For those who play chess, you know that well-thought-out strategic moves yield huge payouts down the road. David Stevens, chairman and CEO of the specialty contract pharmacy firm Accredo Health
The pharmacy services industry seems to be filled with excellent companies that thrive on rapid growth. However, each has come up with different concoctions to sustain the fast pace. The huge drugstore retailers such as CVS
CVS just gained an advantage in this war by receiving approval by the FTC to buy J.C. Penney's
When faced with all of this rapid expansion within the industry, Accredo has no choice but to try to outperform its peers. However, it has a different growth formula in mind: Accredo plans to increase its market share through product growth and acquisitions.
Asking the right questions
Anytime a company's growth strategy is to acquire other businesses, we Fools usually tend to sniff out other opportunities for our investment dollars to work. General Fool rule: Grow your own operations -- don't buy someone else's. That is often the right choice; however, it deserves further questioning as to why management chose this strategy.
In some cases, you'll find that the company simply doesn't manage money well, so it gives its dollars to other management teams through an acquisition in hopes to grow the money faster. In this scenario, Foolish investors should walk away. After all, if management can't manage money, then why would you give it yours?
On the other hand, well-thought-out acquisitions can sometimes be the appropriate move to grow earnings for the shareholders. Since 2000, Accredo has kept a smile on its shareholders' faces -- through a brutal bear market -- due to six well-planned acquisitions. Let's look at Accredo's past couple of buyouts and determine whether this strategy is in the shareholders' best interests. It is simply a matter of asking a few crucial, yet simple, questions.
Is the strategy sound?
Accredo Health provides pharmacy services for the treatment of costly chronic diseases. It is forced to focus on small patient populations and a limited number of complex and pricey drugs. Shareholders simply can't rely on the increasing population of patients with hemophilia (33% of Accredo's revenues) for growth, so management must seek broader market share through the acquisitions of other companies.
Last fall, Accredo purchased certain assets of Baxter's
Is management focused?
Tom Gardner likes to see focused management teams when seeking out picks for Hidden Gems. Is it possible for management to be focused on its own operations, yet still justify buying other companies?
Let's take the example given above. Accredo's sales generated from its hemophilia products represent 33% of its annual revenues. By acquiring assets from a company such as ATS -- which serves hemophiliacs -- Accredo was able to add significantly more market share in this product line. Now it has a larger clientele to focus a third of its business on, which should benefit shareholders tremendously.
What are the benefits?
If you come out of an acquisition and haven't gained an edge over competition, then what have you really accomplished besides burning cash? On June 4, Accredo announced its newest target, Hemophilia Resources of America (HRA). HRA is the leading private provider of hemophilia products, and it generated $84 million in revenues in 2003.
Management expects this purchase to immediately add to Accredo's bottom line. By quickly engulfing HRA, it will be in excellent shape to concentrate on new and existing hemophilia products and revenues. Once this deal is completed in early September, Accredo will certainly have a distinct advantage over other hemophilia providers. Shareholders should look for rapid growth in this line of the company's business in years to come.
Accredo's growth outlook
Accredo Health seems to be on the right track to increasing earnings, and its growth strategy is proving to be warranted. In February, the company announced that it signed a long-term contract with Medco Health Solutions
In January, the company was a much better buy than it is today. Its shares have returned nearly 19% this year vs. only 1.5% by the S&P 500. However, over the long term, these shares still offer attractive growth potential. Accredo is expected to grow earnings nearly 20% year over year and is currently trading at a P/E of 24.
The Fool Ratio of 1.20 suggests that the market has put a premium on these growing expectations. Price to free cash flow of nearly 30 suggests the same, but a closer look at the cash flow statements shows a company that has been able to grow its FCF at an astounding rate over the past five years -- nearly 75% annually.
Shareholders shouldn't expect to continue to see that kind of growth in the future, but should look for it to begin leveling off at a respectable 25% to 30% annual growth of cash flows.
This is great for Accredo's growth strategy -- rather than the company asking a bank for help, it can fuel future acquisitions with its increasing cash flows. Accredo hasn't had to look to the bank too much in the past, as its balance sheet is in excellent shape, with debt to equity lower than and liquidity ratios higher than the industry norms.
I'd never suggest paying too much for a company. (In fact, I'd never say pay too much for anything -- my wife can attest to that.) Currently, Accredo seems to be slightly ahead of itself from a valuation standpoint.
Still, a slight pullback to a share price of $33 to $34 could be an excellent opportunity to jump right into an excellent growth company. So keep your eyes peeled, and watch what Accredo's next move is. One of these days, we might just hear Accredo say "checkmate."