Express Scripts Holding Co. (ESRX, Financial) acts as a third-party administrator of prescription drug programs. It is a good business. In fact, it is the largest pharmacy benefits manager (PBM) in the United States, generating revenue from the delivery of prescription drugs to client-pharmacies, processing pharmacy claims, compliance programs and data analysis.
The stock is trading at essentially the same price it was five years ago even though the company’s earnings are up more than $2 billion and it remains on track to see north of $7 a share in 2017, and even more in 2018. What is more, it is trading at a 10 times multiple because of a disagreement with Anthem Inc. (ANTM, Financial) over cost savings. CEO Tim Wentworth indicated he does not expect the relationship to be mended before the contract concludes in 2019.
Its second-quarter earnings, which were posted July 25, were promising. Total revenue was up 5% to $25.3 billion, net income was up 11% to $801.8 million, the retention rate for 2018 is expected to be above 90% and management is targeting cost savings of $550 million to $600 million by 2021 with an initiative to transform the entire organization.
Anthem accounts for 16% of Express Scripts’ overall sales and 30% of its EBITDA. Adjusting for that loss with no significant client acquisition, the financials fall to $85 billion in sales, $5 billion before taxes and more than $2.5 billion after taxes. Put an industry average multiple (20 times) on it and you still have a $50 billion market cap, a 42% increase over the current cap. That is the worst-case, short-term scenario.
Recent news is promising
In May, Express Scripts launched Inside Rx, a new venture with GoodRx that provides affordable access to patients paying full price for prescription medications. The company is expanding the list of discounted medications available to 63, with new additions including medications from GlaxoSmithKline (GSK, Financial), Sun Pharmaceuticals and Trividia Health for acne, anti-inflammatory eye care, psoriasis, dermatitis and fungal infections, and also expanding the discounted drug options for highly utilized therapy classes like asthma, chronic obstructive pulmonary disease (COPD) and diabetes.
A lawsuit was dismissed on Aug. 1. Shareholders accused Express Scripts of manipulating its share price by withholding its strained relationship with Anthem, its largest customer.
The future is still bright
The pharmaceutical industry may have a lot participants, but Express Scripts is the most dominant pure-play for PBM. Its efficiency and size definitely put a large, deep moat around it. However, the question is not whether it will be around in five, 10 or 20 years. I think that is pretty clear. The question is whether it will provide net growth financially after the Anthem setback. All signs point to yes at this point.
As far as guru investment is concerned, both Ray Dalio (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) have small positions with Dodge & Cox ownership above 6% of total shares.
From a business standpoint, the company's margin of safety is extremely high and it will likely produce higher rates of cash over time as prices continue to rise, helping it keep up with inflation. These dynamics along with a commitment to buying back shares should provide a market-beating return over the long term at this price.
Disclosure: I am not long/short any stocks mentioned.
