Medco: Earnings Preview

Jul.21.10 | About: Medco Health (MHS)

Medco Health Solutions Inc. (NYSE:MHS) is scheduled to release its second-quarter 2010 earnings on July 22, 2010. The Zacks Consensus Estimate for the quarter is 79 cents per share, representing a year-over-year growth of 14.4%.

Along with the first-quarter results, Medco reaffirmed its 2010 outlook, which represents robust growth over 2009. Adjusted earnings per share guidance are expected to be in the range of $3.28 to $3.38, an increase of 16%–19% year over year. The company expects mail order prescription volume to be in the range of $107 million–$109 million, largely driven by generics, with mail penetration at new accounts at about 25%.

Previous Quarter Highlights

Medco reported first quarter 2010 earnings of 73 cents per share that surpassed both the Zacks Consensus Estimate of 72 cents and year-ago quarter’s 63 cents. However, including certain non-recurring items, the company’s EPS came in at 67 cents compared with 58 cents in the first quarter of 2009.

Total revenue increased 10% year over year to $16.3 billion, primarily driven by contributions from significant new client wins as well as price inflation on brand-name drugs, partially offset by higher volumes of lower-priced generic drugs.

Medco’s specialty pharmacy segment’s (Accredo Health) sales increased 17.1% year over year to $2.7 billion due to a significant addition of new clients and organic growth. In addition, out of $16.1 billion of net product revenues, retail products (constituting 50% of revenues) accounted for $10 billion with mail-order products accounting for the rest. Both retail and mail order products recorded an increase of 10% and 10.1% year over year, respectively.

Agreement of Analysts

Estimate revision trends among the analysts reflect a negative bias for the company’s earnings in the June quarter. Over the last 30 days, 2 of the 26 analysts covering the stock have pulled down the estimates for the quarter ended June and 1 has made a downward revision over the last 7 days. None of the analysts made an upward revision over the last 30 days.

We note that for the third quarter, only 1 analyst out of 26 has increased the estimate in the 30 days. The Zacks Consensus Estimate for the third quarter is 89 cents per share. There seems to be negative opinion hovering for fiscal 2010, as 3 of the total 28 decreased their estimate in the last 30 and 1 analyst decreased the estimate in the last 7 days. None of the analysts increased the estimate in the last 30 days.

The bearish sentiment for the upcoming quarter reflects the macro concerns emanating from the pricing pressures that the companies face in the PBM (pharmacy benefit management) marketplace. There has been some concern regarding CVS Caremark’s potential for aggressive pricing, which is very vital for growth in the PBM in 2010 following a number of losses in 2009.

Magnitude of Estimate Revisions

The magnitude of revisions is moderate following the first-quarter results. Overall, estimates for the second quarter have gone down from 80 cents to the current level of 79 cents per share in the last 90 days. For fiscal 2010, estimates increased by a penny to $3.36 per share over the past 3 months. A similar trend can be seen for 2011, with estimates going up by a penny to $4.00 in the last 90 days.


Surprise

Going by past trends, we expect Medco to exceed estimates. The company’s reported earnings per share did not miss its expectations in any of the previous quarters and has a positive four-quarter average of 3.63%. This implies that on average, Medco has topped the Zacks Consensus Estimate by 3.63% over the last four quarters.

Our Recommendation

We believe Medco is well positioned to capitalize on inherent sector tailwinds such as increasing prescription trends, a mix shift toward mail order distribution, the aging of the baby boomers, and significant brand-name drug patent expirations over the next few years. In addition, the company’s acquisition of Accredo Health made it a major player in the high-growth specialty market. However, we remain concerned about the pricing pressures faced by the company in the PBM industry.

We currently have a Neutral recommendation on the stock, which corresponds to the Zacks #3 Rank (Hold).