If you owned shares in Express Scripts (NASDAQ: ESRX), you were sitting pretty by November of 2012. The stock was up around 34% for the year. Things were great. Then the company's CEO, George Paz, began talking down the company's prospects for 2013. That 34% gain sunk to 9% before you could spell PBM.
While Express Scripts shares have slowly crept back somewhat, they're still not close to the previous highs. Will the factors that turbocharged the stock for much of 2012 carry over to 2013, or is the pessimistic outlook justified? Here are three reasons why this year might be better than the company expects.
1. Great economies of scale from 2012 will be even greater in 2013.
Nothing made a bigger splash for Express Scripts in 2012 than the acquisition of rival Medco. The combination of the two companies created the No. 1 pharmacy benefit manager, or PBM, in the U.S. with a 40% total market share. The merger also resulted in Express Scripts becoming the third-largest pharmacy in the U.S., thanks to joining the mail-order businesses of the two separate organizations.
The economies of scale that Express Scripts now has after the Medco deal help the company in multiple ways. For example, it can drive down costs of processing-intensive operations. Just as importantly, Express Scripts can use its leverage to get better deals from pharmaceutical companies and pharmacy chains.
Because the acquisition of Medco wasn't finalized until April, all of the synergies and economies of scale weren't realized in 2012. Express Scripts should feel the impact from these positive benefits more this year than last year.
2. Success in controlling drug costs in 2012 will carry over to 2013.
One big factor for Express Scripts' success in 2012 was increased generic utilization. The company boosted its generic fill rate from 74% in the third quarter of 2011 to 78% in the same period of 2012. That tremendous improvement helped Express Scripts increase pro forma earnings by 62% year-on-year for the first nine months of 2012.
Although the number of new generics hitting the market will drop in 2013, Express Scripts should be able to continue its positive momentum in controlling drug costs. Despite its improvement in 2012, Express Scripts' generic utilization rate still lags behind rivals. CVS Caremark (NYSE: CVS) reported third-quarter generic utilization of 79.3%. UnitedHealth Group's (NYSE: UNH) OptumRx and Catamaran (NASDAQ: CTRX) boasted even higher figures at 80% and 81.8%, respectively. Just catching up to CVS Caremark would help Express Scripts' bottom line.
The economies of scale mentioned in the first point above should also enable Express Scripts to control drug costs more effectively. With the large mail-order pharmacy obtained from the Medco acquisition, the company should be able to steer many patients with maintenance medications from retail pharmacies to less-expensive direct mail delivery.
3. Expectations lowered in 2012 will be easier to beat in 2013.
George Paz stated in November 2012 that customers don't expect to ramp up hiring and had "unprecedented concerns" about the economy. He cautioned against being too optimistic for 2013.
Paz and Express Scripts' customers were probably right. The impact on the economy of multiple new taxes could hinder growth. Every employee's payroll taxes will go up this year, while higher-income earners will see tax rates increase. Then there's Obamacare, which includes a new medical device tax, surtax on investment income, higher Medicare tax, and assorted other tax changes that mean less money in businesses' and consumers' wallets.
Maybe these businesses will hire more despite having hits to their bottom lines due to higher taxes. Maybe consumers will buy more goods and services that spur employers to hire even though they have less money out of each paycheck to spend. Express Scripts isn't counting on those scenarios occurring, though.
Express Scripts shares have these concerns baked into the price, though, because Paz already warned about these headwinds. Lowered expectations are easier to beat. One factor that could help Express Scripts beat those expectations might even stem from Obamacare. The company's largest customer, WellPoint (NYSE: WLP) stands to benefit from higher Medicaid enrollment and more individuals purchasing insurance.
Room to zoom
The gloomy outlook for 2013 given by Express Scripts a few months ago could be on target. However, the company stated that it still expects to grow in the face of these challenges. If the economy is just a little better than expected in 2013, Express Scripts shares should do quite well.
Even if the economy is as bad as predicted, Express Scripts looks to be a good long-term pick in my view. With its scale and a continued need for government and employers to control drug costs, the company is positioned for sustained success. Whether 2013 brings a boom or gloom, over the long run Express Scripts has room to zoom.
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