Unemployment is rampant. The housing market is still in the toilet. The stock market has recovered a little, but there's still pessimism in the air.
It's a beautiful time to be a pharmacy benefit manager (PBM), since that business model essentially results in them making more money when their customers save money.
You mean like a drug store?
Not exactly. Pharmacy benefit managers are hired by employers and health insurers to keep track of drug benefits for the employees and members. They're the middlemen tasked with keeping costs down -- by encouraging the use of generics, for instance -- thus saving money for their customers. Because the PBMs make more money off generic drugs, and the end users -- employees and HMO members -- save money too, it's really a win-win.
Pharmacy benefit managers also supply mail-order drugs, so they're like a pharmacy without the high overhead and the need to hock overpriced milk. By keeping costs down they can provide drugs at a cheaper price than pharmacies. And everyone likes saving some dough these days.
Looking good
Both Medco Health Solutions (NYSE: MHS ) and Express Scripts (Nasdaq: ESRX ) released earnings yesterday, and the generic fill rates look better than ever.
| |
2007
|
2008
|
2009 Year-to-Date
|
|
Medco
|
59.7%
|
64.1%
|
67.1%
|
|
Express Scripts
|
61.8%
|
66.1%
|
67.8%
|
Source: Company press releases.
The increased use of generic drugs helped push up earnings in the second quarter. Earnings per share at Medco were up 25.5% and Express Scripts registered a 16% increase in EPS excluding the cost of an acquisition. Both also increased their yearly EPS guidance.
CVS Caremark (NYSE: CVS ) (a combination benefit manager/pharmacy) reports next week, and I imagine we will see the same trend -- at least for the pharmacy benefit management part of the business.
Bigger is better
Just like Costco (Nasdaq: COST ) , the pharmacy benefit management business is all about volume. Increasing the number of prescriptions filled helps bump up margins and therefore earnings.
Earlier this year, Express Scripts announced that it was buying WellPoint's (NYSE: WLP ) NextRx pharmaceutical benefit management subsidiaries. The deal came with a 10-year contract to provide pharmacy benefit management to the insurer.
In the short term, it’s a good move for WellPoint. Right now, pharmacy benefit managers are priced at a considerable premium compared to health insurers, so the company can realize substantial value by selling its pharmacy benefit division. That's likely the reason that Aetna (NYSE: AET ) is reportedly shopping its pharmacy benefit management division and we might see other insurers, like UnitedHealth Group (NYSE: UNH ) , put theirs on the auction block.
But in the long term, I'm not sure it's the best move. Insurers typically don't break out the earnings for their pharmacy benefit management business, but presumably they're seeing the same kind of increase in profits as the standalone businesses. Unless they're getting outrageous multiples on the earnings, it might be best to hold on for the ride.
But what about when the recession is over?
True, the recession will end eventually, and then it may be a little harder for pharmacy benefit managers to keep people from wasting their extra cash on branded drugs.
But only a little. Once customers have a taste for saving money and the convenience of home delivery, they may not be interested in going back. Plus there's a wave of generic drugs coming soon, which may drive generic drug usage up further as patients using current blockbusters automatically get switched over to generics.
Medco and Express Scripts don’t look cheap right now, but their operational efficiencies have earned them the higher valuation multiples they sport. If they can continue to deliver growth that's far from generic, investors should continue to be rewarded.
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