I don’t know anyone personally who has been affected by the opioid epidemic in the U.S. I hope I never will. I don’t know if I would be able to maintain objectivity in my analysis of drug distributors’ stocks and their involvement in this epidemic if I had experienced getting a call at night informing me that my loved one had died from a drug overdose.
Drug overdoses killed 70,237 Americans in 2017. Of these deaths, 47,600 (67.8%) involved opioids and 17,000 involved prescription opioids (24% of total overdose deaths). Legally prescribed opioids are killing 47 of us every day.
How did we get here? According to the National Institute on Drug Abuse, in the late 1990s, pharmaceutical companies reassured the medical community that patients would not become addicted to prescription opioid pain relievers, and healthcare providers began to prescribe them at greater rates. This subsequently led to widespread diversion and misuse of these medications before it became clear that these medications could indeed be highly addictive.
Today pharma distributors are used as scapegoats for the opioid epidemic — not because they are guilty but because they have money and they are “drug distributors.” They are dragged through the same mud as were the tobacco companies and British Petroleum (after it spilled millions of gallons of oil into the Gulf of Mexico).
Despite the negative headlines, we own drug distributors. Here’s why: They distribute legally prescribed medicine to pharmacies that are approved by several government agencies, including the DEA. Doctors write scripts; pharma distributors order medicine from pharma manufacturers and deliver them to pharmacies. The sad truth about the opioid epidemic is that 21%-29% of patients who were prescribed them for chronic pain misused them, and 8%-12% of those who received an opioid prescription developed an opioid use disorder.
Yet just as truck drivers cannot be held liable for delivering cigarettes to convenience stores, pharma distributors are not manufacturers of drugs and cannot be held liable for the addictive properties of the drugs they distribute, or that doctors overprescribe them and patients misuse them.
Moreover, the DEA should be responsible for limiting the illegal use of opioids. That’s its job — DEA stands for Drug Enforcement Agency. It has legal and enforcement resources that distributors lack, and it has a lot more data and tools. Drug distributors do their part and provide data to the ARCOS database the DEA manages. However, each individual distributor has data only for the drugs it distributes, while DEA has data (which it doesn’t share with distributors) for all opioid sales to pharmacies. The DEA is in a much better position to spot suspicious activity in orders than distributors. The DEA controls how much legal opioid is manufactured in the U.S. every year and in fact has been increasing quotas of opioids produced.
Opioids constitute just a small percentage of the $450 billion in drugs distributed in the U.S. annually, and thus incentives for distributors to overdistribute opioids are limited. Though lawyers and the media keep saying that distributors are some of the largest companies in the S&P 500 SPX, +0.09% by sales, they forget to mention that distributors operate on razor thin margins of less than 2%.
What if the DEA distributed all the opioid drugs to pharmacies instead of McKesson MCK, -0.72% , Cardinal Health CAH, -1.26% , and AmerisourceBergen ABC, +0.47% ? Would fewer people get addicted to opioids? Would opioids be less accessible?
Remember, DEA sets the production targets every year. Maybe DEA would catch a few bad actors sooner — it has more data than distributors and a specific skill set and mindset aimed at catching criminals. But in the big picture, even if DEA distributed opioids nothing would really change. Doctors would still prescribe them, and some patients would still get addicted to them.
Comparing the distributors (not even the makers) of legal medicine that helps millions of people cope with excruciating pain to cigarette companies creates loud headlines but has little substance.
Investors in drug distributors should understand that these companies will likely settle lawsuits with U.S. states— for two reasons: First, McKesson already settled with the FDA for $150 million for “failure to report suspicious orders of pharmaceutical drugs.” Second, McKesson and other drug distributors don’t want to be involved in costly and protracted litigation.
We don’t know how much the settlement with states will be, but it is likely to be hundreds of millions or a few billion dollars. Here is how we look at this. Currently McKesson’s market capitalization is about $25 billion. We think the company is worth at least $50 billion (at 15 times earnings), so there is a $25 billion of margin of safety. If the lawsuit costs the company less than $25 billion, which seems likely, then McKesson will be a profitable stock to own. If not, then the market is right and we are wrong.
So, how does one invest in this overvalued market? Our strategy is spelled out in this fairly lengthy article.
Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver, Colo. His firm holds a position in McKesson. He is the author of “Active Value Investing” and “The Little Book of Sideways Markets.”
More: OxyContin maker reportedly had plan to sell opioid treatment drugs as well