We continue to have a Neutral stance on Express Scripts, Inc. (ESRX) with a target price of $48.00.
Last month Express Scripts reported its second quarter 2011 results. Earnings for the quarter came in at 71 cents per share (excluding special items), in line with the Zacks Consensus Estimate but well above the year-ago adjusted earnings of 60 cents per share. The jump in earnings was attributable to reduced selling, general and administrative expenses and a lower share count as compared to the year-ago quarter.
Quarterly revenues of $11.36 billion surpassed the Zacks Consensus Estimate of $11.32 billion and the year ago revenues of $11.29 billion. (Read our full coverage on the earnings report at: Express Scripts Revenue Rises, Acquiring MHS
Separately, the company said that it has agreed to acquire healthcare company Medco Health Solutions, Inc. (MHS) for $29.1 billion ($71.36 per share) in cash and stock. According to the terms of the acquisition, Medco shareholders will receive $28.80 in cash and 0.81 shares of Express Scripts for each Medco share.
Following the closure of the acquisition, which is expected in the first half of 2012, Express Scripts shareholders will own approximately 59% of the merged entity with Medco shareholders holding the balance.
We expect this acquisition to result in more synergies for the two pharmacy benefit management (PBMs) companies and help lower the cost of prescription drugs.
We note that Express Scripts has completed two acquisitions (excluding Medco Health) over the past few years. In July 2008, the company acquired the Pharmacy Services Division of Medical Services Company, a leader in providing PBM services to clients providing workers’ compensation benefits.
In December 2009, Express Scripts acquired NextRx, WellPoint Inc.’s (WLP) PBM segment. The deal, which significantly expanded Express Scripts’ PBM business, also includes a 10-year contract under which Express Scripts will provide PBM services to WellPoint and its designated affiliates. The dispensing of services to NextRx members should allow Express Scripts to increase generic and mail order penetration, which should help drive earnings.
We believe that Express Scripts stands to benefit from increased generic utilization, shift toward mail orders, strong specialty growth and an aging population. Due to the economic slowdown, a large number of people are moving toward higher-margin generic drugs and adopting cost-saving initiatives like mail orders.
Moreover, the use of generic drugs should increase significantly over the next few years as several branded prescription drugs are scheduled to go off patent. Increased generic uptake and higher use of mail orders should help the company improve its margins and profitability.
We also believe that the company is well positioned to benefit from healthcare reform initiatives like broader insurance coverage, the potential approval of a pathway for bio-similars and incentives supporting the utilization of information technology systems. The implementation of these initiatives should help drive growth at Express Scripts.
However, the company faces intense competition in the PBM industry, which is dominated by players like CVS Caremark Corp. (CVS), Aetna Inc. (AET) and CIGNA Corporation (CI) among others. With competition increasing, the company’s margins could come under pressure due to lower pricing and increased revenue sharing in the PBM market.
We are concerned about the company’s dependence on a small number of customers for a significant part of its revenues. The top five clients of Express Scripts collectively represented 55.2%, 23.7%, and 18.2% of revenues during 2010, 2009 and 2008, respectively. Considering that this percentage has been increasing each year, the loss of a significant customer would have an adverse impact on the company’s revenues and operations.
Moreover, the implementation of proposals to control health care costs in response to increases in prescription drug utilization rates and drug prices would have an adverse impact on the company’s operations. These proposals include single-payer government funded health care programs and price controls on prescription drugs.
Keeping all the aforementioned issues in mind, we have reiterated our Neutral recommendation on Express Scripts. The stock carries a Zacks #3 Rank (Hold rating) in the short-run.
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