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Guru Investment Theses on Express Scripts

Wedgewood Partners Comments on Express Scripts - Apr 10, 2013

Although we have been investors in Express Scripts Holding Company (Express Scripts) (ESRX) since 2007, it was not always a "holding company." Express Scripts is the largest pharmacy benefits manager (PBM) in the country, managing nearly one third of all prescriptions written in the U.S. The Company recently (second quarter of 2012) rose to this market position after successfully closing the acquisition of Medco Health Solutions (Medco), effectively doubling the volume of prescriptions previously handled. Express Scripts' primary value proposition is to drive lower absolute and relative drug spend by injecting itself into almost every step of a clients' drug prescription process -­‐ from patient evaluation and distribution channels, to adherence. The Company's unparalleled scale and unique focus on the behavioral and clinical aspects of the drug prescription process enables them to effectively deliver an "open architecture" drug benefit which maximizes the opportunity for clients to eliminate spending waste. The Company's clients include managed care organizations, health insurers; mid-­‐to-­‐large employers and unions, all of whom are constantly bombarded by double-­‐digit medical care cost inflation.

In our view, Express Scripts' unmatched scale and unique approach are what will continue to reinforce its competitive profile for years to come. For example, throughout 2011 and part of 2012, one of Express Scripts' pharmacy network members, Walgreens, purportedly tried to raise prices on prescriptions, without adding any incremental value -­‐ which would have mitigated savings from cheaper, generic drugs coming to market over the next few years. Express Scripts saw these terms as unacceptable, and boldly removed Walgreens from its pharmacy network, yet clients still had access to another 50,000, lower-­‐priced pharmacy alternatives -­‐ from CVS and Rite Aide, to thousands of independent pharmacies. So Express Scripts' clients were able to make a wholesale move to these new pharmacies, with minimal disruption. Needless to say, the effect on Walgreens was not as subtle, almost 10% of its fiscal 2012 earnings per share were quickly lost as millions of prescriptions were shifted to cheaper competing pharmacies. Ultimately, Express Scripts re-­‐admitted the retailer back into its network in mid-­‐2012, presumably with economics that were more beneficial to clients. While this "narrow network" approach is not a new concept, it had never been done to this scale, but Express Scripts was able to be effective while excluding the largest pharmacy chain in the U.S., a testament to the Company's scale and competitive leadership.

As Express Scripts reaches critical mass in terms of prescriptions, we believe there is still room for attractive growth in profitability through further waste reduction and optimization of client behavior. Express Scripts' research estimates show that there is over $400 billion in pharmacy-­‐related waste every year. If the Company can continue to execute on its competitive advantage, we expect the Company to increasingly drive out more of this waste, and in turn, increase its profitability spread on each prescription (EBITDA/Rx).

In the interim, we expect Express Scripts will continue to be a prolific generator of free cash flow. Aside from information technology and a handful of automated drug distribution centers, there are few, large capital expenditure calls on the Company's operating cash flows. That said, in order to finance the Medco deal, Express Scripts issued debt -­‐ with about $13 billion (net of cash) currently on the balance sheet. We expect that they will be able to generate between $4 billion to $5 billion in free cash flow over the next twelve months – and increasing each year for the next several years. With about $6 billion in debt due by the end of 2015, and $2.8 billion cash currently on the balance sheet, Express Scripts should have ample financial firepower to reinvest in the business, pay down debt and provide share buy-­‐back support over the next few years. The Company ended the quarter at a market cap below $50 billion, when squared against our free cash flow estimates, results in a yield of about 10% which, relative to competing investment opportunities and given Express Scripts' opportunity set, we earnestly believe represents an excellent investment opportunity.

From Wedgewood Partners’ first quarter 2013 investor letter.


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Ratios

vs
industry
vs
history
P/E(ttm) 32.80
ESRX's P/E(ttm) is ranked higher than
54% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 19.00 vs. ESRX: 32.80 )
ESRX' s 10-Year P/E(ttm) Range
Min: 13.5   Max: 36.74
Current: 32.8

13.5
36.74
P/B 2.70
ESRX's P/B is ranked lower than
66% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 2.01 vs. ESRX: 2.70 )
ESRX' s 10-Year P/B Range
Min: 1.85   Max: 31.66
Current: 2.7

1.85
31.66
P/S 0.60
ESRX's P/S is ranked lower than
54% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 0.52 vs. ESRX: 0.60 )
ESRX' s 10-Year P/S Range
Min: 0.33   Max: 1.07
Current: 0.6

0.33
1.07
PFCF 12.40
ESRX's PFCF is ranked higher than
66% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 14.00 vs. ESRX: 12.40 )
ESRX' s 10-Year PFCF Range
Min: 8.84   Max: 25.77
Current: 12.4

8.84
25.77
EV-to-EBIT 20.24
ESRX's EV-to-EBIT is ranked higher than
63% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 11.91 vs. ESRX: 20.24 )
ESRX' s 10-Year EV-to-EBIT Range
Min: 8.9   Max: 30.1
Current: 20.24

8.9
30.1
PEG 1.35
ESRX's PEG is ranked higher than
89% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 4.64 vs. ESRX: 1.35 )
ESRX' s 10-Year PEG Range
Min: 0.43   Max: 1.56
Current: 1.35

0.43
1.56
Shiller P/E 33.80
ESRX's Shiller P/E is ranked higher than
51% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 34.70 vs. ESRX: 33.80 )
ESRX' s 10-Year Shiller P/E Range
Min: 22.6   Max: 67.21
Current: 33.8

22.6
67.21
Current Ratio 0.65
ESRX's Current Ratio is ranked higher than
55% of the 22 Companies
in the Global Health Care Plans industry.

