Pharmacy benefit managers or PBMs control an important part of the healthcare system. These companies work with insurance companies to manage the pharmaceutical component of the healthcare benefits. There are three large competitors in the space: Medco Health Solutions (NYSE:MHS), Express Scripts (NYSE:ESRX) and Caremark. Other companies, like SXC Health Solutions (Nasdaq:SXCI) offer PBM services but also a full suite of healthcare-technology solutions geared toward the pharmacological side of healthcare. There are also some smaller or niche PBMs that focus on a particular area of the business. The economics of the PBM business improve when they have a larger percent of scripts delivered by mail and written for generic versions rather than branded versions of the drugs.
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The push to get customers to order drugs via mail is beneficial to both the PBM (and thus the insurance company) and the customer, as the cost of a three-month supply is typically equal to or cheaper than the cost of a two-month supply from the traditional store front drug store. Similarly, the use of the generic version of a medication saves both the PBM and the customer on the overall cost. So when customers order the generic version of drugs via mail, the profitability for PBMs and the savings for customers is greatest. Another area of high profits for PBMs is with specialty drugs - generally considered injectable drugs. This area has very high profit margins for the companies but also requires more specialization.
Blockbuster Generics Are Coming
The top-selling drug at approximately $12 billion worldwide is the cholesterol-lowering drug Lipitor, manufactured by Pfizer (NYSE:PFE). Lipitor is scheduled to lose patent protection this year. Sales of a generic version of Lipitor should add significant profit to the PBMs bottom lines. Other popular drugs are also losing patent protection between now and 2014. These include Plavix, with about $10 billion in worldwide sales and Zyprexa, with over $2 billion in worldwide sales, among others.
Medco is trading near its 52-week high of $65 and at a ttm P/E of 20-times, this stock looks ripe. However, its expected 20% growth rate may not be appreciating the full effect of the blockbuster generics coming to the market. Similarly, Express Scripts, trading near its 52-week high of $58, has a ttm P/E of over 29-times. ESRX, with the positive impact from the integration of Wellpoint's (NYSE:WLP) PBM, has a higher expected growth rate of close to 29%. SXC paints the same picture - at its 52-week high and with a ttm P/E that far exceeds its bigger peers, or 48-times, although this company trades somewhat like a technology company.
While these stocks look like they've discounted the potential impact from the upcoming generic launches of many blockbuster drugs, the true impact may be far greater, particularly if the PBMs can switch customers to mail and to the generic versions at a faster rate. The actual growth rates can far exceed the expected and these stocks will look cheap and far from fully valued. (Take a page from the tortoise and the hare fable by investing in these constant growth stocks. See Steady Growth Stocks Win The Race.)
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