You will have needed a pill or two if you’ve owned Express Scripts Holding Co. (ESRX, Financial) over the past year — with or without the benefit of a pharmacy benefit manager (which is Express Scripts' line of business).
Early this year, the stock price swooned when its biggest client, Anthem (ANTM, Financial), a major Blue Cross and Blue Shield insurer, went public with a claim that Express owed it $3 billion. The latter denied it owed its client that much, lawyers on both sides sharpened the nibs on their pens, and Anthem filed court papers for significantly more.
While we won’t know for some time how the claim pans out, we do know the Express Scripts share price dropped enough to push it onto GuruFocus'Â Historical Low P/S (Price/Sales ratio) list (in GuruFocus' model portfolios, low P/S stocks have solidly outperformed the Standard & Poor's 500).
Unless otherwise noted, all information in this article has been sourced from the Express Scripts'Â 10-K for 2015, the company website or GuruFocus.
History
- The company was founded in 1986 as Express Scripts Inc. (“ESI”) “as a result of a joint venture between a retail chain of more than 79 pharmacies (Medicare Glaser Inc.) and Sanus Corp. Health Systems.”
- Express Scripts Inc. was incorporated in Missouri in September 1986 and was reincorporated in Delaware in March 1992.
- Aristotle Holding Inc. was incorporated in Delaware in July 2011. On April 2, 2012, ESI merged with Medco Health Solutions Inc. (“Medco”), and both ESI and Medco became wholly owned subsidiaries of Aristotle Holding Inc.
- Aristotle Holding Inc. was renamed Express Scripts Holding Company.
History based on information at the company’s website and Wikipedia.
Express Scripts’ business
Express Scripts is a pharmacy benefit management (PBM) company, an intermediary between companies and organizations that buy drugs (including insurance companies) and the suppliers of drugs. Its clients include:
- Managed care organizations.
- Health insurers.
- Third-party administrators.
- Employers.
- Union-sponsored benefit plans.
- Workers’ compensation plans.
- Government health programs.
- Providers, clinics, hospitals and others.
For these clients, Express Scripts provides services that aim to improve patient outcomes and help control the drug costs borne by its clients. It does this by:
- Evaluating the effectiveness, price and value of formularies (a formulary is an official list of drugs that may be prescribed).
- Providing home delivery and specialty services that save their clients money and improve care for members.
- Using their volume buying power to get discounts for health benefit providers.
- Encouraging the use of lower-cost products, such as generics.
The company operates in two business segments:
- Pharmacy benefit management (PBM).
- Other business operations.
Revenues
In its 10-K for 2015, the company reports the following about its revenue:
“Our revenues are generated primarily from the delivery of prescription drugs through our contracted network of retail pharmacies, our home delivery pharmacies and our specialty pharmacies. Revenues from the delivery of prescription drugs to our members represented 98.0% of our revenues in 2015, 98.4% in 2014 and 98.8% in 2013. Revenues from services, such as the fees associated with the administration of retail pharmacy networks contracted by certain clients, medication counseling services and certain specialty distribution services, accounted for the remainder of our revenues.”
Also in its 10-K, it breaks out its revenue and operating income:
Competition
The company categorizes and describes its competitors this way:
- "independent PBMs, such as MedImpact and Navitus Health Solutions."
- “Others are owned by managed care organizations such as Aetna Inc. (AET, Financial), CIGNA Corporation (CI, Financial), Humana (HUM, Financial), OptumRx and Catamaran (CTRX, Financial) (owned by UnitedHealth Group [UNH]) and Prime Therapeutics (owned by a collection of Blue Cross Blue Shield Plans).
- “Some are owned by retail pharmacies, such as CVS Caremark (owned by CVS Health [CVS]) and Envision Rx (owned by Rite Aid [RAD]).
- “Walmart Stores Inc. (WMT, Financial) engages in certain activities competitive with PBMs. We also compete against adjudicators, such as Argus.
- “With the emergence of alternative benefit models through private exchanges, the competitive landscape also includes brokers, health plans and consultants.”
As to its competitive advantage, Express Scripts notes it is the largest stand-alone PBM company in the U.S., and it offers a full range of services to its clients. Being the largest provides more than bragging rights; any company in this industry must spend heavily to stay current on and comply with the many government rules and regulations as well as the policies on individual clients.
Throughout its 10-K for 2015, it also makes frequent references to innovation, such as “We offer innovative clinical programs to drive better health outcomes at lower cost.”
