Markets & Finance

Prescription for Growth


By Phillip Seligman AmerisourceBergen (ABC), formed from the August 1991 merger of AmeriSource Health Corp. and Bergen Brunswig Corp., is a $36 billion leader in the pharmaceutical distribution industry and a member of the S&P 500. It is the No. 1 distributor of pharmaceuticals to independent community drug stores (30% of fiscal 2001 sales), regional drugstore chains (18%), the hospital/acute care market (31%), and the alternate site (mail order facilities, nursing homes, clinics and other non-acute care facilities) market (21%). Standard & Poor's views ABC as a compelling investment in today's uncertain economic environment. As such, ABC carries S&P's highest investment ranking of 5 STARS, or strong buy.

The company's long-term financial goals of 15%-plus annual revenue growth, 15%-plus growth in earnings before interest and taxes, and 20%-plus gains in earnings per share (before merger and acquisition costs) look achievable. The company has benefited from the significant growth of the pharmaceutical industry. North American sales for the industry, according to IMS Health, are an annualized $162 billion today, and are currently growing at more than 16% per year. That growth rate stacks up against an average annual pace of 12.5% realized from 1997 to 2000.

Driving such impressive growth are favorable demographics and pharmaceuticals capturing an expanding portion of the healthcare dollar.

In addition to its distribution business, ABC owns PharMerica, a leading provider of institutional pharmacy care, pharmacy management services, and direct pharmaceutical services to workers' compensation and catastrophic care patients.

WINNING COMBINATION. S&P anticipates revenue growth for the company above 15% over the next three to five years, driven by cross-selling opportunities, such as sales by AmeriSource's packaging division, which repackages drugs from bulk to standard dosage sizes, to PharMerica and former Bergen distribution customers and access to Bergen's specialty healthcare distribution business by AmeriSource's institutional customers. In addition, there are new, value-added business opportunities with both pharmaceutical manufacturers and providers and increased clout to garner additional customers.

Standard & Poor's thinks that EBITDA (earnings before interest, taxes, depreciation and amortization) margins, which remained at 1.9% on a pro forma basis for the past five years, will widen over time, albeit modestly. Contributing to their expansion will be $150 million in annual synergies ABC looks to realize within three years, via warehouse rationalization, enhanced efficiency of the remaining warehouses, backoffice and computer systems consolidation, and improved procurement. New value-added businesses should also help, as should continued, aggressive cost control.

For fiscal 2002, the first full year of the joint company, S&P estimates that per-share earnings will rise 26% to $2.86 (or 20%, excluding a $0.13-$0.14 benefit from the elimination of goodwill amortization this fiscal year) from the $2.27 S&P expects ABC to post for the recently completed fiscal year. The stock was recently trading at 24 times S&P's fiscal 2002 estimate, a slight premium to the price-to-earnings multiple of the S&P 500 Index, as well as that of the industry. On the other hand, it has been trading at 0.2 times forward sales, well below the industry average multiple of 0.6.

S&P anticipates revenue growth for the company above 15% over the next three to five years, driven by cross-selling opportunities, such as sales by AmeriSource's packaging division, which repackages drugs from bulk to standard dosage sizes, to PharMerica and former Bergen distribution customers and access to Bergen's specialty healthcare distribution business by AmeriSource's institutional customers. In addition, there are new, value-added business opportunities with both pharmaceutical manufacturers and providers and increased clout to garner additional customers.

Standard & Poor's thinks that EBITDA (earnings before interest, taxes, depreciation and amortization) margins, which remained at 1.9% on a pro forma basis for the past five years, will widen over time, albeit modestly. Contributing to their expansion will be $150 million in annual synergies ABC looks to realize within three years, via warehouse rationalization, enhanced efficiency of the remaining warehouses, backoffice and computer systems consolidation, and improved procurement. New value-added businesses should also help, as should continued, aggressive cost control.

For fiscal 2002, the first full year of the joint company, S&P estimates that per-share earnings will rise 26% to $2.86 (or 20%, excluding a $0.13-$0.14 benefit from the elimination of goodwill amortization this fiscal year) from the $2.27 S&P expects ABC to post for the recently completed fiscal year. The stock was recently trading at 24 times S&P's fiscal 2002 estimate, a slight premium to the price-to-earnings multiple of the S&P 500 Index, as well as that of the industry. On the other hand, it has been trading at 0.2 times forward sales, well below the industry average multiple of 0.6.

ROOM TO GROW. We at S&P see significant upside for the shares. A three-year EPS growth target of 20% gives the shares a p-e to growth (PEG) ratio of 1.2 based on our fiscal 2002 estimate, which is modestly above the industry average for 2002. Even so, given our confidence that the company has the wherewithal to exceed that growth target, we decided to apply a PEG of 1.5 to our fiscal 2002 estimate and derived a share-price of $86, around 25% above recent levels.

Our bullishness for ABC shares is also supported by the company's strong, free cash-flow generation. Indeed, S&P Discounted Cash Flow analysis, assuming 20% initial growth, modest deceleration thereafter, and a weighted average cost of capital of approximately 10%, implies an intrinsic value estimate of approximately $90 a share, a 30% premium to the stock's recent quotation. Seligman is an equity analyst covering HMO and drug distribution stocks for Standard & Poor's


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