Drug Supply Chain Falls as Some on Wall Street Say Shake It Off

(Bloomberg) -- Sell-side analysts at Wall Street firms are having mixed reactions to the roll-out of a proposal to limit the legal status of rebates in U.S.-run drug plans, as health-care supply chain stocks slide in trading Friday.

Those at Citigroup and SVB Leerink have told investors not to fret after shares started falling after the proposed rule was released late Thursday, while strategists at Goldman Sachs and Evercore ISI took a more cautious tone.

CVS Health, UnitedHealth Group and Cigna -- through its recent acquisition of Express Scripts -- all have less than 4 percent of their earnings tied to keeping those rebates, Citi analyst Ralph Giacobbe estimated in a note to clients. The “long awaited” drug pricing proposal excluding rebates “falls largely inline with one of the options outlined in the president’s blueprint for lowering drug prices in May,” he said.

On the flip side, Evercore ISI’s Michael Newshel believes that legislation targeting rebates under commercial insurance plans is “quite possible,” and Goldman’s Robert P. Jones agrees. “We question how it might impact the use of inflation-protection, rebate-linked admin fees, and agreements with manufacturers that could span the government and commercial market,” Jones said.

The Department of Health and Human Services released a plan that would roll back so-called safe-harbor protections for rebates under government-run programs like Medicare, which the Trump administration has blamed for helping to keep prices high. Cigna, which also reported earnings this morning, fell as much as 5.6 percent. Drug distributors including AmerisourceBergen, Cardinal Health and McKesson were each down at least 2 percent. CVS and UnitedHealth also declined.

President Trump is set to deliver his State of the Union address on Tuesday. The not-yet-finalized plan targets changes in 2020 and is subject to a 60-day comment period.

Here’s what analysts are saying:

SVB Leerink, Ana Gupte

“Fears overblown; buy the weakness!”

“We see the impact as more than manageable for the Medicare Advantage-Part D, Stand-alone Part D, as well as PBMs in our coverage and would view any weakness as a buying opportunity,” Gupte said of outperform-rated Cigna, CVS, UnitedHealth, Humana, and Anthem.

“The new rule portends changes in commercial may be likely and it is not impossible for rebate elimination legislation to be passed.” Gupte said “this would be manageable” as the well known PBMs have said they pass on 95 percent or more of rebates to employers. “D.C., however, could face backlash from employers who are keen on keeping rebates as they are largely used to offset healthcare costs.”

Goldman, Robert Jones

“We expect the market to interpret this rule negatively for the PBMs, which over the past several years have successfully leveraged scale and competition to create a growing pool of rebates as a primary means of reducing drug costs. However, the PBMs have been weaning themselves off rebates,” Jones wrote, “and they have proven capable of shifting compensation away from rebates, such that this rule might not have the same impact as it would have had several years ago.”

“If the PBMs are under greater pressure to find savings for clients, the drug retailers may be one place they could look. The more fragmented nature of the retail pharmacy market leaves retailers with little leverage in negotiating reimbursement rates with the PBMs.”

For biopharmaceutical companies, “this proposal could be a positive” in the short-term and neutral over the longer-term. The drugmakers focused on biosimilars may wind up being hurt as branded drug prices may become more competitive.

Wholesalers, which have spent the last few years weaning off of reliance on branded drug price inflation, are likely to remain “‘in the center of the debate” until a rule is solidified. AmerisourceBergen and Cardinal would lose as much as 4 percent of earnings, McKesson as much as 3 percent, if list prices on drugs no longer inflated.

Evercore ISI, Michael Newshel, Ross Muken

“The proposal reads as an indictment of the current rebate system, and HHS clearly wants to see broader change.” Evercore cautions that “with bipartisan momentum on drug pricing building already, we think legislation targeting commercial rebates is quite possible.”

“There is already a broad push underway toward more transparent pricing in the PBM industry based on fees instead of retained rebates or spread differences between prices charged health plans and paid to the pharmacy.” Both Cigna’s Express Scripts and CVS have made transparent offerings for employers, with little uptake so far. Evercore estimates that after recent acquisitions, roughly 2 percent of CVS’s 2019 earnings would be from retained rebates and 4.7 percent of Cigna’s.

Drug distributors are likely to suffer with the rest of the supply chain, although it may be “short-term pain.” Specialty pharmacies are most at risk as “compensation is largely based on cost plus pricing.” Traditional pharmacies would also take a hit.

Height Capital Markets, Hunter Hammond

“If the proposed rule is finalized - which we think can happen as soon as 3Q 2019 - we expect that beneficiaries will face higher premiums and lower cost-sharing payments.”

PBMs including CVS, UnitedHealth, Cigna and Diplomat Pharmacy “will likely face near-term headline risk from the proposal and long-term risk if the proposal is implemented as their business models adapt,” the policy analyst wrote.

“Drug manufacturers and health insurers will likely face positive to mixed reactions in the near-term as the administration’s gaze turns to PBMs and would see long-term benefits if the rule was finalized as beneficiaries will enter the coverage gap slower and premiums will rise.”

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