By Marc Lichtenfeld
Years ago, Nancy Reagan implored us to “Just Say No” to drugs. But Americans can’t get enough of them.
Of course, the former First Lady was warning America’s youth about the dangers of illegal street drugs, not everyday pharmaceuticals like blood pressure medication and anti-inflammatories.
According to IMS Health, Americans are expected to fill 3% to 5% more prescriptions in 2011, about the same growth rate as 2010.
As a result, there are enormous profit opportunities for the companies involved in those transactions – from the drug manufacturers to those that manage and fill prescriptions…
Why “PBM” Equals Profits in the New Healthcare Sector
As contentious as healthcare reform is, one thing we can all agree on is that it does little to contain costs. So companies that do manage to lower healthcare costs for their clients will be richly rewarded.
That’s why I’m a big fan of the Pharmacy Benefits Management (NYSEMKT:PBM) sector.
These companies fill hundreds of millions of prescriptions per year, which enables them to buy drugs at a discount and pass the savings on to their customers – insurance companies and employers.
In addition, the “patent cliff,” will boost the PBMs margins. To refresh your memory, this term describes the exclusive patent expiration of many brand-name blockbuster drugs over the next few years. For example, Pfizer’s (NYSE: PFE) Lipitor will lose its patent later this year.
This is a major boost for PBMs, as generic drugs have higher margins than branded drugs, so the shift to generics will increase earnings. With Lipitor, for example, a patient will still get his cholesterol medicine and will probably continue to get it from the same place. All that changes is that the PBM will make more money filling that prescription.
So which stocks should do well in this environment?
The Standout Medicine-Delivery Performer
My favorite name in the group is Express Scripts (Nasdaq: ESRX).
In 2011, the company is expected to fill roughly 750 million prescriptions, with earnings expected to jump by 29% as a result. That’s on top of a 40% surge in 2010.
In addition, it already has a contract with WellPoint (NYSE: WLP) – the largest health insurer in the country – and a recent acquisition will not only add more revenue, but also eliminate about $1 billion in costs for the company as a result.
As for the shares, they’re currently trading at a forward P/E ratio of 18.1 – a discount to its historical average of 19.6. If the stock simply trades at its historical average, it indicates that shares would climb from a current price of $58.40 to $63.
Here’s another potential winner – and one to avoid…
As I mentioned, PBMs will see their earnings rise as a result of the patent cliff and more generic drugs on the market. And that should also bode well for MedcoHealth Solutions (NYSE: MHS).
The company is expected to fill 975 million prescriptions in 2011 and already claims $1.4 billion in new business for the year.
Like Express Scripts, Medco is also trading at a discount, going for 16 times its projected 2011 earnings. That’s below its historical average of 18.6 and a move back to its historical average suggests a share price of over $75.
In addition to its PBM and retail pharmacy, CVS relies on customers buying things like toothpaste, shampoo and holiday items. Those sales are very dependent on the mood of the consumer. Many shoppers prefer to buy those items in discount stores like Wal-Mart (NYSE: WMT) or Costco (Nasdaq: COST).
So while its medicine-delivery business should stay strong, the retail component makes it unattractive.
The companies that can cut costs from the healthcare system are at the very beginning of a very profitable trend. Healthcare reform, generic drugs and the need to lower costs should ensure that the PBMs and their investors are successful for years to come.
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