Australia | May 28 2015
– PBS cuts hit pharma wholesalers
– Some offset from drug additions
– CSO benefits
– Neutral against reduced discounts and cost cutting
By Greg Peel
The latest round of negotiations between the federal government the Australian Pharmacy Guild have been completed and result in inevitable cuts to the government’s Pharmaceutical Benefit Scheme in the wake of the federal budget, and as such another round of headwinds for pharmacy wholesaler earnings. While the legislation has yet to pass the Senate, and the government has met the odd hurdle in the past, brokers do not believe there is anything here that would prevent passage given an offset of further drugs being added to the PBS.
For pharmacy wholesalers such as Sigma Pharmaceuticals ((SIP)) and Australian Pharmaceutical Industries ((API)), PBS cuts have now become a routine outcome of every Community Pharmacy Agreement. This is the sixth such Agreement, and as such is known as 6CPA.
But that doesn’t make the bitter pill any easier to swallow.
The bottom line is the government is targeting $6.6bn in PBS savings over five years, or as UBS points out, roughly an 8% cut. The bulk of the savings will come from a 5% cut to the price of drugs which have come under the PBS for five years or more. Pharma wholesalers will wear the impact of the cuts as a reduction in margins. However the flipside of aforementioned new drug additions to the PBS takes the net cut back to $3.7bn.
The actual impact on earnings for the likes of Sigma and API is nevertheless not so straightforward. The cuts will be implemented progressively over five years and drug additions will also be spread over five years. Wholesalers also typically rebate a material proportion of the 7.5% PBS fee wholesalers receive from the government back to pharmacists so whereas wholesalers come off worst under 6CPA and pharmacists get off lightly, part of the pain can be eased by reducing those rebates.
There was other good news in the form of the wholesalers’ Community Service Obligations, the government subsidy for which has been retained under 6CPA. The CSO ensures the equally timely supply of all PBS drugs to all parts of Australia, for which the government pays a supporting subsidy. The CSO will no longer be indexed, which is bad, but brokers suspect eligibility will be tightened as an offset.
The CSO measures exclude supermarkets and prevent wholesaler competitors from simply cherry-picking the easy money in metro areas, Goldman Sachs points out.
Clouding the earnings impact issue further are wholesaler discounts to pharmacies and cost cutting initiatives being undertaken by the wholesalers, as Macquarie points out.
Given 6CPA hurts the wholesalers and not the pharmacies, the wholesalers can recoup some of their margins by winding back their discounting to pharmacies. Both Sigma and API have also recently announced cost-cutting strategies for their businesses, as these, too, will help offset the PBS losses.
Macquarie also suggests that PBS cuts have become such a factor of life for the wholesalers, 6CPA will have brought with it no surprises.
Macquarie thus assumes the net result will be mostly a neutral one for the industry, and indeed the broker maintains Neutral ratings and unchanged targets for both Sigma and API. Goldman Sachs agrees the impact will be largely neutral, but notes the trajectory for wholesaler earnings will remain pretty flat.
Deutsche Bank has similarly made no changes to its forecasts, while UBS has made “precautionary” downgrades to Sigma forecasts. UBS has made no changes to its valuation approach but has put the industry on “earnings watch”.
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