![]() ![]() Now, evaluating the “Amazon risk” with the wrong mindset might lead to a poor analysis of the true risk of this factor. With news that Amazon’s Jeff Bezos joined in partnership with Warren Buffett and Jamie Dimon to create a non-profit healthcare company in 2019, the headlines risks have continued to press down the price of these medical distribution stocks over the last 5 years.Įven more recently, Amazon announced its foray into the pharmaceutical business with their offering called Amazon Pharmacy. alone and decades of experience of squeezing out competitors. One of the major risks for this industry is obviously Amazon, the master retail distributor with over 100 fulfillment centers in the U.S. I’ve been analyzing the medical distribution industry composed of the following 3 major players: McKesson (MCK), AmerisourceBergen (ABC), and Cardinal Health (CAH). Where Wall Street might not approve of a company’s entry into lower margin markets, a forward thinking leadership could buck that trend and sustain lower margins (and/or profitability) to unlock higher future free cash flows and ROIC. Thus, a higher ROII means lower inventory costs, which both directly increase free cash flows and reduce Invested Capital for ROIC. Inventory is a cash flow statement line item (change in working capital), and inventory becomes an asset on the balance sheet as part of Invested Capital. If we think of inventory investment as just another component of Invested Capital (it is), then we can see how a company’s ROIC can be positively affected by higher inventory turns, and thus how a lower gross margin business can actually earn a higher ROIC than its competitors. How Higher Inventory Turns Lead to Higher ROIC This type of a strategy might not lead to a lot of fanfare from analysts, unless those analysts are focusing on free cash flows and ROIC rather than margins. It’s amazing to see how lower gross margins can still lead to higher return for the right kind of business model, all because of higher inventory turns as a form of a competitive advantage. Turned out that many variety stores ended up struggling or folding with the arrival of the discounters (Kmart, Target, etc), and their inefficient business models undoubtedly played a part. Return on Inventory Investment = (20 x 8).Return on Inventory Investment = (36 x 4).Return on Inventory Investment = (40 x 4).But the key to success for the discounters was their greater inventory turns, which led to equal ROI on lower margins.Īn example of the differences between the various industry players: Instead, these discounters targeted the young, blue collar wives, who weren’t generally seen as great profit generators due to the lower (gross) margin profile. ![]() In the case of department stores (during the rise of Kmart and Target), this meant catering to more affluent customers and higher ticket items such as lavish home furnishings.Ī few shrewd discounters saw an opportunity in the gaps where everyone was rushing away from. To illustrate the importance of inventory turns, I’ll borrow an example from the great book about business failures called The Innovator’s Dilemma, covering the rise of the discount store versus the established department store retailers.Īs companies generally tend to do in standard corporate strategy, managements will aggressively target higher margin markets, and move “up market”. Other components of gross margin, such as inventory turns, can reveal business models with better profits and cash flows even while targeting lower margins.īefore exploring the basics of inventory turns and gross margins, let me work backwards with an example to show just how integrated these two metrics are.įor beginners to these basic terms, refer to the basics of the industry turns formula below and then come back up to read this compelling example. High gross margins are good, but just because they are higher doesn’t always mean a company has a better strategy. ![]()
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