Express Scripts Looks Undervalued In A Very Hot Sector

Summary

• The company's shares have fallen by more than 10% since the Anthem fallout was announced.
• Express Scripts will bounce back. Its competitive advantages are too strong.
• The biotech sector looks like it has very little resistance ahead. Express Scripts will ultimately rally with the sector.

Express Scripts (NASDAQ:NASDAQ:ESRX) continues to underperform both the market and the biotech sector which may mean we have a ripe opportunity brewing. Even Gilead (NYSE:GILD) which had underperformed the biotech sector for up to 20 months finally seems to have found a bottom due to the strong biotech tailwind we have had since the start of the year. In fact, the iShares Nasdaq Biotechnology Index (NASDAQ:IBB) is now up 17% year to date. I just fail to see how Express Scripts will continue to fall in the face of broad market strength in general, which continues to demonstrate strong M&A activity. Being the biggest pharmacy benefit manager in the US, Express Scripts holds significant competitive advantages over its competitors - advantages I believe will stand the test of time.

To name but a few would be the company's vast scale on the provider's end (where the company can leverage its scale to ensure competitive pricing from drug providers). This advantage can then be transferred over to the customer side where the customer can save on prescription costs. This has to lead to more customers over time. We are already long McKesson Corporation (NYSE:MCK) on the distribution side in this sector, again primarily due to current undervaluation and scale advantages. McKesson, however, is well off its lows but shares of Express Scripts are still hovering around the $60 level. I believe the divergence of Express Scripts against the biotech market in general will come to an end pretty soon. Here are some reasons why.

Express Scripts, as the chart illustrates above, has been in a steady downturn since mid-2015. Although the biotech sector also dropped sharply from mid-2015 on, the sector has actually been making higher highs since June of last year. Furthermore on the biotech chart, there seems to be very little resistance until the $340 level as the sector seems to have finally broken through the psychological $300 level as a result of the leaked draft Senate bill.

This means that there is a very good chance that the $59.26 level Express Scripts printed last May should hold. Biotech looks like it is going to continue to rally and sentiment in the Express Scripts remains near its annual lows. Many times, earnings reports (Express Scripts will announce in 13 days' time) usually end up rallying quality undervalued stocks back up to more normal valuations. Therefore, when you combine Express Scripts' low earnings multiple of 11.28 (five-year average of 27.9), upcoming earnings numbers along with an expected rally in biotech stocks, now may be a good time to get long Express Scripts.

Source: Sentimentrader.com

The impending loss of Anthem's business has undoubtedly been the reason why the shares are currently trading in the low $60s. In fact, prior to the announcement back in April when CEO Tim Wentworth stated that it was more than likely that Anthem's contract would terminate in late 2019, shares were trading north of $67. However, I would recommend that investors (even with the recent turbulence shares have experienced) keep looking at the long-term picture to avoid getting sidetracked by short-term movements. Firstly, Tim Wentworth has almost three years to pivot here and build new relationships. Yes, he will have to deal with over $17 billion being taken from top line revenues but he has time on his side.

Remember, when many investors thought it was game over for American Express (NYSE:AXP) after the Costco (NYSE:COST) fallout? Secondly, analysts don't seem to be particularly perturbed with how the Anthem loss will affect the bottom line as they are maintaining their expectations that the company will grow earnings by over 12% on an annualized basis over the next five years. Yes, Anthem is a big client but Express Scripts has a proven retention rate which currently is around 98%. History demonstrates that clients for the most part are reluctant to leave.

The S&P 500 broke 2,440 which was an important technical trend line. If we get follow through tomorrow, it would look likely that new highs are almost a certainty as we approach the next FOMC meeting. Express Scripts remains at the top of my watch list.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ESRX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.