Dilemmas present great opportunities for investors. Consider one huge dilemma in the U.S. healthcare system: Prescription drug costs are rising while there's intense pressure to keep healthcare costs down. What's the investing opportunity here? Pharmacy benefit manager (PBM) stocks.
Pharmacy benefit managers' main purpose for existence is to control prescription drug costs. They negotiate favorable prices with drugmakers and encourage members to use the most cost-effective prescription drugs. These efforts save money for PBM customers, including employers and health plans. If you're looking for ways to profit over the next decade from the prescription drug cost dilemma, here are three pharmacy benefit manager stocks you should definitely watch.
1. Express Scripts (NASDAQ:ESRX)
Express Scripts stands out as the biggest (and arguably the best) pure-play PBM. The company generated over $100 billion in revenue last year, with over $2 billion of that total hitting the bottom line. Express Scripts' claim to the No. 1 spot in terms of size is directly linked to why this is likely the best PBM stock around.
Which PBM is more likely to win the most favorable price concessions from a pharmaceutical company -- the largest PBM or a smaller rival? That's an easy question to answer, of course. A PBM that commands larger volume can demand a lower price. Express Scripts proved this in a highly public way in late 2014 in its deal with AbbVie to lower the skyrocketing costs of hepatitis C drugs for its customers. Expect the giant PBM to wage a similar battle in the near future over a new class of potentially pricey cholesterol drugs.
Express Scripts' scale also helps on another front -- getting patients to help control costs by choosing less expensive drugs and adhering to prescription regimens. The company continues to use its resources to develop innovative programs to accomplish this goal, including a mobile app that allows patients to manage their medications wherever they go.
Probably the biggest knock on Express Scripts is its debt load of more than $12 billion. This debt is a by-product of a series of acquisitions over the last few years. However, Express Scripts should be able to comfortably service this debt with its cash flow. The company could also face some short-term uncertainty from health insurer mergers and acquisitions, but I think Express Scripts is a solid pick over the long run.
2. UnitedHealth Group (NYSE:UHS)
You might be saying to yourself, "Wait a second. Isn't UnitedHealth an insurance company?" Yes, it is. But it's also a rapidly growing PBM with its OptumRx business unit.
That growth kicked into overdrive earlier this year when UnitedHealth announced it was buying Catamaran (NASDAQ: CTRX), the fourth-largest PBM in the country. Once the acquisition is finalized, Catamaran will fold into OptumRx. The combination should bring some of the advantages of larger scale to OptumRx and solidify its position as the No. 3 PBM in the U.S.Once Catamaran is assimilated, the PBM services should make up around 40% of total revenue for UnitedHealth.
There is a potential risk that some customers could be lost during the transition. Over the longer stretch, Catamaran customers that are competitors to UnitedHealth could also look elsewhere as their contracts expire. However, I think that UnitedHealth remains a good healthcare stock for investors to consider -- with OptumRx's pickup of Catamaran making the stock even more attractive over the long run.
3. CVS Health (NYSE:CVS)
When most people think about CVS, drugstores come to mind. That's understandable, since CVS Health is the country's second-largest pharmacy retailer. However, it's also the second-largest PBM in the U.S. -- and that PBM business actually brings in more revenue than the retail pharmacy segment does.
CVS Health joined the buyout wave in May with its announced plan to buy long term care pharmacy services provider Omnicare. CVS is counting on the increasing numbers of aging Americans moving into senior living facilities as a significant growth opportunity for its PBM business.
Even without the Omnicare deal, pharmacy services has proven to be the main driver for CVS Health's earnings growth lately. In the first quarter, CVS' retail pharmacy segment experienced a decrease in year-over-year gross profit while pharmacy services gross profit increased nearly 15% compared to the first quarter of 2014.
Analysts expect CVS Health's earnings to grow more than twice as fast as that of the S&P 500 over the next five years. I suspect those projections will prove to be fairly accurate, in large part due to the company's PBM business.
Playing the field
Investors don't have to fret over which PBM stock is the best to choose. It's probably not a bad idea to consider picking up shares of each of these stocks.
All of them will benefit from the demographic trends that should push demand for healthcare services higher. Express Scripts will likely continue to be the best pure-play PBM stock around. UnitedHealth gives investors exposure to both a top PBM and health insurer. CVS Health brings a growing PBM and solid pharmacy retail mix to the table. When it comes to finding good PBM stocks, there's no dilemma at all.