia came into existence (October 2012, Exhibit 6, black), and now (Exhibit 6, green). Plainly higher HHI (evidence of consortium bids) correlates with higher AMP/NADAC spreads (i.e. higher wholesale gross profits per units), and the effect appears to have increased since the wholesale / drug retail consortia began operating

 

  1. Figures are Average Manufacturer Price (AMP)
  2. “VRX, ENDP, HZNP, and MNK – A Comparison of US Pricing Risks”, SSR Health LLC, March 28, 2016
  3. A-rated alternatives are generic versions of the exacts same ENDP molecule (and drug formulation); therapeutic alternatives are different molecules and/or formulations that can be prescribed as an alternative to the ENDP brand

 

©2016, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE) and to Merck (MKGAY) on both securities-related and non-securities-related topics

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