The healthcare sector is under significant pressure this morning following unexpectedly bad results from health-care giant McKesson (MCK) which tumbled over 20% after the company missed earnings and sharply cut its profit outlook for the year as income dropped by half in its latest quarter. The company said the latest results were affected by a “softer pricing environment” in its U.S. pharmaceutical business and said on the call that “when a competitor significantly undercuts our existing pricing, we are compelled to respond."

Expenses also rose during the quarter. Analysts were surprised by company’s commentary on aggressive price competition from an unnamed competitor.

McKesson said it now expects the year’s adjusted earnings on a per-share basis to be $12.35 to $12.85, down from $13.43 to $13.93.

For the quarter ended Sept. 30, net income was $307 million, or $1.34 a share, compared with $617 million, or $2.63 a share, a year earlier. Adjusted earnings rose to $2.94 a share from $3.17. The latest quarter’s results include a pretax goodwill impairment charge of $290 million, or $1.24 per share.Revenue rose 2.5% to $49.96 billion. Analysts polled by Thomson Reuters expected adjusted earnings of $3.05 a share on $51.21 billion.

The stock this morning is crashing, dragging down the entire sector lower with it:

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MCK also suggested at least one party aggressively trying to recapture share in independent pharmacy.As Cowen analyst Charles Rhyee asked in a note this morning "“Is the neighborhood burning down?” noting MCK’s comments on irrational pricing in market will weigh heavily on group and saying that distributors operate at razor-thin margins; unwritten rule among big three players has been that they all make rational pricing decisions."

Total operating expenses climbed 15% to $2.17 billion. As the WSJ reported, on June, the company said it plans to form a health-care information-technology joint venture that it expected to take public later in an initial public offering. The planned company will combine most of McKesson’s technology segment with the bulk of Change Healthcare Holdings Inc., which is majority-wned by Blackstone Group LP. McKesson would own 70% of the new company, with the rest owned by Change Healthcare’s shareholders, including Blackstone and Hellman & Friedman LLC. The company also unveiled a $4 billion share-repurchase authorization.

The company was promptly downgraded across the street by stunned analysts none of whom saw this coming:

BAIRD (Eric Coldwell)

• MCK’s 2Q results and FY17 forecast worst than Baird’s Street-low expectations
• Customer pricing pressure is surprising new headwind; Baird had thought “healing process” may be close after brutal past 18 months
• MCK suggested at least one party aggressively trying to recapture share in independent pharmacy; comments suggest it’s not CAH, so Baird assumes CAH must now defend customer base as well
• Cut MCK to neutral from outperform, PT to $164 from $220
• Cut CAH to neutral from outperform, PT to $82 from $97

LEERINK (David Larsen)

• Leerink expects price competition is due to joint venture agreements that WBA/ABC and CVS/CAH have created
• Slowdown in generic inflation is forcing distributors to be more aggressive in competing for business
• Sees issues as “new normal,” says drugmakers will be reluctant to raise prices aggressively for at least the next 6+ months
• Cut MCK to market perform from outperform, PT to $160 from $230

AVONDALE (Greg Bolan)

•  Appears that MCK was “snake bitten” in 2Q by ABC’s actions to reclaim market share in independent pharmacy marketplace
•  MCK’s FY17 forecast cut expected to weigh on the sector, though Avondale notes ABC was consistent with its comments on FY17 forecast as recently as Sept. 13
•  Rates MCK market perform, PT to $157 from $197

EVERCORE ISI (Ross Muken)

• ABC may be culprit behind price competition in industry
• Says this could cause group to fall 5%-15% in Friday’s trading, may be in “penalty box” for ~6 months until a return to rational behavior
• “Baffles us” that a key market participant could potentially harm industry economics on price
• Rates MCK buy, PT to $169 from $194

COWEN (Charles Rhyee)

• “Is the neighborhood burning down?”
• Says MCK’s comments on irrational pricing in market will weigh heavily on group
• Says distributors operate at razor-thin margins; unwritten rule among big three players has been that they all make rational pricing decisions
• Rates MCK market perform, PT $188

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As a result of the terrible MCK results, the entire healthcare sector is being dragged lower.

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