Express Scripts: The Right Prescription

08/05/2014 7:00 am EST


Eric Vermulm, CFA

Senior Portfolio Manager, Stack Financial Management

One area of the healthcare sector that shows strong upside potential coupled with numerous catalysts is Pharmacy Benefit Management (PBM), observes Eric Vermulm, Senior Portfolio Manager of Stack Financial Management, in Investech Market Analyst.

The PBM industry is benefitting from demographic shifts, a wave of generic drug launches, and health insurance coverage growth under Obamacare.

As the US population ages and an estimated 30 million new individuals receive health coverage under the Affordable Care Act, pharmaceutical spending is forecast to grow at 6% annually for the next decade.

On top of this, a wave of branded drugs is rolling to generic prescriptions as patents expire. PBMs make an estimated 40% more net income on the lower cost generic fills.

Express Scripts (ESRX) is our preferred name in the space due to unmatched scale and bargaining power. It is the largest PBM firm in the country having achieved a 34% market share as it coordinates prescription plans between health insurers, employers, retail pharmacies, and end users.

Economies of scale often allow ESRX to offer the lowest prices on prescription drugs, as well as the deepest and most applicable formulary selections to customers.

Management is guiding to double-digit earnings per share growth and strong free-cash-flow generation over the next several years.

Positive trends in income per claim and overall drug spending are allowing the executive team to project earnings per share expansion of 10% to 20% per year for the foreseeable future.

The firm’s 2014 EPS guidance of a 17%-to-20% gain is at the high end of this range and translates into a free-cash-flow yield of greater than 8%.

Recent concern regarding private exchanges and regulatory uncertainty provide the opportunity to buy this industry-leading PBM at a discount.

ESRX trades at only 15.3 times adjusted earnings, nearly 30% below its 10-year median of 21.2. With a durable competitive position and numerous tailwinds, ESRX is a quality holding in an aging bull market.

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