Why Investors Hate Express Scripts Q3 Earnings

We heard it through the grapevine -- and the grapes might be souring. That's the song from pharmacy benefits manager Express Scripts (NASDAQ: ESRX  ) . The company is hearing concerns from customers that don't bode well for 2013.

While Express Scripts reported solid results from the third quarter, its gloomy outlook for next year overshadowed the good numbers. Shares opened 11% down from the previous close.

Looking back
The view from the rearview mirror presents a pretty good picture for Express Scripts. Several of the improved numbers stem directly from the acquisition of Medco. Gross profit increased to $2.2 billion, up 153% from the third quarter of 2011. EBITDA jumped 136% to $1.6 billion. 

Net income increased from $324.7 million in the third quarter of 2011 to $391.4 million for the same period this year. However, diluted earnings per share fell from $0.66 in the third quarter of 2011 to $0.47 because of share dilution. 

As a result of the solid quarterly performance, Express Scripts tightened its 2012 full-year earnings guidance from $3.60-$3.75 per share to $3.65-$3.75 per share. The company attributed the outlook change partially to achieving synergies from the Medco acquisition more quickly than initially projected.

Looking forward
Beyond next quarter, though, Express Scripts doesn't have as rosy of an outlook. One factor is that the company is losing UnitedHealth Group (NYSE: UNH  ) as a customer. The insurer announced in July 2011 that it would not renew with Medco.

The bigger issue, though, is at a macroeconomic level. Chairman and CEO George Paz stated that many of the company's clients have "unprecedented concerns" about the country's economic outlook. According to Paz, health plans expect reduced membership next year as large employers pull back from hiring. Because of these uncertainties, Express Scripts believes that the current estimates for the company's 2013 earnings are "overly aggressive." 

Paz was questioned during the company's earnings conference call about why other PBMs are not announcing similar concerns about next year. For example, CVS Caremark (NYSE: CVS  ) announced solid third-quarter earnings without any reference to gloomy days ahead. The same was true for Catamaran (NASDAQ: CTRX  ) . He responded to the question by simply noting that the company has a diverse customer base and that he is only reporting what Express Scripts' clients are saying.

Looking for answers
Is Express Scripts encountering headwinds that others aren't? Is the company merely being overly pessimistic? Or could it be that George Paz is speaking up and telling the truth when others are choosing to not talk about future challenges?

Even though UnitedHealth is taking its business elsewhere, the company's comments seem to confirm the message delivered by Express Scripts. UnitedHealth's CEO Stephen Hemsley expressed caution about 2013 earnings due in part to "the weak business climate and employment outlook in the United States."

It seems unlikely that other insurers and other PBMs won't face the same macroeconomic headwinds that Express Scripts and UnitedHealth will face. My inclination is to believe what George Paz is hearing from clients. If the grapevine is right, it might be best for investors to stay away from these particular vineyards. 

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