Other
Company headquarters are located in St. Louis.
Timothy Wentworth, age 55, serves as chief executive officer and president. He joined Express Scripts when it merged with Medco in April 2012. Wentworth recently succeeded George Paz, who had served as chairman and chief executive officer; Paz continues to serve as chairman.
At the end of 2015, Express Scripts had about 25,900 employees; some 8% of those employees belong to unions.
Now 30 years old, Express Scripts has leapfrogged its way to the top of the PBM castle. With its size and innovative culture, it seems well positioned for further growth.
Risks, opportunities and growth
Risks faced by the company include:
- Operating in a competitive industry, which could lead to lesser margins or loss of clients.
- Industry shifts, such as “a large intra- or interindustry merger or industry consolidation, strategic alliances, a new entrant (including foreign entities or governments), a new or alternative business model.”
- Participating in “a complex and rapidly evolving regulatory environment.”
- Threats to “the security and stability of our technology infrastructure.”
- Two major clients, “Anthem and the United States Department of Defense (“DoD”) ... collectively represented 29.4% and 25.9% of our revenues during 2015 and 2014, respectively.”
- As Mark Yu noted in a GuruFocus article on March 21, Anthem is suing Express Scripts, reportedly seeking some $15 billion.
See the 10-K for 2015 for a more comprehensive list of risks, including seven other lawsuits not noted here.
Opportunities
Among opportunities open to the company are:
Mergers and acquisitions:Â The company notes in its 10-K for 2015 that it can afford to look for deals. “We believe available cash resources, bank financing or the issuance of debt or equity could be used to finance future acquisitions or affiliations.”
Thomas Macpherson points out in the article "The PBM Empire Strikes Back"Â that big PBM companies like Express Scripts may be able to ride a couple of important trends — market-event action and indication-specific pricing — to further increase downward pressure on drug prices. When PBM companies get those prices down, they share in the savings.
Industry clout: Because of its size, Express Scripts is able to influence the pricing of at least some drugs. On its website, it describes how it was able to save its clients and users of a hepatitis C drug more than $1 billion in 2015 alone. Because of a ripple effect, it expects to see national savings of $4 billion per year in this drug category.
Generic drugs: “We also continue to benefit from better management of ingredient costs through renegotiation of supplier contracts, increased competition among generic manufacturers and a higher generic fill rate (84.4% in 2015 compared to 82.9% in 2014 and 80.8% in 2013).” As the company notes, generic fill rates are something of a two-sided sword but ultimately help the bottom line. “Generally, higher generic fill rates reduce PBM revenues, as generic drugs are generally priced lower than branded drugs. However, as ingredient cost on generic drugs is incrementally lower than the price charged, higher generic fill rates generally have a favorable impact on gross profit.”
In a guru stock highlight, Wallace Weitz (Trades, Portfolio) indicated he is not overly concerned about the Anthem suit, “We have run scenarios encompassing a range of different outcomes, and we believe Express Scripts’ shares are undervalued in all but the most dire.”
Weitz went on to say, “We continue to monitor contract-related developments and are otherwise heartened by improved execution across the other 84% of Express Scripts’ enterprise.” Improved execution offers significant opportunity with a company as large as this one.
And, in a Motley Fool article, Keith Speight argues that the Anthem dispute likely will not have a material effect on Express Scripts’ bottom line. In addition, he notes that the prospect of Anthem (Express Scripts’ biggest customer) leaving for another provider is already reflected in the share price.
Growth
The following chart shows Express Scripts’ growth over the past two decades; the green line shows the price per share while the blue line shows EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization):
In announcing its first-quarter results, the company offered guidance for its 2016 adjusted earnings per diluted share: between $6.31 and $6.43. That represents growth of 14% to 16% over 2015.
The 17 analysts followed by Yahoo! (YHOO, Financial) Finance give a low estimate of $6.32 and a high estimate of $6.40.
On the share price side, Yahoo! Finance brokers have a low price target of $63 and a high price target of $95 (at the close of trading on June 6, the stock was $76). The mean and median came in a $81 and $81.50.
