Two years ago, drug store chain CVS bought pharmacy benefits manager Caremark Rx, creating a company that is the largest buyer of pharmaceuticals in America. The combination was supposed to alter the pharmacy business forever. Since then, CVS Caremark's (NYSE:CVS) stock has dropped while its biggest competitor, Medco Health Solutions (NYSE:MHS), has risen. It seems that the retail pharmacy benefits management (PBM) business model wasn't a sure thing, and independents like Medco are continuing to do well, despite a recession. Perhaps that's why it's No.5 on Fortune Magazine's "World's Most Admired Companies" list. There's no question it's a great company, but is it a great stock?
IN PICTURES: 10 Ways To Prepare For Nature's Worst
Is an Acquisition in the Cards?
The Financial Times recently reported that Wellpoint (NYSE:WLP) was looking to sell its pharmacy benefits management business to focus on its managed care health plans, conceding that industry consolidation is just beginning. The Times suggested the sale could fetch between $1 billion and $5 billion in what's expected to be a very competitive auction. Medco is thought to be the leading candidate to possibly acquire the business, although other interested parties include CVS Caremark and the third-largest PBM, Express Scripts (Nasdaq:ESRX). Combining the largest (Medco) and fourth-largest (Wellpoint) PBMs is tempting, as it's already been capturing market share from CVS, its next biggest rival. My only concern is that it increased long-term debt by $1.1 billion in 2008. However, with $2.5 billion in EBITDA earnings in 2008, it easily can handle the added interest expense of an acquisition. Nonetheless, it's something to think about while many companies are tossing off debt wherever possible these days.
A Successful Year
In late February, Medco announced fourth-quarter and year-end results and they were exemplary. Revenues in 2008 grew 15.2% to $51.3 billion and net income 20.9% to $1.1 billion. Cash on hand at the end of December was just shy of $1 billion, generating $1.6 billion in cash flows from operations. The money is pouring in despite selling more lower cost generic drugs, which reduced revenues by $2.7 billion in 2008 but saved customers money in a very tough economy. Its total prescription volume for the year, mail order and retail combined, was 795.9 million, up 6.4% from 2007. Broken out, mail order prescription volumes grew 11.6% and retail prescriptions 3.3%. In addition, its specialty pharmacy, Accredo Health Group, generated $8 billion in revenues in 2008, a 32% increase year-over-year with operating income up 33.8% to $281.2 million. Looking ahead to the rest of 2009, Medco expects full-year GAAP diluted EPS of between $2.45 and $2.55, giving it a forward P/E of 15.8, the low-end of its projected EPS growth rate for the year.
Top Five PBMs by Market Share
|Medco Health Solutions
|CVS Caremark Rx
|Affiliated Computer Services
The Future Looks Bright
As I said earlier, Medco is capturing market share. The debate rages on about whether it will continue to do so because CVS Caremark is putting extreme pricing pressure on Medco and its other competitors. On March 20, John Malley of Watson Wyatt Worldwide (NYSE:WW) told the Dow Jones Newswire that "CVS Caremark became extremely competitive in prices. They're very, very hard to beat."
While CVS Caremark may offer attractive drug prices to its employer customers, the retail chain would rather that end-user employees visit their stores to fill the prescriptions as opposed to doing so by mail order, which is cheaper. That way, the company can increase revenues on impulse purchases like chocolate bars and soda pop. Express Script's CEO believes operating both businesses is a conflict of interest. I don't know if I'd go that far, but certainly CVS Caremark is trying to play both sides of the street and you know what happens when you play in traffic - you get flattened. (To learn more about conflicts of interest, read Pages From The Bad CEO Playbook.)
The Bottom Line
Medco provides drug benefits to 20% of Americans. Given President Obama's desire to insure the 45 million or so people without health care coverage, I have a hard time believing this well-run business will lose its place at the front of the line. In the long term, you have to like its chances.
Stock AnalysisHere are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
InvestingThe further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
Fundamental AnalysisOptions market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
Stock AnalysisCan these two oil stocks buck the trend?
Investing NewsAlcoa plans to split into two companies. Is this a bullish catalyst for investors?
Stock AnalysisIf you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
Investing NewsA rate hike would certainly alter the investment scene, but would it be for the better or worse?
Investing NewsWith market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
Mutual Funds & ETFsInstead of selling your stocks to get gains, consider a short selling strategy, specifically one that uses short ETFs that help manage the risk.
Investing BasicsDiversifying with international stocks can benefit most portfolios, but beware of country risk.
Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>