Express Scripts Holding

01/16/2015 7:00 am EST

Focus: STOCKS

Eric Vermulm, CFA

Senior Portfolio Manager, Stack Financial Management

One area of the market with strong upside potential coupled with numerous catalysts is the management and administration of prescription drug plans, explains Eric Vermulm, of Stack Financial Management and InvesTech Market Analyst.

Pharmacy Benefit Management (PBM), which is part of the defensive healthcare sector, is benefitting from demographic shifts, a wave of generic drug launches, and health insurance coverage growth under Obamacare. 

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 frequently allow ESRX to offer the lowest prices and most applicable formulary on prescription drugs.

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 EPS expansion of 10% to 20% per year for the foreseeable future. 

The firm’s 2014 EPS guidance of 18% to 19% is at the high end of this range and translates into a free-cash-flow yield of greater than 7%.

Recent announcements regarding pricing power and negotiated discounts have helped ESRX rally late in 2014, but we are still being offered the industry leading PBM at a discount. 

Shares trade at 18.5 times adjusted earnings, well below the 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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