Ownership
| Twenty-five of the gurus followed by GuruFocus have positions in Express Scripts. Dodge & Cox has the biggest holding, more than 22 million shares followed by Barrow, Hanley, Mewhinney & Strauss, and Chris Davis. GuruFocus reports that institutional investors own 83.22%, insiders own 0.48% and shorts own 6.6% of the outstanding shares. With the exception of its high-profile legal tangle with Anthem, Express Scripts seems headed in the right direction. And, as noted, the legal issue may not amount to much in the overall situation. Both institutional investors and gurus have large stakes, apparently confident in the company’s ability to keep growing. | Â |
Express Scripts by the numbers
As the capitalization suggests, this is a big company trading well below its 52-week high. It pays no dividends but did buy back a hefty number of its own shares last year. ROE is strong at more than 14.5%.
Financial strength
The automated rating system at GuruFocus gives Express Scripts fairly strong marks for both financial strength and profitability:
It’s illuminating to look at the two columns of icons in the Profitability & Growth section; the first showing how competently Express Scripts functions when compared to its industry. The second shows how poorly it has done recently in comparison with its own history.
Let’s now turn to some specifics, starting with a view of its long-term debt:
As we can see, Express Scripts took on no debt until the late 1990s and stayed at a relatively low level until 2011 when it began to pursue Medlock. In April 2012, it closed the deal with Medlock, buying it for $29 billion in cash and stock.
At the same time, this chart shows how its earning power, as expressed through EBITDA, also surged:
This GuruFocus chart shows how free cash flow took off:
Finally, the company gets a Piotroski F-Score of 7, which is described as being very healthy.
All three charts in this section looked much the same. Debt took off in 2011, as Express Scripts got set to buy Medlock. At the same time, its earning power (EBITDA) and free cash flow (FCF) also headed upward. Along with a Piotroski F-Score of 7, this is a financially strong company.
Valuation
One of the lesser-known benefits of the GuruFocus portal is the inclusion of valuation strategies for individual stocks. For those of us who tend to scratch our heads when confronted with a list of valuation methods, this helps a great deal. You reach it by clicking Analysis on the menu bar, then on Valuations on the submenu below it.
In the case of this stock, GuruFocus says, “Express Scripts Holding Co. is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value and 2) Peter Lynch Fair Value. The Median P/S Value of Express Scripts Holding  for today is 94.58. The Peter Lynch Fair Value of Express Scripts Holding Co. for today is 60.94.”
We’ll focus on Median P/SÂ and take a look at another valuation ratio later. Starting with the P/S (price-to-sales ratio) in Median P/S, we click on P/S in the dashboard on the summary page, which takes us to a new page that gives us more information about this ratio.
It says, “The P/S ratio is an excellent valuation indicator if you want to compare a stock with its historical valuation or with the stocks in the same industry. The P/S ratio works especially well when you want to compare the stock’s current valuation with its historical valuation.” GuruFocus also warns, “The P/S ratio does not tell you how cheap or expensive the stock is. It cannot be used to compare companies in different industries.”
The P/S ratio, as of June 7, is 0.47.
Turning to the "median"Â part of Median P/S, we get this explanation from GuruFocus: “This valuation method assumes that the stock valuation will revert to its historical mean in terms of Price/Sales Ratio. The reason we use P/S Ratio instead of P/E Ratio or P/B Ratio is because Price/Sales Ratio is independent of profit margin and can be applied to a broader range of situations.” Note the reference to historical mean.”
The Median P/S value as of June 7 is $94.58. That is higher than the June 7 price of $76.17 and so we can say the stock is undervalued, specifically, undervalued by $18.41 or 24%.
To put all of that into context – and better illustrate – this chart shows the share price in green and the Median P/S in blue. Note how the blue line is depressed and well below its peak in 2010:
One other quick valuation, one that’s much used and recognized, is the P/E ratio, which stands at 20.08 on June 7 (green line for share price, blue line for P/E).
As we can see, the P/E is near the low end of the range within which it has fluctuated for about 15 years.
Both the P/S and P/E ratios suggest the stock price has fallen below its traditional levels.
Conclusion
There’s no mistaking it: Express Scripts has hit a bump in the road, and a sizable one at that. It has dropped from the mid-$90s to the mid-$70s in the past year. That’s the glass-half-empty argument.
On the glass-half-full side, it could be argued this dip provides an entry opportunity for value-focused investors. Of course, many value investors will not like the long-term debt the company carries, but for those with less stringent criteria, a case might be made for putting it on the short list.
All indications are that this is a solid company with good prospects, but for many investors the shadow of lawsuits, and particularly the legal tussle with Anthem, will put this stock on the sidelines for at least the time being.
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