( Industry Median: 0.88 vs. ESRX: 0.65 )
ESRX' s 10-Year Current Ratio Range
Min: 0.57   Max: 2.21
Current: 0.65

0.57
2.21
Quick Ratio 0.54
ESRX's Quick Ratio is ranked higher than
55% of the 22 Companies
in the Global Health Care Plans industry.

( Industry Median: 0.88 vs. ESRX: 0.54 )
ESRX' s 10-Year Quick Ratio Range
Min: 0.47   Max: 2.15
Current: 0.54

0.47
2.15

Valuation & Return

vs
industry
vs
history
Price/DCF (Projected) 1.01
ESRX's Price/DCF (Projected) is ranked higher than
74% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 1.11 vs. ESRX: 1.01 )
ESRX' s 10-Year Price/DCF (Projected) Range
Min: 0.87   Max: 62.64
Current: 1.01

0.87
62.64
Price/Median PS Value 0.99
ESRX's Price/Median PS Value is ranked higher than
86% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 1.11 vs. ESRX: 0.99 )
ESRX' s 10-Year Price/Median PS Value Range
Min: 0.53   Max: 5.67
Current: 0.99

0.53
5.67
Price/Peter Lynch Fair Value 1.41
ESRX's Price/Peter Lynch Fair Value is ranked higher than
86% of the 35 Companies
in the Global Health Care Plans industry.

( Industry Median: 3.43 vs. ESRX: 1.41 )
ESRX' s 10-Year Price/Peter Lynch Fair Value Range
Min: 0.42   Max: 2.44
Current: 1.41

0.42
2.44
Earnings Yield (Greenblatt) 4.90
ESRX's Earnings Yield (Greenblatt) is ranked lower than
59% of the 32 Companies
in the Global Health Care Plans industry.

( Industry Median: 9.10 vs. ESRX: 4.90 )
ESRX' s 10-Year Earnings Yield (Greenblatt) Range
Min: 3.3   Max: 11.3
Current: 4.9

3.3
11.3
Forward Rate of Return (Yacktman) 27.34
ESRX's Forward Rate of Return (Yacktman) is ranked higher than
93% of the 30 Companies
in the Global Health Care Plans industry.

( Industry Median: 14.43 vs. ESRX: 27.34 )
ESRX' s 10-Year Forward Rate of Return (Yacktman) Range
Min: 21.7   Max: 36.4
Current: 27.34

21.7
36.4

Business Description

Industry: Health Care Plans » Health Care Plans
Compare:UNH, WLP, HUM, AET, CI » details
Traded in other countries:4XS.Germany
Express Scripts, Inc. was incorporated in Missouri in September 1986, and reincorporated in Delaware in March 1992. It operates as a Pharmacy benefit management in North America, offering a full range of services to its clients, which include HMOs, health insurers, third-party administrators, employers, union-sponsored benefit plans, workers' compensation plans and government health programs. It helps health benefit providers address access and affordability concerns resulting from rising drug costs while helping to improve healthcare outcomes. The Company manages the cost of the drug benefit by performing the following functions: evaluating drugs for price, value and efficacy in order to assist clients in selecting a cost-effective formulary; leveraging purchasing volume to deliver discounts to health benefit providers; promoting the use of generics and low-cost brands; and offering cost-effective home delivery pharmacy and specialty services which result in drug cost savings for plan sponsors and co-payment savings for members. It works with clients, manufacturers, pharmacists and physicians to increase efficiency in the drug distribution chain, to manage costs in the pharmacy benefit and to improve members' health outcomes and satisfaction. In an effort to deliver a superior clinical offering which targets the reduction of waste and the improvement of health outcomes, it applies a unique behavior-centric approach to changing consumer behavior which it calls Consumerology. It has organized its operations into two business segments based on products and services offered: PBM and Emerging Markets. The Company's PBM segment primarily consists of the following services: retail network pharmacy management and retail drug card programs; home delivery services; specialty benefit services; patient care contact centers; benefit plan design and consultation; drug formulary management, compliance and therapy management programs; information reporting and analysis programs; rebate programs; electronic claims processing and drug utilization review; administration of a group purchasing organization; consumer health and drug information; bio-pharma services including reimbursement and customized logistics solutions; improved health outcomes through personalized medicine and application of pharmacogenomics; and assistance programs for low-income patients. The EM segment primarily consists of the following services: distribution of pharmaceuticals and medical supplies to providers and clinics; and healthcare account administration and implementation of consumer-directed healthcare solutions.

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