Medco Health Solutions (MHS) reported EPS of 90 cents (96 cents excluding $36.6 million expenses associated with the pending Express Scripts merger) during the third quarter of fiscal 2011, up 12.9% from the year-ago quarter EPS of 85 cents. After adjusting for amortization of intangible assets and merger-related expenses, the company’s adjusted EPS came in at $1.07, beating the Zacks Consensus Estimate by 2 cents and 12.6% higher than the year-ago quarter level.
Medco recorded an increase of 4.1% in revenues on a year-over-year basis to $17.0 billion, in line with the Zacks Consensus Estimate. The increase in revenue was primarily driven by contributions from significant client wins coupled with higher prices charged for branded drugs, partially offset by higher volumes of lower-priced generic drugs.
During the quarter, Medco witnessed a robust 46.9% year-over-year upside in service revenue to $378.7 million based on the acquisition of United BioSource and growth in its client service offerings. Revenues from Medco’s specialty pharmacy segment, Accredo Health Group, increased 16.7% to $3.4 billion primarily due to higher prescription volumes, rise in manufacturer brand pricing, further utilization of specialty products and the impact of recently introduced drugs.
During the reported quarter, the generic dispensing rate increased 2.2 percentage points to 73.8% from the year-ago level. Both the mail-order and retail generic dispensing rates increased 2.0 percentage points to 64.8% and 2.3 percentage points to 75.4%, respectively. The year-over-year growth in the overall generic dispensing rate increased the incremental savings of the company’s clients and members to approximately $700 million.
In the reported quarter, out of $16.6 billion of net product revenues, retail products accounted for $10.1 billion while the rest came from mail order products. Both retail and mail-order products spiked 2.0% and 5.6%, respectively, compared with the same period last year.
Total prescription volume inched down 0.7% to $233.6 million from the year-ago period, despite mail-order volume increasing 0.4% to 27.4 million. Branded mail order prescription volume decreased 4.9% year over year to 9.7 million, while generic mail-order prescription volume increased 3.5% to 17.7 million. Retail prescription volumes declined 1.2% to 152.2 million.
Medco’s gross margin during the quarter remained flat year over year at 6.9%. Selling, general and administrative (SG&A) expenses increased 6.3% year over year to $420.0 million (excluding the pending merger-related expenses).
Medco exited the third quarter with $161.5 million in cash and cash equivalents; down from $853.4 million at the end of fiscal 2010. The company repurchased 6.3 million shares during the quarter for $350 million. On a year-to-date basis, Medco has repurchased 29.3 million shares for $1.787 billion. However, the company has suspended future share repurchases due to the pending merger with Express scripts (ESRX).
Outlook
Medco has narrowed down its fiscal 2011 guidance. The company currently expects EPS in the range of $3.54-$3.58 (previous range: $3.59-$3.69). However, excluding the pending merger-related expenses, the company expects to deliver EPS in the range of $3.65-$3.69; representing a growth of 16-17%.
Excluding all intangible amortization and merger-related expenses, adjusted EPS is estimated in the range of $4.08- $4.12 (previous range: $4.02-$4.12),representing a growth of 15-16%.
With 2012 generic wave, which will commence on November 30 with the introduction of the generic form of Lipitor, Medco expects to deliver nearly 3 cents in incremental EPS for fourth quarter 2011.
Recommendation
Medco has been witnessing severe challenges over the past few months as it lost several contracts. This included the loss of PBM contract with its largest client, UnitedHealth (UNH), the Federal Employee Program (FEP) contract, the Medicare Part D business of Universal American and the biggest US public pension fund California Public Employees’ Retirement System (CalPERS), all to CVS Caremark (CVS). In August 2011, Medco also lost its PBM contract with Blue Cross and Blue Shield.
Despite undertaking various efforts, Medco has failed to successfully overcome these headwinds. In July this year, Medco announced that it will be acquired by Express Scripts for $29.1 billion in cash and stock (the biggest in the health care industry).
We currently maintain our long-term Neutral recommendation on Medco, in line with both CVS and Express Scripts. However, the upside potential of Medco is limited.
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