As the next decade begins, Wall Street can still seize on a clear path to higher earnings for two of the largest U.S. pharmacy benefit managers (PBM) as they capitalize on a wave of generic drug introductions and U.S. healthcare reform.
Some industry watchers see Express as the more immediate sector play, while Medco is a preferred long-term bet.
“If you’re an investor that is a little more shorter term -- a year or two or less -- I think Express has the edge,” William Blair analyst John Kreger said. “Medco I think will appeal more to an investor making a three-to-five year bet because they’ve got a more clear sustainable growth model.”
The PBMs, which administer benefits and control medicine costs for employer and health insurer clients, are set to gain from a huge shift to generic versions of brand-name drugs that will become available over the next three years.
A new U.S. healthcare reform law, which paves the way for 32 million uninsured to get coverage, also is “driving many more users to the party” for the PBMs, said Scott Richter, a portfolio manager with Fifth Third Asset Management.
“They’re up on their surfboard and they’re riding two big waves,” Richter said, referring to the generic boom and reform.
For 2010, Express Scripts projected earnings per share growth, excluding items, of a whopping 34 percent to 40 percent. It trades at a price-to-earnings multiple of about 21. Medco has forecast earnings per share growth, excluding items, of 16 percent to 19 percent, and it trades at 19 times estimates.
GENERIC SWEET SPOT
Medco and Express are two of the three biggest PBMs, each with a market value topping $28 billion, along with the drug benefit unit of pharmacy chain CVS Caremark Corp CVS.N.
The PBMs make a huge portion of their earnings through handling of generic drugs, particularly those prescriptions delivered from their large mail-order pharmacies, which fit with desires by their clients to cut health spending.
“They’re definitely in the sweet spot through the end of 2012 with generics,” said Gabelli & Co analyst Jeff Jonas.
Medco and Express each have 26 “buy” or “strong buy” ratings on their stocks, against five and three “hold” ratings, respectively, according to StarMine.
In another indication of the PBMs’ high profile on Wall Street, 31 sell-side analysts cover Medco -- second-most among large U.S. healthcare companies -- while Express is tied for third with 29 covering its stock, according to StarMine data.
Since Medco spun off from drugmaker Merck & Co Inc MRK.N in August 2003, its shares have soared some 380 percent, while Express Scripts has skyrocketed nearly 530 percent. Over that time, the Standard & Poor's Health Care index .GSPA has risen only 15 percent, while the S&P 500 index .SPX is up 18 percent.
“Quarter after quarter, year after year, they are able to drive more generics and mail generics and their profits just keep going up at above average rates, and that’s why these stocks just keep moving higher,” Edward Jones analyst Steve Shubitz said.
This year, Express Scripts shares are up 18 percent against a slight decline for Medco. The outperformance may reflect brighter earnings prospects for Express over the next two years due to its purchase of WellPoint Inc's WLP.N drug benefit unit.
While the PBMs have similar basic functions and industry watchers say pricing does not vary much, their strategies are seen as distinct.
“A lot of it comes down to telling their story, their strategy, and convincing people their strategy is going to work better long-term to control costs,” said Chris Robbins, chief executive officer of Arxcel, which consults with employers on their drug benefit plans.
Franklin Lakes, New Jersey-based Medco promotes its specialist pharmacists, who focus on specific diseases such as managing chronic conditions like asthma or diabetes, as one of its selling points.
The company has made in-roads in genetic testing that may help doctors tailor medicines for patients and has struck small European deals to plant seeds for overseas growth -- moves that make Blair’s Kreger and others bullish on its long-term outlook.
St. Louis-based Express is focused on tracking consumer behavior to improve trends in mail order, generic use and overall medicine compliance, Robbins said.
CVS Caremark is banking on benefits from fusing a major retail drugstore chain with a PBM.
Despite their rosy near-term prospects, the PBMs face more uncharted territory once the generic wave subsides in 2013 and 2014. While generic versions of biotech medicines could start reaching the market by then, many doubt they will have the same level of use as generic copies of pills and capsules.
“It’s a little early yet for people to be worried about it, but there’s certainly a little less clarity in 2013 and beyond,” Gabelli’s Jonas said.
Other Wall Street fears include new competitors -- a possible push by Wal-Mart Stores Inc WMT.N to serve employer health plans has long made investors jittery -- as well as tougher regulations or greater government involvement.
“There’s clearly a lot of growth to come for these guys, and the question is can they make money on it,” Richter said. “I think the jury is out on competition and what the government is going to do down the road.”
But Kreger notes that the PBMs have already succeeded under administrations run by both major political parties and in both flourishing and struggling economies.
“It’s hard to imagine a scenario in the next five, 10, 15 years where Corporate America won’t care about controlling their healthcare spending,” Kreger said. “They have a model that is proven to work. The demand for that won’t change anytime soon, in our view.”
Reporting by Lewis Krauskopf, editing by Gerald E. McCormick
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