Express Scripts Holding Company (NASDAQ:ESRX) could deliver relative outperformance in 2014 as the upcoming generic wave should offer a two-fold opportunity for pharmacy benefit managers (PBMs).
Headquartered in St. Louis, Express Scripts provides integrated pharmacy benefit management services, including network-pharmacy claims processing, home delivery, specialty benefit management, benefit-design consultation. The company also distributes a full range of biopharmaceutical products and provides extensive cost-management and patient-care services. It manages more than a billion prescriptions each year for tens of millions of patients.
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Express Scripts could capitalize on the robust generic drug pipeline, and an under-levered balance sheet to generate solid future earnings growth. Express Scripts is poised to benefit from the generic drug pipeline in 2014, and thereafter as generics become multisource as well as favorable pricing amidst the pharmacy benefit management selling-season.
UBS analyst Steven Valiquette noted that the company's under-levered balance sheet enables the potential for significant share buybacks while remaining acquisition synergies could drive incremental earnings growth.
Like all segments of the drug distribution supply chain, PBMs have benefited from the increased number of generics launched in 2012 while higher overall generic utilization rates sustained profitability for the group in 2013.
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PBM stocks may benefit most in 2014 from the upcoming 2015 generic wave. Valiquette currently projects that about $29 billion of branded drugs will 'go generic' in 2014, which represents a nice acceleration from the $14.7 billion in branded drugs that are estimated to have gone generic in 2013.
Looking ahead to the next generic launch cycle beginning in 2014, PBMs will see enhanced profitability as initial limited-source generic launches roll off exclusivity in the latter half of 2014, and the greater amount of multi-source generic drug launches benefit the group in 2015.
PBMs also stand to benefit from an aging population and subsequent growth in Medicare Part D enrollment, greater use of generic drugs and increased drug utilization/compliance as a means to control overall healthcare costs, and implementation of healthcare reform (Affordable Care Act).
Most importantly, the composition of the 2014 generics launches includes a large amount of 'exclusivity' generics, which should bode well for the drug distributors' profitability in particular.
Valiquette believes much of the upside was already captured in the drug distributors' share price appreciation during 2013 as investors tend to bake this into valuations in the calendar year before the actual occurrence.
Drug distributors' shares also saw an added lift due in part to the global generic procurement deals struck among the industry players during 2012/13, including the Walgreen / Alliance Boots / AmerisourceBergen joint venture; and the Cardinal Health / CVS collaboration.
While the 2014 generic launch cycle is expected to be more favorable for drug distributors, 2015 generic launch activity is anticipated to favor PBMs. Relative to 2014 launches, the magnitude of multi-source generic launches will increase year-over-year.
Valiquette sees the combination of a greater proportion of 2015 'multi-source' generic launches (about $14 billion) and the 2014 'exclusive' generic launches (about $21 billion) converting to multi-source as enhancing PBM profitability in 2015, and believe this will get priced into PBM stocks in calendar 2014. He anticipates prescription drug volume will grow in the 2 to 4 percent range over the next several years.
The multi-source generic launch opportunity for PBMs in 2015 will also be strengthened by the conversion of exclusive generic launches to 2014 to multi-status in 2015, thereby adding to the generic tail wind for the PBM group.
Express Scripts is yet to provide initial 2014 EPS guidance, which has held the stock back in recent months. The recent positive guidance given by CVS at the company's Analyst Day and other industry participants (UNH) suggest that there should be minimal concerns for PBM industry profitability in 2014 related to macro factors (health reform, private exchanges, etc.).
Furthermore, the mail-order Rx channel looks poised to show its greatest increase in generic launch activity ever in 2014 with about $7.3 billion in generic launch volume (equivalent branded sales) up from just $2.2 billion in mail channel generic launches in 2013 and $5.1 billion in 2012. Following the acquisition of Medco, Express Scripts is now the largest PBM by claim volume, with the largest prescription mail order operation.
Valiquette believes that the generic launch activity within the mail channel should remain above recent industry levels over the next several years
ESRX, which has a market cap in excess of $58 billion, also scores on the valuation front. It is currently one of the least expensive stocks in the sector, trading 14.7 times its forward earnings. Rival, Catamaran Corporation (NASDAQ:CTRX) trades 20.4 times and CVS Caremark (NYSE:CVS) trade 15.4 times.
Collectively, with the generic trends combined with its relatively low valuation, ESRX is in the best position to outperform the group in 2014. The stock has gained 33 percent in the last year and traded between $53.05 and $73.44 during the past 52-weeks.
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